Thursday, June 7, 2007

Globalization Creates Secular not Cyclical Inflation

Excerpt from a Financial Post article today:

When Tata Consultancy, the giant Indian computer services firm, says it is hiring 5,000 workers in Mexico because rising wages are pushing up costs at home, it is little wonder investors are beginning to get queasy about inflation.

Only a month or so ago most economists figured the U.S. Fed would cut interest rates to fight off spreading housing doom. Now even long-standing bears Merrill Lynch and Goldman Sachs have rubbed out their forecasts for U.S. cuts, the European Central Bank is hinting at further increases after yesterday's hike, the Bank of Canada is poised to pull the rate trigger, and investors are beginning to worry that even low-cost giants such as India and China are losing their disinflationary might.

But before markets succumb fully to a good old-fashioned inflation scare, it is worth taking a dispassionate look at where global inflation is actually heading. While it may be heading up after several years of gangbuster global growth, the uptick is likely more cyclical than structural.

The long-term forces that have been holding inflation down -- globalization, the adoption of free-market policies and more sophisticated central bank policies -- are unlikely to unravel overnight. (Though the biggest dividends from falling inflation may behind us.)

The conclusion that this round of inflation is cyclical rather than structural is ridiculous. It brings us to the central debate – is globalization inflationary or deflationary? As the article implies, the growth of low-cost India and China has been a deflationary force on labor prices and certain manufactured goods. While this is undoubtedly true, this growth also has created inflation in many other sectors of the global economy.

India and China are consuming massive quantities of energy and other commodities. Since the supply of commodities is not unlimited (unlike the capacity of Chinese companies to produce junk for Walmart), their prices have risen dramatically across the board. As they grow richer, they become accustomed to a higher standard of living and they have more money to spend on food and other consumables. This is why we’ve seen increases in everything for which supply/capacity is not very elastic: energy, food, metals, transportation, construction, etc. The net result is a dramatic increase in aggregate demand.

Globalization has also had a major impact on asset price inflation. The increase in trade (and a host of other factors) has led to a massive increase in the money supply. Much of this new money has sloshed into stocks, bonds, real estate and other “assets.”

As prices for energy, food, shelter, and commodities rise, it’s only a matter of time before wages rise along with them. We are seeing this in a dramatic fashion in India and China, where wage growth in many sectors is in the double digits.

This phenomenon is not a cyclical trend, it is a structural trend and one we will be facing until India & China are done “emerging” and become mature economies.

1 comment:

David said...

Will as the first commentor on your blog, I have two points

1. Who will become a mature economy first, India or China, and when?

2. I couldn't help but read this blog and think to myself that this entire blog of India and China was just a metaphor for your softball team?

a) Do you play softball
b) Would you describe your team as mature or emerging
c) What do you think the team can do to inflate their batting averages
d) Should the team be recruiting in Mexico to find some good cheap labour
e) Do you think one of the problems with the softball team is that we consume massive amounts of commodities (beer and nachos)that softball fees will decline, but beer fees will increase?