The great emerging market inflation of 2007 and 2008
In a recent FT oped on China, Ken Rogoff had a great one-liner:
“Those who think inflation is caused by too little pork rather than too much money are wrong.”
Replace pork – culturally inappropriate for many high-inflation emerging market economies – with a more culturally neutral food, and his statement captures the core debate in a host of emerging economies right now.
The Gulf, Russia, Argentina, Hong Kong, China and no doubt others are trying to determine whether the recent rise in inflation reflects a rise in commodity prices (fuel, food) or inappropriately loose monetary policies. Stephen King of HSBS isn’t as pithy as Dr. Rogoff, but he framed the issue quite nicely last week:
Broadly, there are two competing explanations for the rise in emerging market inflation. The first is what I’d call the “bad luck” explanation. Those living in emerging markets have, on average, lower per capita incomes than those who live in the developed world. Proportionately, more of their income is spent on basic items such as fuel and food. The prices of these “basics” tend to move around in volatile fashion in response to bad harvests, occasional wars or the onset of disease. As a result, inflation rates within emerging economies move up and down a lot more than their equivalents in the developed world. High inflation in one year could easily be followed by low inflation the next year.
The second explanation is monetary in nature. Inflation is rising because monetary conditions are simply too loose. And because people in emerging markets spend most of their income on the basics, it’s no great surprise that the prices of fuel, food and other essentials go up. This is not a case of bad luck. It is, instead, the outcome (perhaps unintended) of a series of earlier monetary policy decisions
Most of the high inflation emerging economies either peg to the dollar or intervene heavily to manage their exchange rate against the dollar.
Ben Bernanke though can not really be blamed the rise in inflation these economies.
No one forced the Saudis – just to pick an example — to peg to a depreciating dollar and cut domestic rates even as domestic Saudi inflation rose. The Saudis could have dropped their dollar peg. Bernanke’s mandate is to pursue policies that support price stability and employment in the US – not to balance the monetary policy the US needs with the monetary policy the rest of the dollar zone needs.
Right now Bernanke has his hands full with the US. Moreover, it is almost certainly the case that the monetary policy the US needs is quite different from the monetary policy the rest of the dollar zone needs. The Gulf clearly has decoupled from the US, and up until nowl, so has China.
As a result, China and the Gulf are importing a very expansionary US monetary policy at a time when their economies are growing rapidly and inflation rates are picking up.
Stephen King (HSBC) notes that inflation is the almost certain outcome in countries that peg to the dollar during a phase of catch-up and rapid productivity growth. Their real exchange rate needs to rise. If the exchange rate cannot appreciate, then inflation will shoot up.
What, though, if the authorities prevent the nominal exchange rate from rising? In these circumstances, the only other option, ultimately, is a rise in the so-called real exchange rate via a higher domestic inflation rate relative to inflation rates in other countries. Suppose, for example, that Chinese domestic prices and wages are rising 10 per cent per year whereas British prices and wages are rising at around 4 per cent per year. Under these circumstances, the Chinese worker’s buying power over the rest of the world’s output will be improving over time relative to the British worker’s (through Chinese eyes, British goods will appear cheaper and cheaper).
The US slowdown and associated series of rate cuts have just made the cost of dollar pegs a lot more visible now. And – as King notes – inflation tends to generate a lot of social and political strain.
rising inflation can easily lead to an unfair redistribution of income. Some will end up a lot better off. Others will be a lot worse off. The social tensions associated with this process can easily lead to political turmoil. Inevitably, politicians try to keep the lid on this pressure cooker by imposing price and wage controls, but then, of course, they’re heading straight back to the 1970s.
Even more developed parts of the dollar zone are felling to the strain.William Pesek doesn’t think a dollar peg still makes sense for Hong Kong. I agree.
Cutting rates in the face of rising inflation and rising home prices only fuels the current boom.
That is why I would add another risk to King’s list. A host of emerging economies are in effect adopting highly pro-cyclical policies right now.
In the Gulf, loose fiscal policy – spurred by strong commodity prices – has been combined with loose monetary policy and a weak exchange rate. All push the boom on. Tourism and property development are booming along with the petroleum sector. And rising inflation also creates pressure to loosen fiscal policy (why should living standard be falling when oil is high?) which only adds to inflationary pressures and pushes real rates down further. January inflation was up in Saudi Arabia. SAMA cut rates. Real rates moved into even more negative territory.
The Saudis have kept lending rates higher than deposit rates. But with inflation at 7% now and in my view set to rise toward 10% over the course of the year, the expected real lending rate is still quite negative. The underlying pace of growth in the money supply, even with Chinese style rising reserve requirements, remains quite fast.
