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谢国忠

谢国忠博客:只说出心中真相

 
 
 

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麻省理工学院经济学博士

个性介绍: 1960年出生于上海,1983年毕业于上海同济大学路桥系,1987年获麻省理工学院土木工程学硕士,1990年获麻省理工学院经济学博士。同年加入世界银行,担任经济分析员。在世行的五年时间,谢国忠所参与的项目涉及拉美、南亚及东亚地区,并负责处理该银行于印尼的工商业发展项目,以及其他亚太地区国家的电讯及电力发展项目。1995年,加入新加坡的Macquarie Bank,担任企业财务部的联席董事。1997年加入摩根士丹利,任亚太区经济学家,2006年9月辞去该职务。

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don't control price, raise interest rate   

2008-04-16 18:32:59|  分类: 言论 |  标签: |举报 |字号 订阅

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Don't Control Price, Raise Interest Rate(译文在这里)

谢国忠博客 http://xieguozhongblog.blog.163.com/



China is in an all out battle against inflation. But, theapproach-price control may be wrong. China is too open to haveindependent prices. Fuel shortage suggests that such policy cannot lastlong. China may have to come back to hiking interest rate whiletightening capital account control. The following is in the currentissue of Caijing Magazine.


Don't Control Price, Raise Interest Rate

Theprice of Thai white rice, a benchmark for international rice trade,surged 30% to $790/ton on March 31st, prompted by news of variouscountries restricting food exports. Its price has doubled since end of2007 and nearly quadrupled from the level in 2003. The FAO food priceindex has roughly doubled in the past two years. The price trend forfood at present bears eerily resemblance to oil price at $50/barrel-thepoint that oil market began to attract large amounts of speculativecapital. Investment funds that specialize in the futures ofagricultural commodities are becoming popular. Soon, speculativecapital may take over the pricing of food products and cause food priceto double from the current level.

At thesame time, China's labor market may enter a phase of re-pricing.Between 1995-2005, the wage for unskilled workers in China barelychanged despite the economy rising at 8% per annum. This is because theexcess supply of labor kept the labor market a buyer's market. Chineseworkers competed against each other and settled for wage at a minimumacceptable level. Hence, they didn't share in the upside in anexpanding economy. The low wage has caused global production torelocate to China on a massive scale and has also triggered robustgrowth of the service sector. At the same time, the government hasengaged in massive infrastructure expansion to absorb surplus labor.All three developments have rapidly expanded labor demand. Some sort ofturning point has been reached. The labor market now seems no longer abuyer's market. For the first time, wage, especially for youth labor,is now under enormous upward pressure for two reasons.

First,the cost of living has increased enormously. The consumption basket ofunskilled workers or their families has a high share of food products.The enormous inflation of food products has decreased real wage forsuch workers. Hence, the nominal value of the minimum acceptable wagehas increased. Second, the demand for youth labor exceeds supply at thecurrent wage level. The 'shortage' of labor in Pearl River Delta, whichhas gotten worse this year, really reflects that factories are notpaying market wage. The two factors suggest that China's unskilledlabor requires re-pricing for market to reach equilibrium. Meanreversion suggests that the wage level needs to reclaim the lost growthrelative to GDP since1995. I think that wage for unskilled labor inChina will likely rise by 50% between 2008-2010. As labor productivitygrowth is about 8% per annum and total factor productivity 4% perannum, the re-pricing of labor cannot be absorbed by productivitygrowth, even if capital's income share in GDP declines significantly,and will cause significant inflation.

Inflationis a slow moving variable. When it becomes visible, it is too late tostop it. Chinese government has announced an inflation target of 4.8%for 2008. Its purpose is to contain inflation expectation. While theintention is good, the government should be careful about losingcredibility. If the population perceives that the government's effortin fighting inflation is rhetoric, not action, they may take actions todefend themselves. In the past episodes of high inflation, Chinesepeople engaged in hoarding essential goods to fight against thedevaluation of paper money. Such behavior can exacerbate inflationarypressure and cause a vicious spiral.

It isprobably too late to stop inflation now. Indeed, the re-pricing oflabor should not be stopped at all. It is good for social stabilitythat Chinese labor is claiming their share in China's prosperity. Italso will force businesses to use labor more efficiently. Ten yearsago, I visited an electronics assembly factory. 'They are alleighteen', the manager pointed at rows and rows of young girls hunchingover their worktables. 'In a few years, their fingers will not be sonimble. We will get a new batch'. Such callous remarks summarized theattitude of some businesses in treating Chinese labor. They believed ineternal labor surplus.

When you walk into ahigh-end restaurant, a line of waiters greet you. This is purelydecorative use of labor. Such wasteful use of labor reflects low laborcost. In the West, the daily income of a waiter is 2-4 times of acustomer's meal cost. In high-end restaurants for business meals inChina, it is 0.3-0.5 times. This is why restaurant owners find itlucrative to use so much labor for decorative purposes to attractbusiness.

