It has been over six months since the world markets wobbled uncertainly into the New Year. With comfortable hindsight bias overlooking multi-billion dollar losses, it is now time to refresh our view on what to expect during the period which separates us from resinous aroma of Christmas pines.
Investors of All Nations Unite! No amount of diversification has protected you thus far. Year-to-date losses have been remarkable. Shanghai Index has dropped 47%, India 40%, Hong Kong 23%, London 15%, US market (S&P500) 13%, Tokyo 11%. The Pakistani investors eventually decided to ransack the stock exchange in Karachi, and in all candor, other temples of greed deserve commensurate thrashing. Interestingly enough, commodities, so far insulated from the cascading erosion of wealth, have recently joined other asset classes in this broad sell-off.
Alas, the same commodities have now infected the global economy with an epidemic which, along with smallpox, seemed to have been eradicated from the surface of this planet: Inflation.
INFLATION – OR HOW TO TELL MASALA QUESADILLAS FROM SUSHI TORTILLAS
I meet two types of economists among those who have miraculously maintained their jobs on Wall Street. They can be broadly categorized into two tribes - the White Tribe and the Red Tribe. The Whites focus on the industrialized OECD economies and mostly see a prolonged slowdown precipitated by debt market excesses and graying populations. The Reds, on the other hand, concentrate on the commodity prices and over-accommodating monetary policies in the emerging markets. The two tribes do not really speak the same language, even though they believe that they do. When the White Tribe uses the signifier “CPI” (consumer price inflation), it mentally visualizes an American fatso in front of his oversize family mansion which houses a loud shrew and a couple of spoiled kids. When the Red Tribe uses the signifier “CPI”, it imagines cute and skinny Filipino kids who have not seen their mother in a year (she works as a domestic helper in the Middle East) and their dad for six months (he works on a Greek ship). In the former case, food accounts for some 4% of inflation “basket”. In the latter case, it accounts for 50% of inflation “basket”. But the disparity is even larger. Filipino food is basically a commodity – rice and vegetables, protected partly by government subsidies. Meanwhile 82% of the food value consumed by an obese American is derived from packaging, distribution, processing and labor. The differential impact of commodity price swings is heavily lopsided to the disadvantage of the orphaned family.
The Whites are cold, callous cynics. The Reds are passionate, pugnacious alarmists. The Whites usually see no inflation and ridicule the naïve Western consumer whose perception is skewed by the prices of seven daily products, instead of a scientific, multi-factor inflation model. The Reds have been crying inflation wolf for months, panicked by galloping food and energy prices.
THE LAND OF THE WHITE TRIBE
First, are the Whites really wrong? How can one reconcile the recession-prone US economy with persistent inflation pressures? Dismissing outright the global impact of the US demand slowdown has proven to be premature. Indeed, the congenial American fatso is practically irreplaceable. Aggregate US consumer demand is worth over $10 trillion per year. By comparison, Europe and Japan combined represent some $8.5 trillion. For all its swagger, China is a minnow ($900 billion) and India still has a long way to go ($500 billion).
The global economy has over the last 15 years benefited hugely from the disinflationary impact of globalization, facilitated by international labor arbitrage. It is the production of apparel, computers, toys, video and audio equipment - assembled by Chinese girls’ nimble fingers - that has seen the retail prices fall in the developed markets. Alas, these are low-frequency purchase items and they hardly affect the perception of inflation, most impacted by the runaway prices of gasoline, eggs, bread and air fares.
The White tribe continues to ridicule this “inflation perception” as the figment of consumers’ poor understanding of their spending patterns. This is a questionable form of scientism (people do act upon their own perceptions and modify their economic behavior accordingly), but the White tribe does have a point indicating another factor that damps the momentum of the inflationary groove: average wage growth in developed economies.
Indeed, it is only recently that the discussion of increased wages reappeared in the EU’s political discourse. American workers have been deprived of collective bargaining rights during the Reagan administration when Lane Kirkland’s AFL-CIO was more interested in fighting communism in Europe than supporting moribund industries at home. Today, unemployment expectations in the US are at a 28-year high and the precarious character of the (still existing) jobs will not allow the workforce to formulate wage demands that would offset price pressures and entrench inflationary expectations.
Meanwhile, Japan is veering off into a class society. I have two sorts of friends there. One group works for established corporations, with a guarantee of lifetime employment, not unlike their fathers (not mothers) did. Their main risk is karooshi (death from overwork) rather than lifestyle changes. The second group tries hard to make ends meet and maintain their lifestyle by taking unstable weekend jobs combined with part-time employment elsewhere. Culturally and economically, they remain hatarakibachi (busy working bees) and also risk karooshi, but are unlikely to achieve any wage growth before that. It probably did not matter in the recent years so much because your yen tomorrow was always worth more than your yen today, but these days will be over when inflation expectations re-enter Nippon psyche.