And in China low – or negative – real interest rates (See Justin Lin) have fueled an investment boom and contributed to the enormous (though now stalled) run up in Chinese stock market prices, along with higher real estate prices. The rise in the stock market could in turn help support consumption (the classic wealth effect). And all this has happened even as an undervalued real exchange rate, especially an undervalued exchange rate relative to Europe, has supported the export sector. The boom in exports and investment has been highly correlated.
The risk of course is the pro-cyclical policies on the upside will be replaced by pro-cyclical policies on the downside, and the excesses of the boom will deepen the bust.
So in some deep sense, the question is whether the great emerging market inflation of 07 and 08 will be followed by a big emerging market bust in 09 or 10, a bust that will have its roots not in a collapse in external capital inflows but rather in the domestic excesses in the boom years?
58 Responses to “The great emerging market inflation of 2007 and 2008”
Why don’t you just read the data? The core inflation rate in China is about 1.5% in Jan, 2008, correct me if I remember the wrong numbers. Food and energy are the two behind the headline numbers. Pork and egg are the two behind the food numbers.
Food and energy also make up a large share of China’s consumption basket, and Chinese workers are starting to demand wages that offset the impact of rising prices. Headline CPI is around 7%; Pettis expects a similar number for February.
There is growing concern in China about changing inflation expectations, and the asset price implications of negative real interest rates (for depositors — who look at headline not “Core”)
According to Chinese statistics the January/January CPI was up 7.1%, non-food CPI was up 1.5%, food was up 18% (pork up 58%). Since food has a roughly 1/3 weight in the Chinese CPI, these numbers should be about right, (2*1.5+18)/3=7%. So, if the high Chinese inflation did not come from food, then how do you explain these numbers?
The fact is that there was a big fall in pork production in China last year, due mainly to the blue ear disease. The 2004/05/06/07/08 (08 is an estimate) pork meat production data in million tons are: 47/50.1/51.9/47/48 (just for comparison, the world production was 92.8/96.1/98.5/94.7/93 million tons). The pork consumption in China in these years was 46.6/49.7/51.5/46.7/47.7 million tons (08 is again the estimate of the USDA, the Chinese estimates for both the production and consumption in 2008 is a lot higher). So in 2007 production was roughly 7 million tons below potential demand. This is a huge number. Since there was not enough pork meat, and people had to eat something, the prices of the substitute food items also went up (7 million tons of pork meat is rougly the equivalent of 28 million tons of grain).
jin — The 1.5% was the non-food inflaion. It includs energy. Obviously, energy, especially gasoline, must be heavily subsidised in China.
Basically, subprime MBS bonds representing fictitious capital are being eliminated in market valuation. It is a travesty of economic justice that the Federal Reserve is printing and inflating the money supply in a vain attempt to bailout the Wall Street Hedge Funds laden with subprime debt holdings. In a repeat of the Long Term Capital Hedge fund fiasco, Fed Chairman Bernanke has been on the phone continually with Robert Rubin and other Hedge Fund managers who are on the record pleading for a federal taxpayer bailout. Acting as Robin Hood in reverse, the Federal Reserve’s inflationary monetary policies are stealing by stealth, the hard earned savings of the US middle class facing record food and energy inflation. The economies of the rest of the world have imported US inflation under the global dollar hegemony regime.
Brad, with the FED cutting, peg countries are clearly importing inflation through their trade imbalances. What is the inflation implication for the US, though, if they depeg or revalue? Greenspan was just in the Gulf, telling them to depeg. Do you expect any movement anytime soon?
Also, are you a Duncan (the dollar crisis) fan?
ac, thank you for your data.
Brad, we all know food accounts for a large part in China’s CPI and people look at headline CPI more often. My arguement is that this is precisely a food problem. If you are worried about the social unrest generated from higher pork price, you should not use tight monetary policy to decrease pork demand, which would embark a bigger unrest. The correct way is to increase meat supply.
Isn’t politics the reason the Saudis maintain their dollar peg?
Didn’t it used to be called petrodollar recycling?
Do you think that maintenance of the Saudi dollar peg has anything to do with Mr. Bush’s visit to the region?
What would dollar markets look like if the Saudis floated, i.e., absorbed fewer dollars?
And how long before they decide to float?
other countries can depeg, or other countries can keep their pegs and the US can stop debasing their currency and punish the criminals behind the subprime asset bubble- find the individuals who profited from the fraud and make them pay it back (e.g Chuck Prince, Paulson, etc.).
