盛宴即將結束

盛宴即將結束/謝國忠
2009-06-01
謝國忠搜狐博客http://xieguozhong.blog.sohu.com/

Please see the attached my op-ed piece arguing that the world is heading towards stagflation. Dollar, treasury, and oil have moved big in the past two weeks partly due to rising inflation expectation. I don't think inflation story is a straight line . As high oil price threatens economic outlook, the prices may reverse in the short term. However, the inflation story will stick around. As its expectation forces central banks to tighten, it will crash the stock market rally.

The arguments against inflation are (1) that excess capacity keeps price down and (2) that money supply is kept within a dysfunctional financial system, ie, money velocity is low. Neither can stop inflation, I believe. Deflationary forces-IT and China are no more. Financial market can make inflation self-fulfilling through commodity speculation. Labor unions will rise in bad economic environment. 1970s is returning. Find your platform shoes and polyester suits. It is a different party from Greenspan's. Andy

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Crashing the party

Ignore the stock market rally, the world is heading for a long stretch of stagflation

Andy Xie

Updated on May 29, 2009

The stock market discounts the future, they say. If so, the rally in the past three months should foretell an economic boom ahead. Don't hold your breath; it isn't coming. Instead, the world is sliding into stagflation. The culprit is the policy response to the global credit crisis. Instead of restructuring, policymakers have been trying to wash away the consequences of the bursting bubble with liquidity. Instead of creating another boom, it will lead to inflation.

In the first quarter of 2009, the US economy contracted by 1.6 per cent, the eurozone's by 2.5 per cent, and Japan's by 4 per cent. The manufacturing export-led economies in the developing world fared worse. The global economy has sunk about 5 per cent and global trade 20 per cent from the peak in the second quarter of 2008. Even though the speed of shrinkage has slowed, the global economy is still likely to be contracting in the second quarter.


A collapse of this magnitude hasn't happened since the 1930s. One would imagine that policymakers and investors would be repenting of their bubble-making behaviour of the past. Yet, attention has shifted from the crisis to the elixir of liquidity. Rather than repent , investors clamour for a new bubble. It seems like Alan Greenspan is still in charge.



The global economy is like a train hanging over a cliff. While the front is in the air, there is enough of it still on the ground to keep the whole thing from falling further. Financial markets are dancing on the roof of the train, and the vibrations could send the train tumbling.



The fuel for the market enthusiasm is liquidity. It has returned to stock markets with a vengeance. The inflow into emerging market funds, according to Morgan Stanley, has totalled US$21 billion in the past 10 weeks, equal to half of the total inflow in giddy 2007. In financial markets, liquidity is akin to a free lunch. It's the tide lifting all the boats. But, this time, the boats are not just stocks but also goods and services. When asset inflation is followed quickly by consumer price index (CPI) inflation, central banks must decrease liquidity. That would crash the asset market party.


Mr Greenspan practised the liquidity sorcery for two decades at the US Federal Reserve without causing inflation. Three special factors brought him this extraordinary luck. First, the IT revolution was making the supply side more efficient. In particular, the labour-intensive service sector that dominates developed economies was retooled, to save labour. This factor kept the wages of white-collar workers down during Mr Greenspan's reign.



Second, the fall of the Berlin Wall unleashed more than 2 billion workers from the developing world into the global trading system. It triggered the rapid relocation of manufacturing activities from high-cost developed economies to low-cost developing ones. As a consequence, global trade grew twice as fast as the global economy, keeping a lid on the prices of tradeable goods and the wages of manufacturing workers in the developed economies.



Third, the collapse of the Soviet block severely contracted the demand for natural resources like energy. The rapid growth of China and India led to rising demand for such resources, but the Soviet contraction offset this inflationary force. This demand and supply dynamic made the commodity market an unattractive place for financial investment. Commodity prices remained low despite a prolonged global economic boom.


Today is quite different. IT has been absorbed into production already. Indeed, as it is increasingly becoming a consumption tool - often for killing time at work - it is slowing, not increasing, productivity. The prices of manufactured goods already reflect wages in developing economies. Global trade no longer shifts prices down like before. And the demand for commodities in the ex-Soviet block is increasing, adding to the rising demand from China and India.



Many argue that inflation couldn't happen in a weak economy. But inflation was a problem in the 1970s during a decade of sluggish growth. The term "stagflation" was coined for that decade. I am afraid the world is entering another decade of stagflation . The only force to keep inflation down is so-called excess capacity in a weak global economy. However, much of the excess capacity, like in the car industry, needs to be eliminated permanently, as future demand will be different from the past. The way out is to restructure both the demand and supply side. But central banks around the world mistakenly see monetary stimulus as the way out.


As they pump more money into the global economy, commodity prices may respond first. The oil price has risen more than stock markets since March, to US$60 per barrel, even though demand is still declining. The driving force is inflation expectations. Financial investment , rather than the demand for current use, is driving the oil price. Hence, monetary growth is becoming inflation through expectation.


The current party is likely to be short-lived. Next year, inflation expectations may become apparent. That would lead to expectations of interest rate rises. While central banks will still be reluctant to raise rates, rising bond yields will force them to do so . But they won't raise rates quickly enough to stem the inflation momentum. Stagflation will probably take hold.


Some argue that inflation should be good for stock and property prices, as it increases sales and profits in nominal terms. History points the other way. In the 1970s, US stocks averaged 1.3 times their book value, versus 1.7 times now.


Stagflation is bad for stock market valuations. Thus, property prices should rise in tandem with inflation. But, the world has gone through a property bubble during a period of inflation. As CPI inflation picks up, wages will take a long time to catch up with past property inflation. Property prices are likely to fall as inflation rises. At some point, the two will meet, as defined by the historical average ratio of wages to prices. Property prices will fall substantially before they rise.


Andy Xie is an independent economist