Andy Xie: Inflation exported from the US will come back to haunt it

In an interview on Bloomberg, Andy Xie explains how US stimulus is causing inflation in emerging markets and how this will be re-exported back to the US via higher commodity prices.

Stimulus is prescribed as a panacea for recession. In today’s global economy, it isn’t effective in the best of circumstances and is outright wrong for what ails the West now.

Trade and foreign direct investment total half of global gross domestic product. Multinational corporations drive both. They shop around the world for the lowest-cost production centers and ship goods to wherever the demand is. Demand and supply are dislocated. So when a government introduces stimulus, the initial increase in demand doesn’t necessarily boost local supply. More importantly, if multinationals decide to invest somewhere else, there wouldn’t be an increase in jobs to sustain the growth in demand beyond the stimulus.

Before you scream traitors, please bear in mind it’s only natural that capital seeks growth, real growth that comes from either productivity or population growth. And within the developed economies, both are in short supply. Japan’s stagnation is NOT due to any policy failure or “stimulus not big enough”, but rather because it has seen both peak productivity and declining population.

Just as water flows down, stimulus affects low-cost economies more, wherever it is initiated. As the West pours money into the global economy through large fiscal deficits or central banks expanding balance sheets, the emerging economies are drowning in excess liquidity. Everything is turning red-hot.

These words are so true. I have blogged about wage increases in all kind of places before.

However, he then went on to explain how unemployment will not be able to check this imported inflation, and here’s where I disagree with him. While I do believe in imported inflation for the matured economies, I don’t think the workers in these economies are in a position to bargain for wage increases. Instead, inflation will have a double whammy on the average Joes as their assets prices and wages keep falling while everyday living expenses increase. The only spin you can put on this nightmarish scenario is that being squeezed on both sides, the painful adjustment will be quicker, or as Xie put:

The West must wait for the Wangs and the Gandhis to become rich enough so that they demand Western wages and spend like the Smiths and Gonzalezes.

It is a long and painful process for the West. And there is no way around it.

Wage hike…in N. Korea

Something interesting from the S. Korean Yonhap news agency: pay raise for N. Korean workers.

True, 5% wage hike isn’t much. But I think it highlights the problem of raging inflation throughout the developing economies. Only a few days ago, garment workers in Bangladesh protested violently over wage demands, despite an 80% pay rise. With soaring food prices, there’s no way to avoid further rises in wages.

What does this mean? First of all, exporters may be less inclined to leave China for other countries, as wages are rising across the board. More importantly, exporters will demand higher prices to compensate their rising costs. While individual exporter may have minimal pricing power in the global market, developing countries on the whole do have the power and inflation will be exported to the developed economies in the form of higher prices for consumer products. Yes, all that mountains of printed money is coming home to roost in the developed economies.

What about all that invincible deflationary force? It will be there too, QE2 or not. It’s just that inflation and deflation will occupy different sectors of the matured economies. A scenario from hell.

The real Chinese revaluation story

The media has been busy propagating and debunking the RMB revaluation story, but I think both narratives are off-target. Yes, China is having a significant revalution, just not with its currency.

Instead, China has chosen an aggressive program of internal revaluation, i.e. raising costs for the exporters internally, by inducing wage-led inflation, cutting export subsidies, and stiffening environmental regulations etc.

Most of the recent coverage of China’s labor disputes have focused on the workers’ being simply more demanding in sharing the spoils. But one should also note the subtle, and very important, support that the Chinese government is giving them. Besides rallying behind the workers in state media, labor activists have been allowed to organize freely (rare for China’s pro-capital government), so long that they train the target on wage demand only. Raising the minimum wage is also a cue for the workers that their action is being sanctioned by the state.

Why is China going this route instead of currency appreciation recommended by the developed economies? Well, this is simply a better way of adjustment for China. With currency appreciation, the losses to Chinese exporters become gains for exporters in other countries, i.e. a net loss of wealth for China. With internal revaluation, the benefits go towards Chinese workers, i.e. only a redistribution of wealth within China. This later approach also helps in building up a middle class and reorient the economy towards more consumption.

Another way to achieve internal revaluation is by cutting export subsidies. China has announced cutting export rebates on over 400 types of products deemed energy-intensive or polluting. This allows the government to target only industries deemed inefficient and force them to upgrade, and helps soothing trade relations with the West as a bonus.

The implementation of environmental regulations has also been tightened, to the benefits of future generations of Chinese. Again, this is an area that simple currency appreciation may not be as effective.

At the end of the day, although China has decided to bite the bullet and pony up for rebalancing its economy, it still seeks to minimize the costs and maximize the benefits. It’s just that their preferred method may not be the most desirable one from the POV of the developed economies.

Stagflation in China

A new research note from Wu Qing of the Development Research Center of the State Council, which is a key government think tank. I can’t find anything in English, so you’ll have to bear with my translation.

Chinese economy is moving from a temporary high growth, low inflation period towards stagflation. Economic data of May pretty much confirms this.

The inflation call is hardly surprising as many have noted that inflation is being transmitted downstream. What’s more interesting is the call of rapid slowdown of growth.

Since the major economies of Europe are not competitive in labor intensive products and the euro has depreciated against other currencies besides the RMB, Chinese exports to Europe may not suffer too much.

What could possibly impact Chinese exports is the rapidly escalating wages. …14 provinces and cites have hiked the minimum wage by an average of 20% this year, with 10 more to announce soon….

The IMF raised Chinese forecast GDP growth to 10% in April. However, Chinese economic growth is trending downwards, from 11.9% in Q1 to perhaps only 8% in Q4. Without new stimulus, growth may drop below 8% during the first two quarters of next year.

He sees inflation to peak in H2 this year but may lingers till early next year. Coupled with the expected slowdown in growth, China may see its first bout of stagflation in H1/2011.

The beginning of a new era

The labor unrest in China’s southern manufacturing hub has been finally resolved, with Honda raising wages by 35% and Foxconn by a whopping 66%, in addition to other benefits. These events are watershed moments as China has arrived a turning point where demographics and economic development work together to enable more power and profit sharing to labor. This is essential in gradually nudging China towards more consumption and a more balanced economy.

Of particular note is the attitude adopted by the official media which, despite being rather cautious in the beginning, eventually rallied behind the workers. Since wage-led inflation is congruent with China’s policy goal of re-balancing its economy, I expect more industrial actions going forward.

What does this mean? For starters, China will soon cease to be synonymous with low cost. There will also be more competitors for natural resources. Although China has been the leading commodities importer for a while, a significant part of those are being processed and exported. The rise of Chinese consumers create new demand, with direct consequence on pricing and availability of natural resources. As such, China will become an exporter of inflation to the rest of the world.