If we want to talk about real justice, and leave aside the concerns of our own personal countries, the latter solution is by far more equitable- the (world) masses are are bearing the brunt of this travesty of (American) greed. The bubble has burst.
As long as USD is world reserve currency, Bernanke has an obligation not to debase. The US became the most powerful country in the world precisely because it could randomly manipulate money supply in its own interests, and people still accepted it. It has a responsibility- otherwise, if you want to talk about being equitable, give back all the wealth that was created by this privilege.
Guest — the US has no such responsibility. In Bretton Woods 1 the US had a responsibility to maintain the dollar’s peg to gold. In Bretton Woods 2 foreign central banks built up dollar claims even though the US had made no similar commitment. and since they built up claims during a time when the dollar was weakening, they knew what they were getting into. a couple of academics (including yours truly) made those risks very clear in a couple of reasonably widely circulated papers.
AP Simkin — yes, politics seems to have played a role in the Saudis decision to hold fast to the dollar. but they seem to be signaling that they are open to a revaluation, just not a broader regime shift (i.e. a basket peg/ float, etc). I don’t think the current situation is viable. on the other hand the Saudis may be able to hold out for some time — those fighting pressure for a reval have demonstrated that they can hold out far longer than many think. at some level tho the domestic political costs of maintaining an inflationary dollar peg will be too large.
AC — My bet is that the rise in food prices will soon spillover; i am on Rogoff’s side of this debate, not Jon Anderson’s. China is supposedly holding domestic oil prices $20-30 below the world market price. it isn’t clear if that is sustainable. Of course, it is quite possible on this that I could be wrong, and China’s price pressures stem from a pig shortage, not an expansionary monetary policy.
Guest, speaking about Hank Paulson arranging for a federal taxpayer bailout at Goldman Sachs,
” Second, this is a shared responsibility of industry, government and homeowners. We in government are working to expand options through the FHA, and we’ve worked with the industry to reach as many homeowners as possible to let them know that help is available. There is more that government and industry can do, and our efforts will continue to evolve. ” – Hank Paulson
Translation: We are attempting to bail out the Wall Street banks, as much as possible, by shifting the risk to the FHA where US taxpayers will be expected to pick up most of the costs. Paulson and the banksters are showing no morals by asking for bailouts from taxpayers. Obviously, morality is a one way street for Paulson. Is it any wonder that everyone across Asia is trying to dump every US Dollar that they own for precious metals, and currencies with “sound” monetary policies.
THE GREAT EMERGING STAGFLATION OF 2008
U.S. dollar in the toilet and the great capitalists talk socialism. The blind leading the blind.
Bring on the AMERO maybe it it’ll be worth more than the paper it’s printed on.
THE GREAT EMERGING STAGFLATION OF 2008
U.S. dollar in the toilet and the great capitalists talk socialism. The blind leading the blind.
Bring on the AMERO maybe it it’ll be worth more than the paper it’s printed on.
The biggest threat to US economy is a stable Euro. With massive debt of over $55 trillion (source: http://www.truthin2008.org), the only way we can prevent a disaster is to make sure that there is no stable alternative to US$. The world has been our banker because of faith in US$ and this is why they have been lending money to us despite massive national debt. If a stable alternative currency such as Euro replaces US$, who is going to finance our debt laden high standard of living?
Written by NO to Euro on 2008-03-04 11:01:06
DC and Nick and No to Euro:
aren’t you just speaking to yourself, acting as if another…
after all look at the timing of your postings from first guest to last, you are waiting, hoping to pounce, wasting your and everyone else’s time. I wish I had your time, blogging all day…unemployed or employed for a purpose which might fall on deaf ears, ears made deaf by your restatement of perspective, lack of foresight, and self-serving diatribes. BW1, perhaps, BWII choice, surely great and sovereign states which you protect voraciously are big boys and understand the consequences of their actions, as do others, no one seems to complain when they are making money and things seem to go their way, yet as the Tao teaches, good and bad in everything.
If the Fed proposed tomorrow to fix the price of orange juice, everyone would think they were mad. Ironically, the vast majority sees nothing wrong with price fixing interest rates, even though it is clearly proven the Fed has no idea what it is doing. Consecutive bubble blowing is proof.
The sad thing in all of this is there is no need for guessing. We would not be in this mess if there was no Fed and there was no such thing as fractional reserve lending.
It’s time to eliminate interest rate and currency madness. The way to do that is to abolish the Fed specifically, central bankers in general, and fractional reserve lending right along with them. Sound money and sound monetary policy is the solution, not price fixing. Price fixing interest rates rates and currency manipulation got us into this mess, it will not get us out of it.
