To some extent, inflation in China is a delayed result of the $586 billion stimulus packageBeijing announced in 2008. Following the initial onset of the global financial crisis, the People's Bank of China (PBC) embraced a period of loose monetary policy as a way to keep its economic engine running. Hailed as a success at the time -- and as a favor to the global economy -- the flood of money into the economy has led to increased domestic asset prices.

Another major part of China's inflation problem is the price of food, which increased more than 11 percent in the past year. While some of this increase has to do with changes in international food prices, much of China's problem is a function of increased agricultural wages. As has been pointed out elsewhere, the pull of higher wages in urban areas has left China with a depleted rural workforce. In some areas, this has led to a doubling of wages for farm laborers. Rising food costs indicate that these increased labor costs are being passed on to the Chinese consumer. 

Beijing's currency policy is also involved. By keeping the yuan undervalued, China improves its export position globally, enabling it to run a large trade surplus. This leaves Chinese exporters with a lot of foreign currency -- mostly dollars -- that they mustexchange for yuan for use in the domestic economy. As dollars are exchanged for yuan, the money supply in China increases, creating an inflationary environment. Maintaining an undervalued exchange rate only makes matters worse, since the PBC must pay out more yuan per dollar than it would if the currency were allowed to appreciate. 

For years, China has been managing this delicate situation by having banks, where most of the surplus yuan are stored, buy government bonds. This effectively mops up the excess currency from the economy, but the current bout of inflation shows the limits to this strategy. China is now putting even more pressure on banks to slow lending. Last week, banks were ordered for the sixth time this year to increase the amount of cash reserveskept on hand. And in late October, the PBC raised interest rates for the first time in nearly three years. 

So far, these measures have not been enough to curb rising prices, and the Chinese consumer is being forced to adjust accordingly. As noted, food prices have been especially impacted. Even more significant is the type of food affected, as pointed out by the Financial Times: In the previous round of significant Chinese inflation, in 2008, increases in food prices were concentrated in pork and other meats, which many Chinese citizens don't consume regularly. This time, rising food costs are being driven by increases in the price of vegetables -- a far more important part of the Chinese diet. 

This helps explain why a recent PBC survey reveals that only 14 percent of households are "satisfied" with current prices, the lowest level in more than a decade. Similarly, the Chinese Academy of Social Sciences just reported that Chinese citizens are becoming increasingly dissatisfied with their lives. Their biggest concern? Rising food costs. 

To make matters worse, the potential for a falling dollar in the near future could make all imported commodities that are priced in dollars, including many foodstuffs, even more costly for the cash-strapped Chinese consumer. 

Beijing clearly has to do something. But what? 

If food is at the heart of the problem, Beijing could aim to ramp up domestic food production. However, this is not a quick fix: New crops won't grow overnight, and reversing labor migration is difficult. Furthermore, China's "core inflation" rate -- a measure that excludes food and other goods that face volatile price swings -- has also been rising over the past several months, suggesting a deeper problem. 

The surest way to halt inflation would be to revalue the yuan. This would help to slow the growth of the money supply by reducing the country's trade surplus and cutting the flow of foreign exchange entering the economy. A revalued yuan would also directly translate into increased purchasing power for Chinese citizens. Since most of the food China buys from the world is priced in dollars, a stronger yuan would mean cheaper food imports while also reducing the consumer prices of other major commodities that are part of the inflation problem. 

A revalued yuan would be widely viewed as a positive development for the global economy since it would begin to help rebalance trade between China and the world. But despite the threat of inflation, Beijing seems as determined as ever to maintain currency stability. Late last week, the PBC's news arm stated, "Keeping basic stability of the yuan exchange rate at a reasonable and balanced level would be advantageous to multiple parties." Serious signs of domestic unrest could change this position, but for now Beijing is not willing to sacrifice industrial production fueled by the weak yuan to achieve price stability. 

That leaves interest-rate hikes as the most likely policy choice for Beijing in the coming months. Some experts have already begun predicting multiple rate increases on the horizon. Setting aside whether this would be sufficient to address inflation, it would put the brakes on the dynamic Chinese economy. As one of the few bright spots in the world economy, reduced growth in China would likely slow the already plodding global recovery. 

None of Beijing's options are free of trade-offs -- either for China or the world.

**Daniel McDowell is a Ph.D. candidate in International Relations at the University of Virginia, specializing in International Political Economy.