The Imperfect Storm

China's winter of discontent could have a chilling effect around the world. When the worst January storms in living memory hit southern China, paralyzing rail traffic, stranding tens of thousands of travelers, cutting off coal deliveries to power plants and producing widespread outages, Prime Minister Wen Jiabao went into crisis mode. He traveled last week to the center of the storm, the city of Changsha, to comfort travelers massed in its rail stations, and ordered authorities to restore transit and power services posthaste. Several days earlier, he issued a warning heard way beyond Changsha: 2008 will be "a most difficult year for the economy" due to "uncertainties" internationally and "new difficulties and contradictions" at home.

Wen's warning may kill the lingering hope that China can boom despite a U.S. slowdown, and grow fast enough to help prevent a nasty global slowdown. Talk of "uncertainties" had analysts wondering whether the era of double-digit Chinese growth may be coming to a close. In new forecasts, the World Bank and the United Nations project that global growth will slow to 3.4 percent this year, down from about 4 percent in 2007. Growth below 3 percent, economists concur, constitutes a global recession. The International Monetary Fund forecasts a bullish 4.1 to 4.4 percent in 2008, down from an estimated 4.9 percent in 2007. Still, IMF chief economist Simon Johnson says emerging markets like China would not be immune to a U.S.-led slump, adding, "Reports of decoupling have been greatly exaggerated."

Wen did not spell out the "new difficulties and contradictions" China faces at home, but the storm highlights more than a few candidates. Last week's gridlock exposed a rail system and provincial power grids taxed beyond their capacity. The fact that rail disruptions led to shutdowns on the power grid exposes a new vulnerability in China's reliance on coal for power. The crisis also shows how spotty price controls, which free stock and real-estate prices but cap energy prices, can backfire.

Beijing's ceiling on electricity tariffs, maintained to check inflation and aid energy-intensive heavy industries, contradicts its decision to deregulate coal prices last year. The result: the price of China's most abundant fuel has risen 17 percent since the start of 2008. Most coal-fired plants now operate at a loss, which may explain why the industry has been slow to respond to Beijing's calls for more juice since the storms began. The cutoff of power and supplies to energy-hungry industries like steel, automobiles, IT and aerospace is sure to have a big impact on economic growth. "Snow and ice may not be the result of poor government policies," argues South China Morning Post business commentater Tom Holland, "but the transport disruptions and power cuts that followed certainly are."

These contradictions are scaring investors away from China's stock market, which has fallen by a quarter since it peaked in October. The mainland's largest listed company, PetroChina, has lost 44 percent, or $400 billion in market value, since August, more than the total market value of Microsoft ($310 billion), Bloomberg calculates. "I see all the signs of a boom-bust cycle," says Robbert van Batenburg, head of research at the New York-based firm Louis Capital Markets, which is advising clients to sell China funds short. Van Batenburg says that since 2000 Chinese policymakers have boosted growth beyond their "wildest expectations," but the cheap money, export focus and unfettered capital investments utilized to achieve double-digit growth have become "negatives to the extent that they will ultimately crack the system." Chief among those threats, he says, are China's huge trade imbalance and soaring inflation.

Experts say a major policy shift could be in the offing, including lower interest rates and more public spending. Far from "decoupling," China looks set to follow the U.S. lead in crafting a rescue package to fight the downturn. More railways and airports will certainly be part of that spending mix, but they can't possibly be built soon enough for Wen Jiabao, who as prime minister and head of the State Council bears ultimate responsibility for Beijing's response to the storms. Addressing a tired throng at the Changsha rail station, he promised, "It will not be long before you can go home to celebrate the New Year." But millions would fail to make it home in time to ring in the Year of the Rat. The damage had been done.