Suddenly China finds itself damned if it inflates, and damned as it deflates. After appearing to sail so effectively through the world financial crisis, China’s economy is at a major, difficult turning-point, requiring big shifts in policy emphasis, and acceptance of much slower growth for at least a few years.

The outward sign of its problems is the inflation that resulted in 2010-11 from 2009’s recovery policies. Yet the first quarter of this year saw the economy shift sharply back into a deflation that is worsening the current downswing.

China’s recovery entailed a massive money and credit expansion with top-down direction towards investment; and deliberate restraint of yuan appreciation against the dollar, keeping China undervalued, and therefore the US overvalued. Investment rose as a percent of GDP from 42 per cent in 2007 to 49 per cent in 2010 and 2011, and fixed-investment price inflation moved from minus 4 per cent in mid-2009 to 7 per cent by mid-2011. Undervaluation pushed export price inflation (in yuan) to 7 per cent by early 2011, and the corporate goods price index was rising at nearly 10 per cent last summer.