The inflation news from the United States was absolutely benign yesterday, March 18.
Can’t say the same for a big piece of the developing world. Inflation is on the loose from China to India.
The only question is Will somebody important to the global economy wreck the recovery in an effort to fight inflation that threatens to run out of control?
For the moment at least, inflation in the U.S. looks like it’s under control. In February the CPI (Consumer Price Index), once seasonally adjusted, was flat. That puts this headline number at a 2.1% increase for the 12-month period. Core inflation, which takes volatile energy and food costs out of the number (and is useful, I assume, mostly to economists who don’t eat or drive) is now running at an annual rate of 1.34%.
The Federal Reserve doesn’t use CPI as its inflation benchmark (It prefers a measure called Personal Consumer Expenditure or PCE.) but translating from the Fed’s calculation suggests a core CPI target of 2% to 2.5%. At an annual rate of 1.34%, the core CPI isn’t even close to the Fed’s inflation limit.
The inflation picture couldn’t be more different in China, India, Vietnam, the Philippines, and other countries in the developing world.
Inflation at the consumer level ran at an annual 2.7% in China in February, up from 1.5% in January. The 2.7% rate might be deceptively high because of the effects of the week-long Lunar New Year holiday in February. But inflation at the producer, or wholesale, level suggests that the consumer number is indeed as bad as it seems. China’s Producer Price Index climbed at an annual rate of 5.4% in February. That was a big jump from the 4.3% annual rate in January and a huge increase from the 1.7% annual rate in December. Since consumer prices usually follow producer prices the February jump is bad news for China’s effort to keep consumer inflation under the 3% target set recently by Chinese Premier Wen Jiabao.
The inflation picture may be even worse in India. In February the wholesale price index, India’s inflation gage, climbed to an annual rate of 9.89% from 8.56% in January. “I will not be surprised if we have a double-digit inflation by March. We are primarily concerned with food inflation. It has to be tackled,” Finance Minister Pranab Mukherjee said during the discussion on the budget for the fiscal year that begins in March 2010.
And tackle inflation is what the Reserve Bank of India did on March 20 by raising the rate that banks pay to borrow from the central bank by 0.25 percentage points to a 5% rate.
And these aren’t isolated cases. Inflation in Vietnam has doubled in the last seven months to an annual rate of 8.5%. In the Philippines, where inflation indexes were flat in mid-2009, the inflation rate has climbed to an annual 4.2%.
China is the country that worries me most.
First because its economy is the marginal consumer for many of the world’s commodities and the global economy—and investors—are counting on China to keep growing at better than 8% a year. Fighting inflation could jeopardize that growth rate.
And second because labor shortages in China’s export engines, coastal provinces such as Guangdong and Jiangsu, have set off a bidding war for workers that threatens to generate a classic inflationary wage spiral. (The labor shortage is a result of national programs to increase economic activity in the inland provinces that used to provide the bulk of migrant labor for coastal factories. More of these workers are simply staying home and working there.)
On March 18 Guangdong, China’s biggest exporting province, announced an increase in the provincial minimum wage of about 20%. That brings wages in the province back into line with wages in Jiangsu, Guangdong’s big export rival. Jiangsu raised its minimum wage by 13% last month. The increase brings the average monthly pay—after adding in bonuses based on output—to a little less than $300 at current exchange rates.
As you might imagine a 20% increase in the minimum wage has set off a firestorm among employers in the two provinces. Take this survey with a grain of salt, therefore, but research by the China Council for the Promotion of International Trade shows that for 1,000 labor intensive exporting business surveyed profit margins were as low as 3%. Despite those reportedly low profit margins, exporters in Guangdong exported $53 billion in goods in January and February 2010. That was up 22% from the same two month period in 2009.
So, let me get this straight, the increased wages is being funded by government programs that keep people imployed in inland China. The bet is, that those programs will jumpstart the inland economy so the government funding eventually won’t be necessary (there goes my ‘western’ thinking). But of course, this isn’t usually the view no matter who runs the program (USA nor China). They are committed to employing people in communism. At some point it will either help deplete their reservese (already written by JJ) or it will be taken away and restart the flood of workers back to the coast.
Don’t forget Hong Kong’s realestate exploded 30% year over year, Economist magazine identified them as the most overpriced real estate market in the world. Pegging their currency to the dollar means limits what they can do.
