Marshall Auerback responds
Marshall Auerback responds to Rebecca’s “I have to side with China on this one”.
There’s another factor as well. There’s been an enormous increase in money and credit in the past year. In fact, it seems to be as great as 5 years’ growth in credit in the previous Chinese bubble. What happens is that the increase in money and credit is so great and so abrupt that you tend to get a high inflation quite quickly even if there are under utilised resources? Add to this the fact that you’ve got massive fiscal stimulus occurring today in China.
You have the makings of a very messy situation: if China seeks to sustain demand via fiscal policy, then you could get a big inflation problem, which could severely erode the tradeables sector. And you have all of these Chinese students all steeped in Chicago School monetary theory, coming home and taking over. So they might do a Paul Volcker to stop inflation.
But, what if the they don’t? Inflation can take off and thereby begin to ERODE the competitiveness of Chinese exports. This might be the real reason why China is so reticent to revalue its currency. The Americans might go crazy if the Chinese devalue, but if the inflation is high enough, they might have to do it, as it will severely erode their terms of trade and cause their tradeables sector to collapse.
Or you get the hard-line monetarists triumphing by fighting inflation and you get riots as unemployment increases.
It could get very ugly.
This could be happening now in China. Everybody says no. The consensus is that inflation is a couple per cent and it is all pork prices because there was a lousy corn harvest.
However, economists such as those at Lombard Street in the UK, Jim Walker, Simon Hunt and the like try to figure out the changes quarter to quarter in Chinese nominal GDP which is reported only year on year. And they come up with giant double digit growth rates for the second half of last year.
Now this is complicated by the fact that the Chinese have revised up their GDP numbers and they throw the revisions all into the final quarter of the year. But when these guys try to adjust for that statistical screw up they still come up with giant nominal GDP increases. Lombard Street thinks it was twenty five per cent or so in the second half of last year. They think it was twenty per cent real and five per cent inflation.
Economies never grow at a twenty per cent real rate. And Simon Hunt says if you look at proxies like power output and rail traffic you don’t get those kinds of numbers for real growth, which suggests that inflation must be higher than four or five per cent. Indeed, it could already be double digit. It is hard to say. But if it is double digit then the resultant inflation will cause a real revaluation of the trade weighted exchange rate.
And more so if the dollar rallies. That could well crush the volume of exports and the profitability of the industrial tradeables sector. Exports are the only area where China makes any kind of money because they can sell these products for about 10 times what they obtain for a comparable product in the domestic economy (where profits are virtually nil). The export sector is a big contributor to overall super excessive fixed investment in China. FDI will go to zero net.
There will be strong forces for a reduction in fixed investment in this large sector. Hence, there is a good chance that even without monetary tightening by the Chinese authorities, the overall fixed investment boom in China will turn down.
Nobody is thinking about this but it is a real possibility. And with fixed investment now at fifty per cent of gdp (which is unprecedented in any economy) and exports at more than thirty, we’re looking at ratios that have never been reached before on a combined basis turning these two down could create a severe recession in China. China has gone too far this time. I think they are in a box that they and others don’t recognize. The “Black Swan” event this year could well be a devaluation of the RMB.
by Marshall Auerback, posted by Rebecca Newsneconomics
The argument here needs to be made clearer. There is, for instance, no reason to think domestic consumer price inflation would lead to an erosion of China’s competitiveness in the tradables sector. To the extent that comsumer price inflation drives down real wages, it could help China’s competitiveness. That is, in fact, one prescription that is being offered for the fix in which Spain finds itself.
The rest of the argument seems to grow from this notion that inflation will lead to a deterioration of Chinese price competitiveness abroad. That very much depends on the nature of Chinese inflation. Wage-led inflation could do that, but nominal wages tend to be led by productivity and by by consumer prices. It would be helpful for Auerback to lay out the mechanism through which domestic inflation would erode Chinese competitiveness, rather than merely assert that it would be so.
A lot of questions popped into my mind — the first being whether the Chinese economic statistics we see bear much resemblance to the reality on the ground in China. It’s clear from all the construction, imports, and exports that the country has been growing rapidly for several decades. But still, it is a somewhat managed economy and to some extent, the same guys that manage it are the ones who collect and publish the statistics.
The second — and I think the same one the KHarris brings up — is how coupled the Chinese Currency is to the world economy. How much access do Chinese actually have to assets,products,etc originally priced in foreign currencies and vice versa. If the export/import economy operates in dollars/euros/etc, isn’t the affect of inflation and deflation in the renminbi likely to be much attenuated — at least for those of us who live elsewhere?
RE “if you look at proxies like power output and rail traffic you don’t get those kinds of numbers for real growth”
China January Power Use Gains 40% as Economy Recovers (Bloomberg) — China’s January electricity consumption jumped 40.1 percent from a year earlier as an economic recovery in the world’s second-biggest power producer spurred demand from factories.
There are a number of concerns with this argument as mentioned above…Auerbach tends to be an outlier on the issue.
Although I’d like him to be more explicit as well but a rapid inflation in producer prices which would result in rising prices of exports which would lessen competitiveness of their exports, isn’t that the obvious way
I think Aurback makes an interesting point. The amount of money the chinese gov has been pushing into the economy to make up for lost exports is staggering, something like a few trillion USD from what i’ve read. There is an expectation of a great deal of defaulted loans in a variety of sectors which is why the Chinese gov is raising reserve requirements and threatening to dissolve all municipal loan guarantees. There is a large bubble in chinese and asian real estate. There are large bubbles in many places caused by this rapid esclation in gov liquidity. This results in alot of poor asset allocatoin. All this liquidity is in the pipeline as is all liquidity from world fed banks. When world demand comes back and they begin to produce they will not be buffered from input prices inflation. The increase in prices stemming from input inflation will make their exports less competitive. China’s ponzi scheme will come crashing if exports don’t come back to 2007 levels, they don’t have strong domestic consumption and can’t keep this leve of stimulus up any longer. The US consumer isn’t coming back to 2007 levels for a decade or longer. China will be forced to take it on the chin and risk internal upheaval or will they devalue. Auerback’s point is interesting and well taken.