When it comes to the growing global worries about inflation, it looks like it will be ‘As goes China so goes the world’.
China is the 2nd largest economy in the world, and rapidly gaining on the U.S. Among other statistics, it’s the world’s largest importer of copper, steel, cotton, and soybeans, and the world’s largest exporter of goods - to say nothing of being the world’s largest owner of U.S. debt.
Inflation fears have been circling the globe in recent months, with many blaming the U.S. Fed’s additional round of ‘quantitative easing’, launched last fall to give the U.S. economy another boost.
However, the fears began in China a year ago. China launched a massive $585 billion economic-stimulus plan in the depths of the financial crisis two years ago. In relation to the size of its economy at the time it was considerably larger even than the huge stimulus plan launched in the U.S. All that easy money chasing a limited supply of goods, properties, and investments surged China’s economy and stock market into bubbles.
The problems began coming home to roost last year. After surging up with the rest of the world’s stock markets in the first half of 2009, the Chinese stock market rolled over into a bear market, in which it lost 33% of its value in its plunge to its low last July.
The easy money remained in the system, China’s economy continued to boom, and speculation shifted from its stock market to its real estate sector (sound familiar?).
Concern about its overheated economy and soaring real estate prices finally prompted China to begin reversing its easy money policies a year ago. It began by raising the capital reserves its banks had to hold, in effect removing money from its financial system, and increasing the size of down-payments required to purchase real estate. When those efforts had no effect on the soaring economy, real estate speculation, or inflationary pressures, the Chinese central bank began raising interest rates. And as the problems have persisted, it has become increasingly aggressive, with multiple hikes in interest rates and increases in bank reserve requirements, the most recent taking place last week.
The global spike-up in food and oil prices has not helped for sure. But China’s inflation problems are not confined to real estate and commodity prices, either.
China is in the stage of its economic development where it needs, and wants, to increase domestic demand for its products, and move away from dependence on exports. To achieve that goal, wages and salaries must rise to move more of the population into the middle class.
Already the minimum wage in China’s major cities and ports has been raised an average of ten percent. Meanwhile, China’s National People’s Congress is meeting this weekend to establish China’s next ‘Five-Year Plan’. An important feature of the plan is reportedly endorsement of higher wages and salaries.
Wage-price inflation is the worst kind of inflation because it feeds on itself. As wages rise, companies have to increase the prices of their products. As prices rise further, workers demand still higher wages, and a difficult to stop inflationary spiral can get underway, as took place globally in the 1970’s.
With China being the world’s largest exporter, a potential wage-price spiral there has serious implications for the rest of the world.
For example, in November mainland China’s inflation problems spilled over into Hong Kong, where the Consumer Price Index rose 0.5%, an annualized rate of 6%, the fastest monthly increase since mid-2008.
Last month Li & Fung Ltd., headquartered in Hong Kong, the largest supplier of products to Wal-Mart, predicted that the price of Chinese and Hong Kong exports will increase as much as 15% this year. The second-largest retailer in Britain, Next Plc, said it expects higher labor costs in China will result in an 8% increase in its prices in the first half of this year.
Rising inflation has already become a significant problem in important global economies outside of China, including Hong Kong, India, Brazil, and emerging markets like South Korea, Indonesia, and Singapore. Their stock markets topped out in November and are down 10% to 17%, on concerns about the rising interest rates and tighter monetary policies that have already begun, required to combat the inflationary pressures.
Similar inflationary pressures have not yet arrived in the U.S. and Europe, and the consensus opinion has therefore been that interest rates in the U.S. and Europe can remain at record lows at least until the end of this year, if not well into 2012.
But the chief of the European Central Bank shocked analysts on Thursday by saying that inflation pressures have indeed become worrisome, and the ECB could raise interest rates across the 17-nation Eurozone as soon as its next meeting in April.
That does leave U.S. Fed Chairman Bernanke as about the only global central banker who does not acknowledge that inflation that began a year ago in China is relentlessly circling the globe, with the pressure pushing it from China increasing, not subsiding.
That complacency is not likely to last much longer - or it will be too late.
Meanwhile, another reminder: Gold is the historical hedge against inflation.