A little inflation is a good thing. It is the proverbial carrot that makes the economy grow. Weren’t we the ones who were complaining just a few week ago that China had too much production capacity in this and that? The inflation thing would be scary only if China did not have that idle capacity…
Besides, the wage increases are only in the 2 coastal provinces. China will adjust by keeping its population inland. This will lead to a more balanced industrialization. There will be a little shock in the beginning but it will be OK in the long run.
Ed,
I must say your post is EXCELLENT.
What gets a lot of people in trouble is thinking about foreign economics/culture in the same way we view the USA. That is always a killer.
I see 2 distinct positives for the Chinese issues.
1. It will push China to domestic consumption MUCH faster than China would like. It might cause a hiccup in growth rates, but for long term health of the global economy/US economy this will be a good thing.
2. These inflation problems will bring much more balance to global trade. Currencies in Asia are going to appreciate which will increase demand for developed country goods. A trend you are seeing now is much more “onshoring” of work. Companies are bringing jobs back to the USA because the workforce has a customer service mindset (I can’t tell you the number of countries that wish they had our customer service skills).
This will be an interesting time!
Whichever way one slices it, China inflation will require credit tightening and forcing the economy to slow and that WILL definitely have negative effect on global economy. There is no way that 9-10% growth rate will not cause inflation, though they were getting away with it due to “fixed asset” investments till now. Wage spiral is the sure sign of inflation down the road. It is not a matter of good or bad – just a simple fact.
Yes, it will help in their internal consumption and other “desirable” attributes, but will hasten monetary/fiscal tightening as well. Since we are here as investors – it will effect the equity markets, though as Jim says, eventually they will recover and continue their upward trek.
Sounds like he’s saying that it’s a fork solving two problems; the higher wage keeps the employees from leaving the province (which doesn’t push inflation tooooo much because it is minimum wage/survival wage) while the added expense to employers reduces corporate spending, holding the line on inflation.
Ed, why is the following true:
By making the low end workers more expensive, and raising the costs of employing workers overall, that move will help to solve their problem, and may even prevent an inflation spiral.
I don’t understand how raising the minimum wage or raising the costs of employing workers will fight inflation. Can you explain?
In the interview of Mr. Hessler, he described how a young woman got hired into a job and gradually got her entire family employed at same. Then most of their village. After that the Dad became the negotiator for the entire group and got their wages raised. Don’t worry, I won’t mention that “u” word. I just thought it was interesting, along with the guy who memorized a machine and then moved to a competitor and re-built the machine from memory. I think he said it was the 3rd or 4th copied generation of this machine.
I have to give China credit. Raising the minimum wage in that situation is BRILLIANT! While I am normally against raising the minimum wage, when you have a shortage of workers, raising the minimum wage is EXACTLY the right thing to do. By making the low end workers more expensive, and raising the costs of employing workers overall, that move will help to solve their problem, and may even prevent an inflation spiral.
The Chinese knowledge of economics awes me sometimes.
harpstein –
My assumption on margins is based on the commonly accepted fact that Chinese wages are so drastically below most of their competition. If true, then they can sell at a lower price than the competition and still have significantly higher margins. Therefore they have the ability to absorb some of the current wage increases.
Speaking of China, I was listening to Micaheal Feldman’s “Whad’Ya Know?” on PRI and he interviewed Peter Hessler, author of: Country Driving: A Journey Through China from Farm to Factory. The book sounded very fascinating and gives an insight into all facets of China, from rural to urban. I have not bought it yet but wanted to pass this along.
You assume that chinese companies over-charge for their produced goods which seems unlikely. They’re largely competing with the rest of the world, so I assume they operate on thin margins like every other manufacturer. I agree that increased wages are good, we need China to begin consuming our goods and we need the labor cost gap to close. I think the concern is that China puts the breaks on now, when the recovery is so fragile and they spook the rest of the world into a double-dip recession.
I am confused. I keep reading about how important it is for the Chinese to increase domestic spending. It seems to my poor tired brain that an increase in wages would stir an increase in consumption. I understand the concern with a wage push inflation spiral. But I also have a hard time not believing that Chinese companies, with such cheap labor (even after the healthy hike in minimum wage), don’t have the margins to absorb the increases. I could be wrong. Maybe they are so narrow that they would have to increase prices making developed economies (read USA) more competative by making wages more equal. Again, foolish me, I read that as a win also. I welcome any civilized corrections to my errant thinking.