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.

Chinese labor disputes and consumption

The AP has a nice article on the recent labor disputes, in the context of the transition of Chinese economy.

Boosting wages fits in with Beijing’s strategy of closing the income gap and promoting more equal growth in coming years, said Liu Shanying, an analyst at the Chinese Academy of Social Sciences’ Institute of Political Science in Beijing.

“If incomes won’t go up, how can domestic demand be boosted? Strikes for better pay are very much in line with the big trend of Chinese economic development,” he said.

One reason behind the more assertive work force is a shifting job market since China pumped up its economy with massive stimulus spending to fend off the global recession. Manufacturing has begun to expand into the Chinese interior, leaving traditional industrial enclaves on the coast competing for labor and giving workers a stronger bargaining position.

Workers “have the upper hand, and also sense the government is trying to address inequalities, so the workers feel more comfortable in pushing for high wages,” said Lee. [Chang-Hee Lee, a specialist on industrial relations at the International Labour Organization’s Beijing office.]

As I said before, all these are part and parcel of China’s push to rebalance its economy geographically (away from the Eastern coast) and structurally (towards households and consumption). Therefore, China is going down the path of internal revaluation rather than external adjustment via the currency. As a result, we are going to see an explosion of Chinese consumption in the coming decade. But GDP is likely to be more moderated. There already have been discussions on the viability of the current 8% “minimum growth target”. Not that China needs that high a growth rate anymore, with less people entering the workforce due to changes in demographics.

Does this mean the recent change in currency regime is nothing but a hoax? Yes if you are an exporter competing against China. But for China, this is just a necessary step towards turning the RMB into a reserve currency in the future. With substantial internal revaluation and the elimination of many export subsidies, some punters are already calling the RMB overvalued. Li Dao-kui, a member of the Chinese Monetary Policy Committee, suggested that it would take the RMB 10-15 years to be fully convertible and competitive as a reserve currency.

Foxconn to relocate to inland China

Hong Kong media has reported that Foxconn is to close most of its Shenzhen (that’s the suicides factory located along the eastern coast) operations and relocate to factories more inland, like the one up north in Tianjin and to the southwest in Chongqing. There are also reports that it’s reviewing opportunities in India. So perhaps some operations will eventually move out of China all together.

Company spokesperson maintains that the relocation has been in planning for a long time, and is in accordance with Guangdong government’s plan to upgrade coastal industries. However, while the upgrade proposal has been out for two years, it’s only recently that Foxconn is seriously considering relocation. So this is clearly driven by increased costs along the coast. Wages at inland factories located in Tianjin and Wuhan, for example, are only half of that at Shenzhen.

This type of relocation will most likely be welcomed by the government (the central government anywayz. Not sure about that of Shenzhen) which is busy rebalancing the economy, both geographically and structurally. It also helps put a lid on coastal workers’ wage demand to less than explosive and hence more adaptable for the exporters.

Besides wage concern, China’s pending new trade agreement with Taiwan, which will eliminate most tariffs, prompt some Taiwanese companies ling Ting-Yi to consider relocating back to Taiwan to cut down on transportation costs to Southern China.

So all in, major shifts in economic make up is at hand right now.

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.