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http://english.caing.com/2010-08-16/100171139.html
{snip}
The developed world is essentially competing on bad economic news. Major currencies move on who is worse at the moment. The Greek debt crisis caused the euro to plunge. Now the weak employment and resuming property weaknesses have caused the dollar to plunge. Maybe the yen is next.
On the other side of the world, inflation is sweeping over the emerging economies. Oil has climbed above US$ 80 per barrel again. Copper is back above US$ 7,000 per ton, closing in on the pre-crisis peak. The prices of agricultural commodities are gapping up. India is seeing double digit inflation. Emerging economies as a whole are experiencing inflation rates above 5 percent on average. India, Korea, and Taiwan have recently raised their interest rates, fearing accelerating inflation and an overheated property market. China has taken steps to rein in the overheating property market. It is still reporting moderate inflation. But, as the data loses touch with what people feel on the street, the pressure for rate hikes may become too strong to resist. Inflation and asset bubbles dominate the concerns of emerging economies.
The global economy seems to be bifurcating into the ice-cold developed economies and red-hot developing economies. Will the bifurcation persist? If the two sides converge, which side will dominate?
Let me write the conclusions first: Inflation, not deflation, will dominate the global economy. The deflation scare causes the central banks in the developed economies to sustain a loose monetary policy. It will fuel inflation in emerging economies. Through trade, currency markets, and ultimately inflation expectations, inflation will hit developed economies.
We are seeing the interplay between the forces of globalization and policy mistakes. Globalization has severely restricted the effectiveness of economic stimulus. Trade plus FDI are half of the global GDP. Trade is visible in terms of stimulus leakage. But, where investment occurs in response to demand growth is far more important. Multinationals can invest anywhere in response to demand. It cuts the linkage between demand stimulus and investment response. The latter is crucial to employment growth, which is necessary for sustaining demand growth beyond stimulus. Essentially, demand is local, but supply is global. This is why the old assumptions on stimulus are no longer reliable.
{snip}
When the Fed or the ECB tries to stimulate, they are actually stimulating the global economy as a whole. Water, no matter where it comes from, flows downwards. Stimulus, similarly, flows to where costs are low and banking systems are healthy. If you believe this logic, the actions of the Fed and the ECB fuel inflation and asset bubbles in emerging economies rather than stimulate growth at home.
A similar move occurred after the U.S.'s Savings and Loans crisis in the early 1990s. The Fed cut interest rates to 3 percent to help its banking system recover. The lower interest rates pushed Western banks to lend a lot to Southeast Asia, fueling a property bubble there. When the U.S.'s monetary policy was tightened, capital was pulled back. It caused the Asian Financial Crisis of 1997-98.
Today's story is much bigger and with more dimensions. The emerging economies are twice as big relative to the developed economies with double the trade volume relative to the global economy then. Investment and financial capital can now flow with little friction across the world. I suspect that the Fed policy today would cause distortions in the global economy three times as big as it did in the early 1990s. Its consequences would cause a global calamity far bigger than the Asian Financial Crisis.
The big difference from the 1990s is the employment response to the stimulus in the developed economies. Despite trillions of dollars in stimulus and a sharp one-year rebound in the global economy from the middle of 2009, the developed economies have virtually seen no employment growth. The consequences of the financial crisis have eaten away quite a big chunk of the stimulus. It is, however, not the full explanation. We are seeing overheating in emerging economies. The stimulus is just working somewhere else.
{snip}
The stimulus policy is more likely to end with inflation. Inflation is a monetary phenomenon. The massive growth in the money supply in the U.S. and other developed economies is not causing inflation for three special reasons. First, the financial crisis has crippled their banking system. Before it is fully repaired, it will slow down money velocity, equivalent to a reduction in money supply in the short term. Second, weak demand is forcing suppliers to refrain from raising prices. Third, as discussed before, multinational companies are investing in emerging economies.
The first two factors are temporary. When the two factors are removed, many argue that the central banks will have time to withdraw money before inflation happens. This is a bold assumption. The amount of money that has been injected into the global economy is so massive that removing it would be extremely hard. The odds are that the central banks won't be able to.