On the other hand, many workersin forties or even thirties are retired. When you walk through citieslike Chongqing or Chengdu, you see crowds of such retirees playingmahjong on the sidewalks. When youth labor is plentiful, businessesprefer to hire them, because they are easy to train and can adapt tothe rapidly changing environment better. However, a bit more trainingcan turn the retired middle-aged workers productive. It is totallyirrational for a society to leave such people in their prime idle.

There-pricing of China's labor doesn't mean that China's labor is nolonger cheap. It is still cheap, just less cheap. Nor does it meanabsolute labor shortage in China. As youth labor inflates in cost,businesses will make labor use more efficient and find it profitable totrain middle-aged workers. Chinese economy is wasteful in usingresources. The worst is in wasting labor. The re-pricing of labor inthe coming years will force the economy to become more efficient. Whenbusinesses restructure their labor use, China will not lose as muchcompetitiveness as the rising labor cost suggests.

Surginglabor cost cannot be controlled by the Chinese government. Nor could itfood price. Agriculture has been unprofitable around the world fordecades. Governments in developed economies have provided massivesubsidies to farmers to keep them in business. The introduction ofbiofuel in response to surging oil price was the catalyst for thesurging food price. The United States introduced subsidies for turningcorn into ethanol as a gasoline substitute. It established a linkagebetween the prices of agricultural commodities and oil. As oil pricehas kept surging on speculative capital, it has lifted the prices ofagro commodities.

Instead of playingthrough oil, speculative capital is now moving into agriculturalcommodities directly. The price surge in the past three months has muchto do with the setting-up of investment funds that buy futures ofagricultural commodities. What's occurring in agro commodities nowbears striking similarities to the oil market when its price hit$50/barrel. The momentum is attracting financial capital. Even thoughthe futures market is not deep, as capital flows in and prices surge,the market becomes larger and more liquid, which attracts more capital.Big investment banks are beginning to provide research support andtrading instruments. More and more analysts will put sensational pricetargets on agro commodities like they did on oil. Like oil before,agricultural commodities may become a big bubble in 2008.

Financialspeculation happens when a market has positive momentum. It is amagnifier of an established trend. Oil, for example, did have strongdemand due to the strong global economy. The supply response has beenmuted as governments control over 80% of oil reserves, and they havelow incentives to increase supply when they already have enough money.Financial capital sees the low supply and has kept price surgingdespite demand weakness. Hence, the support for the oil bubble hasswitched from demand strength to supply weakness.

Similarly,the fundamentals for agricultural commodities have been improving forthe past five years. As mentioned above, the linkage to oil has boostedthe fortune of the agro commodities. The food demand for eating hasalso been improving. Emerging economies have experienced four years ofstrong growth. They tend to spend their income gains on improving diet,i.e., more meat and dairy products in their food consumption. It meansmore demand for grain. Despite a weak US economy, emerging economieswill continue to grow at a healthy pace, because they have highreserves of foreign exchange and can continue to invest despite exportweakness. As fundamentals for agro commodities remain strong andspeculative capital lacks alternative outlets, capital will flow intothis market and exaggerate the increase of food prices.

Energyand food is the twin scourge for global inflation in 2008. The monetarypolicy of the Fed is the root cause for all the bubbles in the world.The Fed is printing money to save the US financial system. The monetaryexpansion is causing dollar depreciation and inflation, which makescommodities attractive. As traditional financial instruments likestock, credit, and bond are in bear markets, excess liquidity has beenpouring into commodities. The commodity bubble will burst when the Fedshifts its policy priority to price stability from financial stability.It doesn't appear likely in 2008. The Fed may not even shift its policyin 2009.

It appears that Chinese governmentcan't stop inflation from surging in 2008 or even in 2009. The rise offood price and wage is catch-up increase. Does that mean that thegovernment shouldn't do anything about inflation? It would be verywrong if one concludes that nothing should be done because inflationcannot be stopped in the short term. Inflation can cause instability inthree ways. First, the expectation of sustained high inflation cancause businesses to raise prices and workers to demand wage increase.The spiral could last longer beyond the necessary price adjustment offood and labor. The government has to take actions to convincebusinesses and workers that it will bring down inflation in future. Theexpectation for low inflation in future will moderate their behavior.

Second,inflation can frighten savers about the value of their bank deposits.Chinese households have Yuan 18 trillion in bank deposits. The depositrate is four percentage points below inflation at present. Chinesehouseholds are losing Yuan 2 billion on the real value of theirdeposits everyday. The fear for further loss may inspire savers towithdraw deposits from banks and purchase commodities like cooking oil,rice, or toilet paper for value preservation. Hoarding happened inevery episode of high inflation in China. Unless something is done, itcould happen again and destabilize the country.

