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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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inflation returns. sell bonds   

2008-05-29 12:34:47|  分类: 言论 |  标签: |举报 |字号 订阅

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Inflation Returns. Sell Bonds /谢国忠 

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


The world is now entering a stagflationary period: economies areslowing down while inflation is picking up. This period may last fortwo years. In the second half of 2009, major central banks may begin toraise interest rates to fight inflation. It may cause a globalrecession in 2010. The global economy experienced a property-cum-creditbubble over the past decade. The consequences of the bursting arespread in two phases. In the first phase, major central banks arecutting interest rates and pumping liquidity to stabilize financialinstitutions. The priority of financial stability adds inflationarypressure. Only when financial institutions are strong enough centralbanks will switch priority to price stability, which may cause a globalrecession. The major central banks are pushing out the economicadjustment to deal with financial crisis first. The cost is thatinflation will peak higher during the adjustment period.

Inaddition to the expansionary monetary policy, the current stock ofmoney in the global economy is inflationary. Deflationary forces fromemerging economies, which we will discuss below, checked theinflationary forces from asset inflation in the west. As the bubblebursts, the money is coming out of property and credit markets and isbeing channeled into commodity market, which, in addition to supplyconstraints, is a major force in commodity inflation. As commodityinflation pushes up living costs everywhere, wage inflation is justaround the corner, which leads to a second wave of inflation. The loosemonetary policy to save financial institutions is adding fuel to fire.Bursting property-cum-credit bubble slows down economic growth, whichdoes decrease inflationary pressure on the demand side. However, themonetary environment is highly inflationary on the cost side, fromindustrial metals, energy, agricultural products, and, with a lag,labor.

2011 may mark the beginning of thenext cycle. Would it be similar to the past, like the last upturn from2003-2007? I think not. The past two decades of low inflation are anexception rather than the rule. The future will be more inflationprone. Businesses that have prospered on piling up debts will strugglein future even when the global economy recovers from the current crisis.

Thepast two decades marked a steady decline in inflation rate. Financialmarkets attributed the trend to the successful efforts by central banksand rewarded them by pushing down bond yield. At the bottom, the 10year US treasury barely yielded 3%, down more than half from theprevailing level two decades ago. Alan Greenspan who presided at theFed over this period of great disinflation was lauded as the greatestcentral banker of all time. Even though Greenspan always came to therescue every time that something threatened the US economy by cuttinginterest rate and pumping liquidity, inflation kept dropping. Mostthought Mr. Greenspan had a secret recipe to target growth andinflation at the same time.

As lowinflation and strong growth continued year in and year out, Greenspan'sreputation mushroomed. Phil Graham, the senator from Texas, onceremarked that, if Greenspan had died, he would seat him in a chair tostabilize financial markets. Studying Greenspan became an industry.Scholars and pundits competed fiercely against each other to see whocould praise him more. In 2001, the respected journalist, Bob Woodwardwho made his name exposing Nixon's cover-up of the Watergate scandal,wrote a book-'Maestro: Greenspan's Fed and the American Boom' to praiseGreenspan for America's prosperity. He attributed Greenspan's recordpartly to his musical talent-the ability to pay attention to details.The chorus of sycophancy was deafening.

Iwrote for many years that Alan Greenspan was leading the US economyand, indeed, the world through the status of the dollar on a wrongpath. The low inflation was not due to his and other central banks'policies. It was due to the end of the Cold War and the rise ofglobalization. Neutral monetary policy would have required westerncentral banks to allow prices to fall. Low inflation didn't precludeexcessive monetary expansion.

When theBerlin Wall fell, it was the end of an ideological struggle. It wasalso a tectonic shift in the global economy. The economies of theSoviet block in the former Soviet Union ('FSU') and Central and EasternEurope virtually collapsed overnight. These were already industrializedeconomies. Half of their economies were government-directedinvestments. As their political systems changed, the state investmentscollapsed. These economies all believed in the Washington Consensus andembraced an export strategy to bring their economic recovery. However,their existing capital stock couldn't produce the goods the West wantedto buy. Without exports to compensate for investment weakness, theirconsumption power also vanished.

As theseeconomies crashed, their people began to flee. Russian scientistssurfaced in New York as taxi drivers. The best and the brightest Polishyouth became bartenders in London. Some of the most eligible women inEastern Europe married the underclass in the West. Mittal bought steelmills in Eastern Europe for pittances and went on to build the largeststeel company in the world. It was an unparalleled human tragedy for somany, but was also the greatest arbitrage opportunity for some.