Before the first two factors are removed, inflation still can happen via the emerging economies. The price of oil is above US$ 80 per barrel, even though the global economy and the demand for oil are depressed. It has more than doubled from the lows during the 2008 crisis. One could argue that the shortage in supply is the reason. I seriously doubt it. Inflation expectations are likely the critical driver. Today, oil producers are less willing to extract oil from under the ground in exchange for paper currency. Ceteris paribus, the price needs to be higher to motivate them to produce the same amount of oil. Unfortunately, the oil price goes up with further loosening in monetary policy.
{snip}
The recent history shows how volatile commodity prices can be. If the Fed does pursue "QE 2," the CRB index will surely surge. And, it won't collapse like last time. There is so much more money in the world now. Some of it should turn into inflation through commodities. The value of commodities is about one tenth of the global GDP. It is a powerful force in turning money supply into inflation.
{snip}
In the case of the U.S. [comparing to Japan], its bubble deflates after the manufacturing price has declined to China's cost level. China is entering a decade of wage inflation. China's export prices are likely to rise. Hence, the U.S. won't experience what Japan has. Also, the dollar is weak, because the U.S. runs a large current account deficit. The dollar isn't likely to be a source of deflation. The temporary deflation due to suppliers cutting costs at the expense of profit margins will not last.
A weak economy doesn't mean deflation. Ultimately, inflation is a monetary phenomenon. When inflation spreads to the developed economies from the emerging ones, inflation expectations could become a factor. In the 1970s, despite high unemployment rates, labor demanded a wage increase to compensate for inflation. If the Fed keeps a loose monetary policy for the next decade, such a wage-price spiral is surely to occur.
There is a bright spot for developed economies from globalization. While their economic data tends to surprise on the downside, the corporate profits will surprise on the upside. This observation is important to many who make a living by taking positions before data releases. Such market gyrations are not important overtime. What's important is its importance to the soundness of the pension system in developed economies. After globalization, aging is the next most important force. After losing labor income growth to globalization, a healthy corporate sector is the only path for meeting their pension liability.
The globalization reality is that developed economies like Europe, Japan, and the U.S. will suffer slow growth and high unemployment. Stimulus is the wrong medicine for solving problems. Believing this will lead to excessive stimulus, which causes inflation and bubbles in emerging economies first and inflation in developed economies later.
{snip}
{snip}
The developed world is essentially competing on bad economic news. Major currencies move on who is worse at the moment. The Greek debt crisis caused the euro to plunge. Now the weak employment and resuming property weaknesses have caused the dollar to plunge. Maybe the yen is next.
On the other side of the world, inflation is sweeping over the emerging economies. Oil has climbed above US$ 80 per barrel again. Copper is back above US$ 7,000 per ton, closing in on the pre-crisis peak. The prices of agricultural commodities are gapping up. India is seeing double digit inflation. Emerging economies as a whole are experiencing inflation rates above 5 percent on average. India, Korea, and Taiwan have recently raised their interest rates, fearing accelerating inflation and an overheated property market. China has taken steps to rein in the overheating property market. It is still reporting moderate inflation. But, as the data loses touch with what people feel on the street, the pressure for rate hikes may become too strong to resist. Inflation and asset bubbles dominate the concerns of emerging economies.
The global economy seems to be bifurcating into the ice-cold developed economies and red-hot developing economies. Will the bifurcation persist? If the two sides converge, which side will dominate?
Let me write the conclusions first: Inflation, not deflation, will dominate the global economy. The deflation scare causes the central banks in the developed economies to sustain a loose monetary policy. It will fuel inflation in emerging economies. Through trade, currency markets, and ultimately inflation expectations, inflation will hit developed economies.
We are seeing the interplay between the forces of globalization and policy mistakes. Globalization has severely restricted the effectiveness of economic stimulus. Trade plus FDI are half of the global GDP. Trade is visible in terms of stimulus leakage. But, where investment occurs in response to demand growth is far more important. Multinationals can invest anywhere in response to demand. It cuts the linkage between demand stimulus and investment response. The latter is crucial to employment growth, which is necessary for sustaining demand growth beyond stimulus. Essentially, demand is local, but supply is global. This is why the old assumptions on stimulus are no longer reliable.
{snip}
When the Fed or the ECB tries to stimulate, they are actually stimulating the global economy as a whole. Water, no matter where it comes from, flows downwards. Stimulus, similarly, flows to where costs are low and banking systems are healthy. If you believe this logic, the actions of the Fed and the ECB fuel inflation and asset bubbles in emerging economies rather than stimulate growth at home.