It’s actually not either/or. My personal view is that the current round of inflation is due to a food/fuel shock which is translated into prices via expansionary monetary policies.
One thing that makes this situation not a no-brainer for Chinese policy makers is that the current pattern of inflation (high food, low everything else) helps farmers, so there is less of a desire to slam on the brakes than there was in 2004. The danger is that the price rises will go into other goods if monetary policy is not changed.
We are about to see BWII crumble and looks like it is going to crumble in the same way that BWI crumbled.
DC: You are taking two positions that seem to be logically inconsistent. If inflation is due to pork and not monetary policy, then Bernanke is not responsible. If inflation is due to Bernanke, then the drop in pork production is irrelevant.
Guest: As long as USD is world reserve currency, Bernanke has an obligation not to debase.
Fact of the matter is that the Fed is a US government agency and whether people like it or not, it is going to do what it thinks is in the best interest of the United States, without too much thought about the consequences to the rest of the world.
This is why it is a bad idea to have another country run your monetary policy.
Guest: The US became the most powerful country in the world precisely because it could randomly manipulate money supply in its own interests, and people still accepted it. It has a responsibility- otherwise, if you want to talk about being equitable, give back all the wealth that was created by this privilege.
People and nations will act in their interest, and if you don’t expect that, then you are going to be living in some abstract dream world. Whether or not the US has some abstract responsibility to the rest of the world is totally irrelevant. The US has power, and it will use that power to do what is good for the US. It’s somewhat absurd to think that it will do otherwise.
DC: Obviously, morality is a one way street for Paulson.
It’s actually a one way street for pretty much everyone. Yes, the US and rich bankers are being self-serving, but does anyone think that Chinese bankers would be more well behaved than American bankers?
DC: Is it any wonder that everyone across Asia is trying to dump every US Dollar that they own for precious metals, and currencies with “sound” monetary policies.
Which causes a major problem for the PBC. When someone in China sells a dollar they are selling it to the People’s Bank of China who buys it at a rate that everything things is too high. At that point the PBC is sort of stuck. If it lets the dollar crash, then it wipes out its reserves. If it doesn’t let the dollar crash, then it just builds up more reserves that could crash later.
I really don’t quite understand why you are so giddy about the dollar crisis. If the dollar becomes worthless it’s going to take China down with it. If the dollar goes down 15-20%, China can absorb it. If the dollar does down 50%, China has an major economic crisis on its hands.
What are you talking about? I stated that the hard earned savings of the US middle class, facing record food and energy inflation, was eroding. What does that have to do with pork prices in China? Inflation in the US is purely a monetary problem and has everything to do with Bernanke’s “cheap money” policies. We are in this mess because of Federal Reserve policies that have purposely fostered inflation. We are now on the back side of a credit bubble unlike anything we have seen since the great depression.
Guest: We would not be in this mess if there was no Fed and there was no such thing as fractional reserve lending.
If you eliminate government-sponsored fractional reserve lending, you’ll end up with private fractional reserve lending, and you’ll end up with a system that is worse than the system we have (see the US banking system in the 19th century).
I really dislike “political snake oil.” Yes the current system may be bad (and it’s really not *that* bad), but that doesn’t mean that any alternatives you propose are going to be any better.
Two questions I always ask when people come up with political or economic policy proposals:
1) what’s in this for you? If someone says that they are doing something altrustically purely for my interest, they are either lying or stupid.
2) what’s wrong with your proposal? If someone comes up with an idea and they can’t tell me the ten things that are wrong with it, they means that they haven’t thought things deeply.
DC: I stated that the hard earned savings of the US middle class, facing record food and energy inflation, was eroding. What does that have to do with pork prices in China?
You think that the CPI increases in the US have nothing to do with the CPI increases in China? Food and fuel are basically global markets so that what happens in the US and China are connected. If pork prices are too high, Chinese consumers switch to other foods which pushes those prices up in the US.
DC: Inflation in the US is purely a monetary problem and has everything to do with Bernanke’s “cheap money” policies.
I don’t see how you can consistently argue that inflation in China is not a monetary phenomenon while inflation in the US is. If you argue that Bernanke is cause inflation in the US through cheap money, then the peg will cause those policies to create inflation in China.
DC: We are in this mess because of Federal Reserve policies that have purposely fostered inflation. We are now on the back side of a credit bubble unlike anything we have seen since the great depression.
No we aren’t. People really don’t have a sense of history, so whatever small problems exist now suddenly become these great huge problems that never have existed before.
