The Olympics: Let's root for China

Government banking regulators have also put pressure on banks to tighten their lending in the mortgage market in an effort to avoid a U.S.-style financial meltdown like the one that sucked in Fannie Mae (FNM, news, msgs) and Freddie Mac (FRE, news, msgs).

It's not clear whether these policies have had much effect so far on inflation. Yes, it fell from 8.7% in February to 7.1% in June, but that may be quickly reversed if oil prices start to climb again. But it has had an effect on economic growth. The growth of China's economy, as measured by gross domestic product, has declined from 11.3% in the fourth quarter of 2007 to 10.6% in the first quarter of 2008 to 10.1% in the second quarter. Slower economic growth often translates into lower inflation, although the huge amount of short-term hot money currently flowing into the country may disrupt that connection.

Now, 10.1% may seem like great growth to anyone living in a U.S. economy struggling to get even 2% growth, but the drop is too much for what I'd call the growth party in China's government and business sectors. (To a great degree, those are one and the same in the Chinese economy.)

This faction has been increasingly vocal lately. Its arguments: The slowdown has gone too far. The government needs to prop up stock and real-estate prices. The central bank needs to do more to fight any appreciation in the yuan, since currency appreciation is pricing Chinese exports out of the market.

This group has won some victories, most noticeably the rollback of a tax on shares that temporarily supported stock prices, but for most of 2008, what I'd call the party of monetary discipline has won out.

Olympic Games as a showcase

That is where the Olympics come in. The games have created a huge outpouring of national pride in China. These aren't just an athletic competition but also a coming-out party for China as a Great Power.

It's hard to understand for anyone young enough to have seen only the resurgent China of the past 20 years or so, but this is a country that many Chinese see, with historical justification, as the victim of two centuries of exploitation by stronger Western and Asian countries.

Listen to the promise China's Olympic athletes made in a ceremony in Beijing unveiling the national team, according to the Web site Sohu.com: "For the glory of the motherland, I will, during the Beijing Olympics, doggedly struggle, summon all courage and energy to be first, compete with fairness and friendship, win without pride, and lose without losing spirit. We will achieve the twin goals of athletic success and civilized spirit, make a good showing for the nation's people and win honor for the motherland."

It's fair to say that for the hundreds of millions of Chinese, the stakes in these games are very high.

If China comes out of the games covered with the glory of 40 or more gold medals, the praise of foreign commentators for the organizational quality of the games, and the sense that the country put its best face forward and the world appreciated what the Chinese have accomplished, then you're looking at a country on an emotional high. Satisfaction with the Beijing government will soar. Worries about falling stock and house prices will seem petty in comparison to the national triumph. And the party of monetary discipline will stay in control of economic policy. The world can count on a China that is committed to modest measures to fight inflation, if not to slow growth appreciably from current levels, then at least not to try to push the pace significantly.

If China comes out of the games feeling disappointed in its athletes or, even worse, feeling the world somehow cheated the Chinese team out of its just medal count and then disrespected China and its effort in putting on these games, then the country heads into a funk.

The national government doesn't like funks. It recognizes the way a vague mood of dissatisfaction can grow into domestic unrest and political dissent. The government knows one tried and true method for ending a funk: more growth, which means more jobs, more stock market profits, more real-estate appreciation. If China comes out of the Olympics in a funk, the world should be prepared for China to rev up the ol' engine of growth and push back toward the 11% level of 2007.

Continued: Bubbly mood means no bubble

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