Chinaand India also shifted their economic orientation at about the sametime. They were small and agrarian economies at the time. Their changewas felt over time as their manufacturing expanded. China, inparticular, played a remarkable role in the growth of global trade.Over the past three decades, China's exports have risen 150 times andhave probably become the world's largest, exceeding Germany's, in 2008.The speed of China's rise is unprecedented. Its size also means thatthis rise has global implications. In particular, China has been theprice setter for manufacturing products. Through relocation ofmanufacturing enterprises to China, it has had an enormous impact onglobal labor cost also.

While the collapseof the Soviet block triggered prolonged weakness in commodity prices,China's rise kept manufacturing cost low. The combination led to lowglobal inflation. Greenspan was at the right place and the right time.Falling inflation didn't have much to do with central banks at all. Inanything, they made a mistake by maintaining loose monetary policyduring this period. From the western perspective, the rest of the worldwas put on sale at a massive discount. It could enjoy the low pricesbut also face sluggish wage growth. There was a distribution challenge.The net impact was positive.

Major centralbanks, led by the Fed, made a big mistake by interpreting low inflationas a license for keeping loose monetary policy. I wrote on manyoccasions arguing that the Fed should not make haircuts more expensiveto offset the declining prices of imported shoes. In the newenvironment, neutral monetary policy could have meant declining CPI, aslong as the broadest price gauge, GDP deflator, remained positive.

Theloose monetary policies had a large impact on asset prices. Thedeflationary forces from the ex-Soviet Block and China prevented risingmoney supply from working into CPI, i.e., rising money supply didn'tlead to rising CPI. Instead, money flowed into asset markets and turnedinto rising asset prices. Bond prices rose and yields dropped sharplyin the 1990s. When bond market couldn't take in more money, it flowedinto stock market and formed a bubble in tech stocks. When the techbubble burst in 2000, it flowed into property market through new creditinstruments. Property prices were already overvalued during the bondand tech bubbles due to falling financing costs and rising wealtheffect. The latest bubble made credit available to people who couldn'tqualify. Most of the excess money growth in the world since 2001 hasgone into property.

The bursting propertybubble has cast a long shadow over Greenspan's legacy. A mini industryhas risen to revalue his legacy. For self defense, Greenspan wrote acolumn titled 'We will never have a perfect model of risk' for theFinancial Times on March 17. He defended his long-held view that acentral bank couldn't identify a bubble ex ante and could only lessenthe pain by loosening monetary policy after a bubble had burst.Further, he claimed that property bubble was taking placesimultaneously in many countries and, hence, the Fed's policy couldn'thave stopped it. He is wrong on both counts and should bear majorresponsibility for today's catastrophe.

Bubbleshave happened repeatedly in modern history. The basic valuation metricsusually tell the story. When a stock market rises substantially abovethree times book value, it is usually a bubble. When property pricerises substantially faster than income for three years or longer, it isusually a bubble. Of course, exceptions have happened in the past andcould happen in future. However, because tolerating a bubble has such aserious consequence in future, a central bank should lean against anasset market even when it is not 100% sure that it is a bubble.Greenspan's logic is the opposite. He believes that a central bankshould tolerate a rising market trend for as long as possible becauseit cannot be sure that it is a bubble. His philosophy doesn't balancethe benefit of the current boom against the potential loss of a futureburst. I was just shocked how the best and the brightest bought intohis argument. That shows the power of wishful thinking even amongthinking people.

Greenspan's recipe forhealing is also flawed. Excessive money supply is usually part of abubble story. When it bursts, printing more money could worseninflation problem. Nobody questioned his recipe because inflation wasnot a significant concern at the time. But, printing money eventuallyleads to inflation. Printing more money leads to more inflation. TheFed is doing what Greenspan prescribed. The world is now inflationprone. The Fed's policy will cause inflation to peak a high level. Ofcourse, the current Fed inherited the bubble from Greenspan and doesn'thave a choice. The government has refused to use fiscal policy tostabilize the financial system. Between financial and price stability,the Fed is now choosing the former.

Thesecond part of his argument is that property bubble was happening in somany countries that the cause couldn't be the Fed. That is again wrong.The forces that I described brought inflation down globally and madeinflation less sensitive to money supply. The Fed took the lead inexpanding money supply among all central banks. As the dollar is thebase currency for global trade, other central banks faced the choice ofcurrency appreciation or following the Fed. Most were concerned abouttheir economies and opted to follow the Fed, i.e., the Fed was the mostimportant factor in causing property bubbles around the world. Onebyproduct of globalization is that monetary policy generates externaleffects. If one country suppresses inflation, it suffers less growthand helps bring down inflation elsewhere. The spillover makes eachcentral bank reluctant to tighten. This dynamic has a serious impact onhow inflation evolves over the next two years. The net effect is thatinflation will peak at a level that all central banks panic at the sametime.