“does anyone think that Chinese bankers would be more well behaved than American bankers”
Once in a while, at least some Chinese bankers end with a bullet in the head for corruption. Was anyone prosecuted at Robert Rubin’s Citicorp for involvement in the Enron embezzlement and criminal fraud? Were Bill and Hillary Clinton ever prosecuted for their personal involvement in the Whitewater land scandal deals that bankrupted a Savings & Loan bank? Just wait till Hillary gets back into the Whitehouse to shred legal and financial documents.
Reality check to Twofish. The spot oil price yesterday closed at a record $103.50. That is a record inflation adjusted price. It will soon be $120 by this summer. Everything in the world economy is directly influenced by the oil price. The rise in oil and gold has been directly correlated to the devaluation of the US Dollar from the irresponsible monetary policies of the Bernanke Fed Reserve. The US Economy can look ahead to years of stagflation from gross mismanagement by the Fed.
China is supposedly holding domestic oil prices $20-30 below the world market price.
Doesn’t that just mean that when it comes to imported oil China is valuing the yuan at what it would be if it was freely-floating?
DC: Once in a while, at least some Chinese bankers end with a bullet in the head for corruption.
Actually they generally don’t.
Besides extreme penalities just convince people to hide problems and blame other people rather than just taking responsibility and fixing the problems. You’d think that after shooting so many people for corruption, you’d have less of it, but you don’t.
DC: Was anyone prosecuted at Robert Rubin’s Citicorp for involvement in the Enron embezzlement and criminal fraud?
No, because Rubin and Citicorp didn’t do anything illegal.
DC: Were Bill and Hillary Clinton ever prosecuted for their personal involvement in the Whitewater land scandal deals that bankrupted a Savings & Loan bank?
No, because there wasn’t anything illegal happening.
DC: Everything in the world economy is directly influenced by the oil price. The rise in oil and gold has been directly correlated to the devaluation of the US Dollar from the irresponsible monetary policies of the Bernanke Fed Reserve.
So you do think that Chinese inflation has nothing to do with pork shortages, or do you? If you think that Bernanke is following an irresponsiblity monetary policy, then you must think that the Chinese government is also being irresponsble for importing that policy, which is the point that Brad has been making for years.
The only consistent thing in your arguments seems to be that everything the US does is wrong, and everything China does is right, but that view just leads to a lot of very unclear views.
Here’s why it matters. Do you think the Chinese government should raise reserves and abandon the peg or not?
dc and 2fish — we probably should allow space for others to express their views. this post was meant to cover a broad range of emerging markets, and I am interested in answers to the question I posed at the end — namely, if the emerging world setting itself up for a crash when current negative real int. rates end?
don’t blame bernanke. fiat currency involves built in moral hazard – and in a doomed helicopter situation shouting at the pilot isn’t going to help anybody.
and if the people are hungry, it may have something to do with exponential industrial, economic, and population growth, on a finite earth.
on the other hand, if you fiat enough fiat currency, in a globalised world economy, it seeps out everywhere and you cannot stop it, for all the pigs in china.
you generate confetti blowback.
the real ill is not in the policy, but in the proportions. the people most to blame for imbalance are those with the option to shift their money. people whose income just about covers their purchase of necessities cannot do much to destabilise markets. what is scarily different from 1929 is the proportion of consumer spending which is discretionary, and the ratio of investment ‘play money’ to household monthly budget money.
so far, except in places like iraq and gaza, the real and tangible international economy remains intact. even in cleveland, ohio, the mansions are still standing. it’s not a property bust – its a mortgage bust.
if anyone out there is making leveraged bets on pork, wheat, or tulips – these will continue to grunt, get ground, or bloom.
- but financial fashions change and the last bubble to deflate will be the bubble bubble.
the united states economy, thus the dollar economy and the global economy, is not responding to the controls. the best metaphor is not a crash, but a stall.
i don’t buy your theory, brad, about fed responsibility. the idea that the business class lounge can fly on regardless, while tourist class falls out of the sky. to survive, the fed will have to preserve the global context in which the economy of the united states operates. don’t shoot the rickshaw driver.
hope you can follow the mixed metaphors.
I gather the process of sterilization hasn’t changed materially in the past 6 to 9 months? China et al are all still shoveling their CA surpluses into dollar debt markets unabated?
I don’t really understand how China could suddenly have a materially different rate of growth in money/credit unless it were related to a breakdown in this sterilization process. Or maybe the role of the dollar peg has been overstated? We seem to have people arguing that the dollar peg is causing China to import inflation, yet if anything that peg has loosened in recent quarters.
