International | Aug 15 2007
By Greg Peel
For the last few years the emerging markets boom has driven up commodity prices, particularly base metals and oil, to levels which have surprised even the most astute of analysts. The China story in particular has led to the commodity super-cycle – a secular shift in world commodity valuation that stepped-jumped expected average prices to much higher levels and blew away slow-moving analysts still clinging to anachronistic concepts of mean reversion.
As the world was coming off a period of extremely easy (some would now say too easy) monetary policy following the effects of the dotcom bust and 9/11, it was a given that strong global economic growth would force tightening phases and higher interest rates. However, in the earlier stages economists remained baffled as to why global inflation had not skyrocketed as a result of skyrocketing Chinese demand.
It soon became clear, however, that China was absorbing the imported inflation of higher commodity prices and recycling it back to the world as exported deflation. This is because the mass-production machine was able to sell particular everyday goods – from computers to mobile phones to fridges – at ever lower prices. While a pegged renminbi has made this possible, the bottom line is that the world has outsourced its manufacturing industry to emerging markets in which the average wage was significantly below that of so-called Western countries. Given the sheer enormity of the populations of the likes of Brazil, Russia, India and China (BRIC), those wages remain well below Western levels today.
And deflation has not just occurred in goods. India has given the world the notorious Mumbai call centre, allowing everything from insurance to phone plans to be sold at a lower cost to the provider.
Inflation has, nevertheless, been experienced across the globe, but not at levels that were initially assumed. That which the BRICs cannot provide, such as child care, financial market services and medical care for example, has dramatically increased in price. The world is paying a lot more for energy now, and food prices have become the latest to soar given a conspiracy of weather conditions and developments in biofuels.
Which brings us to China’s latest problem.
As noted in “Chinese Inflation Runs Rampant” (Asia; 14/08/07), China has just recorded a 5.5% inflation figure for the month of July, precipitated by extraordinary food price hikes including China’s staple, pork, which rose 45% in the month.
The Australian and New Zealand central banks, among most others, have been forced over the past two years to constantly raise interest rates against the threat of inflation in strong economies. These moves have been necessary (according to central bank thinking) despite the dampening effect of exported emerging market deflation. Now that China’s domestic inflation measure appears to be out of control, how long will it be before Chinese deflation turns to Chinese inflation? Are we suddenly staring double-digit interest rates in the face once more?
No, say Macquarie Bank economists, but that doesn’t mean the world should not keep a wary eye on Chinese developments.
For one thing, a lot of the rise in the pork price has had to do with an outbreak of a dangerous disease that has forced the destruction of many pigs. This has curtailed supply, and pushed prices higher. Once supply stocks can return to normal, and Chinese pig farmers rush to cash in on high prices, the situation should ease. Hence inflation should ease. Importantly, Macquarie notes non-food Chinese inflation in July was a far more modest 1.0%.
That is not to dismiss the fact that Chinese export prices have actually begun to rise considerably in recent months, matched by data suggesting US import prices from China have risen. Imports from China account for about 14% of all imports to both Australia and New Zealand. China is no longer having the same deflationary effect it once had.
But even these numbers are divergent from the trend, say the Macquarie economists. There should be some reversion and hence there is not an immediate concern for our local economies. But nor should we remain unwatchful as “tradeables”, such as that which China readily exports, account for some 45% of our CPIs.
There is no doubt that the Chinese figures are more than just an aberration. The price of eggs in China also rose 30%, just quietly. There is no chicken disease outbreak at present, as far as we know, and although Chinese authorities are suspicious of price collusion there is a simple reality that surging global ethanol production has forced up the global price of grains at a time when drought and flood has hampered the supply side. Chickens are fed grain – hence higher egg prices. The same is true for pigs, as well as other meat sources. Nor are Australia and New Zealand immune to similar effects on the supermarket shelf.
Food aside, slow but constant moves by Chinese authorities to revalue the renminbi will only make all Chinese export prices higher. Indeed, it is anticipated that incremental currency moves will systematically wipe out a lot of Chinese manufacturers who are already trading on paper thin margins. A reduction in the supply of goods must also force up prices. Macquarie notes that if the price of goods from China starts rising in any “meaningful” way, inflation expectations would start rising at “a more rapid clip”.
Next step, much more aggressive monetary tightening.