A similar move occurred after the U.S.'s Savings and Loans crisis in the early 1990s. The Fed cut interest rates to 3 percent to help its banking system recover. The lower interest rates pushed Western banks to lend a lot to Southeast Asia, fueling a property bubble there. When the U.S.'s monetary policy was tightened, capital was pulled back. It caused the Asian Financial Crisis of 1997-98.
Today's story is much bigger and with more dimensions. The emerging economies are twice as big relative to the developed economies with double the trade volume relative to the global economy then. Investment and financial capital can now flow with little friction across the world. I suspect that the Fed policy today would cause distortions in the global economy three times as big as it did in the early 1990s. Its consequences would cause a global calamity far bigger than the Asian Financial Crisis.
The big difference from the 1990s is the employment response to the stimulus in the developed economies. Despite trillions of dollars in stimulus and a sharp one-year rebound in the global economy from the middle of 2009, the developed economies have virtually seen no employment growth. The consequences of the financial crisis have eaten away quite a big chunk of the stimulus. It is, however, not the full explanation. We are seeing overheating in emerging economies. The stimulus is just working somewhere else.
{snip}
The stimulus policy is more likely to end with inflation. Inflation is a monetary phenomenon. The massive growth in the money supply in the U.S. and other developed economies is not causing inflation for three special reasons. First, the financial crisis has crippled their banking system. Before it is fully repaired, it will slow down money velocity, equivalent to a reduction in money supply in the short term. Second, weak demand is forcing suppliers to refrain from raising prices. Third, as discussed before, multinational companies are investing in emerging economies.
The first two factors are temporary. When the two factors are removed, many argue that the central banks will have time to withdraw money before inflation happens. This is a bold assumption. The amount of money that has been injected into the global economy is so massive that removing it would be extremely hard. The odds are that the central banks won't be able to.
Before the first two factors are removed, inflation still can happen via the emerging economies. The price of oil is above US$ 80 per barrel, even though the global economy and the demand for oil are depressed. It has more than doubled from the lows during the 2008 crisis. One could argue that the shortage in supply is the reason. I seriously doubt it. Inflation expectations are likely the critical driver. Today, oil producers are less willing to extract oil from under the ground in exchange for paper currency. Ceteris paribus, the price needs to be higher to motivate them to produce the same amount of oil. Unfortunately, the oil price goes up with further loosening in monetary policy.
{snip}
The recent history shows how volatile commodity prices can be. If the Fed does pursue "QE 2," the CRB index will surely surge. And, it won't collapse like last time. There is so much more money in the world now. Some of it should turn into inflation through commodities. The value of commodities is about one tenth of the global GDP. It is a powerful force in turning money supply into inflation.
{snip}
In the case of the U.S. [comparing to Japan], its bubble deflates after the manufacturing price has declined to China's cost level. China is entering a decade of wage inflation. China's export prices are likely to rise. Hence, the U.S. won't experience what Japan has. Also, the dollar is weak, because the U.S. runs a large current account deficit. The dollar isn't likely to be a source of deflation. The temporary deflation due to suppliers cutting costs at the expense of profit margins will not last.
A weak economy doesn't mean deflation. Ultimately, inflation is a monetary phenomenon. When inflation spreads to the developed economies from the emerging ones, inflation expectations could become a factor. In the 1970s, despite high unemployment rates, labor demanded a wage increase to compensate for inflation. If the Fed keeps a loose monetary policy for the next decade, such a wage-price spiral is surely to occur.
There is a bright spot for developed economies from globalization. While their economic data tends to surprise on the downside, the corporate profits will surprise on the upside. This observation is important to many who make a living by taking positions before data releases. Such market gyrations are not important overtime. What's important is its importance to the soundness of the pension system in developed economies. After globalization, aging is the next most important force. After losing labor income growth to globalization, a healthy corporate sector is the only path for meeting their pension liability.
The globalization reality is that developed economies like Europe, Japan, and the U.S. will suffer slow growth and high unemployment. Stimulus is the wrong medicine for solving problems. Believing this will lead to excessive stimulus, which causes inflation and bubbles in emerging economies first and inflation in developed economies later.
{snip}
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<--- my new fav emoticon. so captures how i feel during these times.
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