I *can* understand why ongoing growth in demand might be running into actual supply constraints (the “too little pork”) without a change in the sterilization process.
another helicopterconfettisceptic :
I would also question whether Chinese inflation reflects monetary growth arising from inadequately sterilised intervention. The Chinese monetary base has been growing more slowly than nominal growth, and broader monetary aggregates are only just keeping pace.
If the Chinese authorities are willing to change the process of sterilisation, they have plenty of capacity to sterlise by privatisation, especially if they do wish to continue to gently deflate the stock market, as I explain here:
Despite Brad’s comment about Twofish and DC bickering, I cannot resist the temptation to note that the “record inflation-adjusted oil price” that DC mentions is presumably only a record because it is deflated by the inflation measure that he (and I) disparage on other occasions as being fiddled down.
Twofish writes, “The only consistent thing in your arguments seems to be that everything the US does is wrong, and everything China does is right, but that view just leads to a lot of very unclear views. ”
Actually 73% of Americans want the US forces out of Iraq, but both Hillary Clinton and George Bush are in agreement that US forces should occupy Iraq permanently. What good is having an US democracy when the will of the people is completely ignored? Of course, the elites always know better.
Twofish, you are flat wrong. Actually China’s policy of non-interference in the internal affairs of other sovereign nations is the correct and rational policy. It’s the same reason why you never get personally involved with the family affairs of your next door neighbor. The world is headed for a new multi-polar world order; US foreign and Economic policy is intellectually bankrupt.
“So in some deep sense, the question is whether the great emerging market inflation of 07 and 08 will be followed by a big emerging market bust in 09 or 10, a bust that will have its roots not in a collapse in external capital inflows but rather in the domestic excesses in the boom years?”
Jen’s petrodollar piece in the FT seems to imply that the oil exporters SWF’s will be moving into EM equities. How does his theory fit in with your analysis?
“Who controls money controls the world.”
Henry Kissinger – Council on Foreign Relations
China’s Inflation problem is far from being the worst in the developing world. – DC
The Emirates (12%)
Totally agree on the pro-cyclical policies imported by emerging economies and the gulf states, problem is how do these economies implement contra-cyclocal policies when the western model till now is so very pro-cyclical, any ideas anyone?
as for the dollar peg; how about focussing on the one currency that did de-peg, how’s kuwait doing? (apologies if this is completely inaccurate, had a long night) Would be careful about the HK peg, lots of speculators waiting to cash in on the de-pegging, might just spark off unpleasant events on the Hang Seng, given the uncertain mood in markets these days, Pesek might just get something he didn’t wish for. Then again, he is a journalist, as they say, any news seems to be good news.
There was an interesting article in Bloomberg stating that the emerging markets cycle followed a 11/14 year cycle; in other words the bright spark was predicting 2011 as the year of the bust. Sounds pretty much like the Joseph story complete with the technicolor coat ensemble. Problem is, most people would tend to pre-time this, say 2010, wouldn’t they?
bsetser: namely, if the emerging world setting itself up for a crash when current negative real int. rates end?
I doubt it, at least in the case of China. The emerging world is emerging because there hasn’t been enough capital spending, so even horribly inefficient capital spending will be useful. Crashes in emerging markets usually happen when there is a withdraw of funding from the developed world, but in the case of China and the Middle East, the capital being created is indigineous.
groucho — if the gulf wants to invest more in asia, it will just add to their reserve growth. if asia lets their currencies rise and starts to run deficits it might be a different story. generally speaking, more flows to asian economies that already have an incipient inflation problem won’t help much.
judy — kuwait’s inflation is roughly in line with the rest of the gulf. i though would note that Kuwait’s move so far has been small, and overwhelmed by other moves: the euro and rmb and yen have all appreciated by more. and since kuwait imports a lot of from all three, one wouldn’t expect much of a benefit. kuwait needs to appreciate v the world, not just the us.
and then there a complex set of issues associated with a small move, expectations for a further move and the incentive for capital inflows that are hard to sterilize. but that is really another topic.
2fish — the capital creation is indigenous, tho in the gulf’s case, it has been helped along by an exogenous shock that increased the oil price. and in china’s case the puzzle is how savings increased more than investment when both have soared.
my question tho was whether there are potential domestic crises that don’t have their roots in the old fashioned withdrawal of external financing and associated pressures for procyclical macro policies. clearly a lot has changed, so i wondered if the potential triggers for trouble have also changed.
@ bsetser “if the emerging world (is) setting itself up for a crash when current negative real int. rates end?
How about this.