Thereare already many cases of hoarding. In Taipei, consumers queued to buytoilet papers. Hong Kong just saw panic-buying of rice. In China,cooking oil is one favorite for hoarding. Some shops limit customers toone bottle for each purchase. Such practice invites people backtomorrow to buy more. Down this slippery path, China may have to rationessential goods again, setting the country back twenty years indeveloping a market economy.

Third, peopleon fixed pay like pensioners, welfare recipients, and students are hithard by inflation. India, Yemen, Mexico, Burkina Faso and several othercountries have had, or been close to, food riots in the last year,something not seen in decades of low global food commodity prices. TheUS government has a food stamp program to ensure social stability forthe low income group. The US's Congressional Budget Office (CBO)projects that by October, 28 million people will depend upon federalfood assistance, up from 26.5 million in 2007. This will be the largestnumber of people depending on food stamps since the program began inthe 1960s. To maintain social stability during surging food price, agovernment must help the people on fixed pay. If China doesn't takepreventive measures, it may see similar disturbances as other countrieshave seen.

To safeguard stability duringinflation, China must protect the value of bank deposits by raisingdeposit rate above inflation, increase fiscal transfers for thedisadvantaged, and avoid price control. Many are worried aboutattracting hot money if deposit rate is raised. This is a legitimateconcern. It can be addressed in two ways. First, China can tighten upcapital account control. The recent tightening measures are alreadyhaving an effect. Underground money shops in Hong Kong now charge up to10% commission for channeling money into China.

Chinacan and should tighten capital account control. While capital accountconvertibility is desirable in the long term, a higher priority now isto increase monetary independency. The Fed is pursuing a policy tostabilize its financial system and is tolerating inflation for now.Without monetary independence, inflation can spike out of control inChina. One big hole to plug is the allowed HK$ 10,000 purchase of Rmbper day in Hong Kong. The total amount of Rmb deposit in Hong Kongthrough this channel totaled Rmb 48 billion in February 2008, up fromRmb 30 billion November 2007. The amount is still small but is risingrapidly. It may pose a challenge to the stability of Hong Kong dollar.As Hong Kong people convert their HK dollar into Rmb, the former mayvanish. China may have to close this loophole soon for China's and HongKong's stability.

To discourage hot money,China can raise long-term deposit rates first. For example, fortwo-year deposit or longer, China could introduce inflation plusinterest rate, similar to the inflation protection bonds or TIPS in theUS. Hot money rarely has the patience for a two-year bet. Hence,raising long-term deposit rates will hardly attract more hot money. Itserves the purpose as a safe haven for savers who are worried about thevanishing value of their hard-earned money.

Chinacan issue inflation protection bonds like the US government alreadydoes. The introduction of such an instrument can improve China'sfinancial stability. Life insurance companies face enormous risks wheninterest rates fluctuate. Because, their liabilities are fixed innominal terms and their income depends on interest rates, they can sinkinto negative equity value like in 1998. The inflation protection bondscan stabilize this part of the financial system. Also, banks can usethis market to offer inflation protection deposits, which benefits mosthouseholds.

China's fiscal situation isexcellent now. The fiscal revenue bottomed at 11% of GDP in 1990s. Itis now 20%. Further, state-owned enterprises in telecom and financialsectors are flush with profits and can contribute to fiscal revenue ifneed be. The SoEs were in dire financial condition in 1990s. Chinesegovernment now has plenty of money to protect the disadvantaged duringinflation. Steps have already been taken to increase pension paymentsfor retirees and allowances for college students. If need be, moreactions should be taken.

In Chinesebureaucratic culture, it is always tempting to use price control todeal with inflation. However, it is very damaging for the economy inthe long run and may even cause crisis. Price control is invitation forpanic-buying and hoarding, because, it under-prices goods. Rationalconsumers will buy more under-priced goods, which leads to shortage.The widespread shortage of diesel fuel, for example, is a good example.The prices for processed petroleum products are 30% below crude price.It leads to smuggling of such products into the international market.

Chinamay repeat the mistake in grain market. As international prices surge,imports stop, which pushes up local prices. The government may unloadinventories to keep domestic prices low. This is a high risk move fortwo reasons. First, we don't know the true level of inventory. Chinaimports over 50 million tons of feed meals per annum. It is hard to seehow long the inventory can last to replace imports. Second, there couldbe smuggling of under-priced Chinese grain into surrounding countriesin Southeast Asia.

While inflation ispicking up, Chinese economy is also slowing. Much of the world isexperiencing the same. China, however, is slowing from a high level. Ifthe growth rate drops by 30% to 8%, it is still a good growth rate.China didn't have trouble in the 1990s at a similar growth rate.However, China always gets into trouble when inflation is double digitrate. Hence, China's policy priority should be inflation rather thangrowth.

Inflation can't be stopped now. Butit must be managed to ensure it declining overtime and societyremaining stable during the meantime. Raising interest rate is theright approach. Price control is the wrong one.

谢国忠博客 http://xieguozhongblog.blog.163.com/
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