With OECD countries having reached wage growth peak in 2006, the current weakness of the workforce’s bargaining power all but disembowels the inflation apparition. But the economic well-being suffers nonetheless, regardless of the economists’ triumphalism.
THE LAND OF THE RED TRIBE
The Red Tribe focuses a lot more on the commodity prices and the mechanisms through which they affect emerging market economies. But why are emerging markets more exposed to inflationary shocks from commodity prices? Is it just oil and food? Well, not quite, as those who suffer most from price increases often happen to be oil exporters - Venezuela, Russia and Saudi Arabia among them.
Rising food and energy prices only translate into persistent inflation if monetary mass and/or credit grow faster than the gross national product. If India’s or China’s money supply has expanded by 20% year over year, Saudi Arabia’s has grown by 72%! Negative interest rates (i.e. interest rates less inflation) have reached nearly 5% in Russia and 8% in Egypt.
Loose monetary policies have created a liquidity shock in emerging markets fuelling demand for raw materials. The manipulation of the exchange rates and subsidized domestic commodity prices shifted the burden of price adjustment upstream, to dollar-denominated commodities. Given the potentially unstable nature of many of these countries’ political structures, their governments have been obstinate in implementing the plethora of non-market mechanisms. Price controls, emergency supply increases, VAT rebates, export taxes and quotas, or outright export bans have all been destined to dampen the impact of commodity prices on privileged industries or potentially restive urban populations. The demand for raw materials thus continues unabated and the resulting price increases are exported to the developed nations which carry the burden of demand adjustment.
Nevertheless, with the increased rigidity of local labor markets (thanks partly to China’s new labor law), there is a risk that food and energy price increases eventually seep into the “core” inflation. Most Asian and Middle Eastern governments may have little choice but to eventually raise interest rates and let their currencies appreciate. Ample foreign reserves and improved terms of trade with the developed countries give emerging markets enough room to allow their currencies to appreciate incrementally. When this happens, their hitherto “cheap” currency will no longer dis-intermediate the commodity price inflation for the Western end-user. These appreciations, unless corrected by the developing nations’ runaway inflation, would prolong the dollar’s depressive lows.
WHERE THE REDS MEET THE WHITES
Lauded by technocrats and demonized by populists, globalization has for the last two decades played a decisively disinflationary role, shielding comfortable western consumers from the shrinking pressure on their wallets.
One of the hugely underestimated side-effects of this cross-border process has been successful labor cost arbitrage. If cheap labor was not allowed to move to the existing industrial installations, then the installations moved to the labor. Since at least 2000, massive shifts in low-skilled labor endowment have been doubly beneficial. They ensured expanding margins for global companies and provided disinflationary safety valve for consumers’ economies. Mexican delivery boys in New York, Polish baggage handlers at Heathrow Airport and Pakistani workers in the Persian Gulf have all combined their forces to slow down the inexorable cost pressure that accompanies economic growth. For as long as the exchange rate differentials flattered their mental anchoring in home countries’ financial realities they willingly filled the labor market niches long abandoned by host economies’ local populations.
We should hope that the remaining pools of inexpensive labor and affordable, non-Western capital will partly offset the inflationary pressures unleashed by the commodity prices. Alas, many of the sources of this politically incorrect and often illegal “cheap labor” may now have seen its peak. Latinos have been the first to suffer from the construction industry shake-off in the US. The pool of Eastern Europeans entering Western Europe’s job markets is not unlimited, although it could potentially be offset by culturally alienated youth from Middle East and Africa. Coastal China has been suffering from rising labor costs for two years as the supply of female labor has peaked. Further flows are still possible into urban India and the Gulf countries.
The globalization of labor flows does and will continue, but is unlikely to directly benefit the profit share of Western, or Western-listed companies. Nor are he recent labor flows positive for the dollar. To protect the value of their remittances, ship crews are now demanding that their wages be paid in Euro. Foreign construction workers in the Persian Gulf will eventually force these economies to break the dollar peg. Japan’s exports are now invoiced in the yen. And China finds it difficult to stem capital inflows drawn by the perception of the unsustainability of the current exchange rate. All these trends bode ill for the dollar, the denominator of most commodity prices.
As the Red Tribe and the White Tribe debate the inflation “decoupling”, they might need to take into account that the burden of commodity prices shifts ineluctably towards dollar economies. Some of the Red blood will then be spilled onto the White Tribe’s clean shirts.
No comments:
Post a Comment