High capital inflows initiate an increase in local money supply.
This creates inflationary pressure which may result in negative real rates.
The inflows also appreciate the currency due to increased demand.
The capital inflows are generated by resource “windfalls” or
wage disparity and regulatory disparity which drives the whole outsourcing deal.
The situation is exacerbated by the mobility of capital and goods but less mobility for labour.
The appreciating currency reduces wage disparity, may increase costs and reduces international competiveness.
This used to be called the dutch disease, and can kill the local economy.
The conventional wisdom is raise rates and quarantine excess capital in something like the Norway SWF.
The quarantining directs the capital to the international market which in turn creates the sort of problems that you have recently outlined on this blog.
Uneven growth rates and inflation rates between trading partners adds another layer of supply and demand problems and are bound to cause trouble for both parties.
I think the answer has to be yes, unless you are very lucky, have timely and reliable information and careful, cooperative and competent management.
I would rather have these global economic challenges to solve that retreat into protectionism which leads to isolation and irrelevance.
Emerging economies will benefit from floating and liberalizing, albeit at some cost to the local status quo.
American authorities, especially Federal Reserve officials, harbor the mistaken belief that swift action can forestall a Japan-like collapse. The greater imperative is to avoid toxic asset bubbles in the first place. Steeped in denial and engulfed by election-year myopia, Washington remains oblivious of the dangers ahead.
There are eerie similarities between the United States now and Japan then. The Bank of Japan ran an excessively accommodative monetary policy for most of the 1980s. In the United States, the Federal Reserve did the same thing beginning in the late 1990s. In both cases, loose money fueled liquidity booms that led to major bubbles.
Moreover, Japan’s central bank initially denied the perils caused by the bubbles. Similarly, it’s hard to forget the Fed’s blasé approach to the asset bubbles of the past decade, especially as the subprime mortgage crisis exploded last August.
taxpayer — right now i don’t see much floating, and i see a fair amount of deliberalization (notably price controls)
bsetser: in china’s case the puzzle is how savings increased more than investment when both have soared.
Sharp increases in productivity caused by massive urbanization and industrial restructuring.
Precious metals are rising because anybody with money and half a brain can understand the following:
Gold YOY: +55%
Silver YOY: +61%
2fish – something similar happened in india, but savings didn’t grow faster than investment
We are currently on the backside of a credit expansion as a result of lax governmental controls as well as lax collateral standards among the lenders. I believe there is no question that credit will contract as these factors reverse over next several years and decades.
The result of this expansion has been outsized consumption in first world economies and outsized capacity in emerging economies. The United States is the first country to experience a consumption contraction, but I believe most if not all of the first world economies will be following the US lead shortly. The support of this view comes from (1) the ratio of per capita debt/income ratio relative to history as well as (2) public per capita debt/income ratios relative to history.
As for the emerging economies, a large excess capacity is already in place due to these outsized consumption demands. I believe that a hard landing is emerging nations is already inevitable. I suspect the feedback loop from the United States is already hitting China and the likelihood of further capacity expansions from here will be limited. As a result, I don’t believe Yuan strengthening would have a material impact on the size of the hard landing. However, in the case that this view is incorrect regarding capacity expansion (due to temporary and short-term substitution of demand in other first world nations), then Yuan appreciation might dissuade further dislocation.
I view the Fed loose policy actions to be largely impotent. I don’t believe the supposedly easy money is finding its way into the economy. This one is harder to prove as all the channels for money flow are not visible. However, I would look at the lock up in credit markets as a sign of a slowdown in the velocity of money. In addition, I would look at balance sheet expansions and bankruptcies to be signs of contraction of credit.
Finally, in my opinion, the rise in the commodity prices does not represent inflationary pressures due to supply limits or loose monetary policy, but rather represents the rebalancing of portfolios towards commodities. As the credit contraction takes hold, commodities will join the line of a deflation of assets globally.
Faber, as usual, puts it best…
“…basically, if you print money like the Fed or other central banks do, the value of money – of paper money – goes down and then it’s reflected in an increase in the value of assets such as gold that cannot be multiplied at the same rate. I mean someone could say, “oh, the gold price has gone up a lot since 2001.” I can turn around and say: “No, the gold price is the same. It’s the dollar the dollar that has collapsed against the price of gold.” And why did the dollar collapse against the price of gold. You call up Mr. Greenspan and Mr. Bernanke and you ask them about it. Of course, they will never give an answer. Each time Ron Paul asks them a sensible question they just evade the question and they move on to something else because, as I explained, they are a bunch of liars. And actually, if there was a court for honest money, both Mr. Greenspan and Mr. Bernanke should be hanged…” http://www.financialsense.com/transcriptions/2008/0112.html
The Federal Reserve is printing like there is no tommorrow for the US Economy.
Spot Oil rises to record $104
New Record Low Vs. Euro for the Dollar
Spot Gold at $991 per ounce, edges closer to $1,000
Japan Central Bank may intervene to support tumbling dollar
Pressure is building in Japan for official intervention to cap the surging yen before it triggers a sharp industrial slowdown and tips the country back into slump.
Foreign hedge funds that borrowed at near zero-rates in Tokyo to chase higher yields abroad are scrambling to unwind “carry trade” positions, estimated at $1.4 trillion in its varied forms.
David Woo, currency chief at Barclays Capital, said: “I don’t think we are yet at the point where the Bank of Japan is once again going to intervene by buying US Treasuries, but there is no question that people are worried. If the dollar gets to 100 yen, it could happen.”
The major Asian powers are increasingly irked by what they see as America’s beggar-thy-neighbour policy of dollar devaluation, which effectively steals growth from other countries. The question is when and exactly how they will react.
Often forgotten, Japan is still the biggest creditor nation by far, with net overseas assets of $3,000 billion. The last time Japan acted was during the deflation scare from 2003-2004, when it purchased $250bn of US Treasuries over a fifteen month period.
bsetser: 2fish – something similar happened in india, but savings didn’t grow faster than investment
India and China really have very different economies. A lot of the increase in savings was due to large amounts of savings in the state owned enterprises, and that resulted from the specific incentives that those enterprises are subject to.
Violent US Dollar currency shifts are extremely damaging to the “real” industrial economy. In the fourth quarter for example, Toyota Motor Corp reported approximately $194 million in currency related losses. Should Toyota concentrate on building high-quality manufacturing of vehicles or should their executives waste their time speculating in the currency markets? http://biz.yahoo.com/fxcm/080305/1204753356457.html?.v=1
DC — any company operating in different countries has to manage currency risk. Toyota was making enormous profits when the yen was at 120, in part because of its (considerable) manufacturing and design skills and in part because of exchange rate moves in its favor.
taxpayer — right now i don’t see much floating, and i see a fair amount of deliberalization (notably price controls)
Written by bsetser on 2008-03-05 09:55:46
I wonder hold long they can hold out?
The export competitiveness that the peg gives them is creating a pressure point.
They can let the air out gradually (float or pseudo float like China) or risk a more damaging and unpredictable blowout.
The rush to get out of the dollar is not making it easier for them.
The commodities rises flowing through to foods like tempeh and pork are creating domestic tension.
They are wedging themselves with price controls, pinning their hopes on a commodities downturn sooner than they can realistically expect.
The commodities have their fund money floor -for now.
Brad, to address your question for one emerging market, China, I think that the risk of your scenario unfolding is pretty high. It is true that non-food prices inflation is still low, but that misses the point altogether. With such high price rises in the food component (officially 33% of the basket, in reality more), there should be DEFLATION in the non-food component, or at least disinflation, as spending is diverted away from non-food to food. The fact that there is low but rising inflation in the non-food component has always been, for me, very strong evidence that inflation is a monetary problem and it is setting up the banking system for a sharp adjudstment.
When you speak off-the-record to think-tank or government types, there is a real sense of unease. People still repeat the mantra — it’s pork, not money — but it seems to me that they are doing it with less conviction. The problem, as you knew I would say, is that none of the measures used so far to address monetary expansion are likely to work until they fix the capital flow imbalance, which at root is a currency problem.
I am very sympathetic to your argument. I also got the impression in nov. that the “pork” argument was as much about managing expectations as a real statement of conviction. There weren’t as many Jon Anderson’s (inflation will be 2% by the fall) as I expected. The Gulf is saving a similar set of issues. So far the argument that it is “just” rent and thus inflation will come down when new supply hits the market hasn’t been borne out. Inflation was already supposed to be back down in qatar and the uae and well it hasn’t fallen. Combine the liquidity from less fiscal sterilization (i.e more spending/ investment of the oil windfall) and from speculative inflows and you kind of have china on steroids, but without energy cost pressure …
basically, real int. rates are still likely to be very variable across the cycle in the emerging world, with a high risk of a period of over ivnestment and then of under-investment …
Manufacturing companies hedge against currency risk by buying currency options which those awful “banksters” sell. Automobile companies in particular have extremely complex and sophisticated treasury operations and financial structures since they have to be able to respond to shifts in commodity and currency prices.
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