The global economy is now at the endof a cycle, characterized by a bursting bubble and slowing growth. Indue time the economy will surely recover and another cycle will begin.The dynamics of the transition are important. I believe that centralbanks will tighten before the new growth cycle kicks into full steam,as they switch from financial to price stability in the second half of2010. The global economy will probably have a double dip then. Thesecond dip is probably more serious than the current one.

Amore interesting and longer term perspective is how the next cyclediffers from the current one. I believe that inflation will become muchmore sensitive to money supply. Ceteris paribus, interest rate willhave to be higher to maintain price stability. This forecast is basedon the view that (1) the countries in the ex-Soviet block haverecovered and (2) China has reached the limits of low cost expansion.The strong disinflationary forces in the past two decade were one-time.As central banks tackle cyclical issues, they should keep in mind ofthe secular change. Interest rates should be significantly higher infuture.

At the bottom of its debt crisisten years ago, Russian economy was priced below $300 billion. Itscurrency collapsed. Its real output collapsed. The former superpowerwas worth less than Taiwan. Its economy has since recovered above $1trillion and is growing at over 6% in real terms. Its currency isstrong. Due to its high inflation, the real currency appreciation ismuch higher. The recovery has depended on surging oil price, which ispartly due to western monetary policy. The rising income has led torecovery in its own consumption of natural resources. Russian domesticoil consumption shrunk by half between 1989-99. The reduction washigher the demand growth in China during the period. Its demand is nowgrowing at over 4% per annum. While rising oil price is the main driverfor its recovery, its expanding economy is raising its own oil demand,which is inflationary for the world.

TheCentral and Eastern European countries in ('CEECs') have joined theEuropean Union and have made great progress towards reaching westernliving standard. Like Russia, they suffered weak economies and weakcurrencies in the 1990s. Their economies grew by 1.2% between 1989-99.They have improved in the current growth cycle and have averaged 5%growth rate since 2000. These economies already total $3 trillion indollar terms. Similar to Russia, their oil consumption shrank by morethan half between 1989-1999 but is growing at over 3% per annum atpresent.

Russia plus CEECs are biggerthan China in nominal GDP and consume 70% as much oil. In terms ofresource consumption, they were a massive deflationary shock to theworld economy. Their oil consumption reduction was twice as much asChina's consumption growth between 1989-1999. Their recovery plays anequally important role as China's demand in the energy market. In termsof labor supply, the CEECs have lower unemployment rates than in theWestern Europe. Both CEECs and Russia suffer from aging like the west.Their labor market, in my view, is also inflationary to the globaleconomy. Despite strong currencies, their domestic inflation trendstell the story. The CEECs are experiencing 6% plus inflation now, muchhigher than in Western Europe. Russia's inflation rate is hitting adouble digit rate.

China's manufacturingexpansion has been the other factor keeping inflation low. The low costexpansion is now running into limits. Four key inputs-labor, land,coal, and environment are running into supply constraints. For a longtime, coal mining was not profitable. Coastal assembly plants couldorder tens of thousands of workers from central China without raisingwages. Local governments competed against each other to attractfactories by offering cheap industrial land and tax breaks. Theyignored environmental protection as an incentive to factory operators.

Coalaccounts for two thirds of China's energy consumption. Its price hasbecome sensitive to demand growth as all mines are producing at maximumcapacity. We can only guess the price elasticity to demand growth. Itmay be 3-5, i.e., 10% growth may cause price to rise by 30-50%.Measured at international prices, China's energy consumption cost isalready over 10% of GDP. Of course, price control and subsidies keepthe figure a bit lower. As the share of energy in GDP is so high, itsprice increase causes inflation to rise significantly. Hence, asChina's manufacturing expands, its energy cost will rise as a share oftotal cost.

Youth labor is in 'shortsupply'. The Pearl River Delta ('PRD') has been reporting labor'shortage' for three years. It actually reflects that the PRD is notraising wages to market equilibrium levels. That is a major turningpoint in China's labor market. Until two years ago, the PRD factoriescould get as many workers as they wanted. They usually negotiated withinterior governments first before they would help in recruitingworkers. The negotiations were to keep the wages from falling. Theexpansion of the economy and the shrinkage of the youth pool are thereasons for the turnaround. In future, factories have to raise wages ifthey want to expand.

Residential andcommercial land prices have skyrocketed in China, in many tier-1 citiesby 10 times or more since 2000. Local governments still try to keeptheir industrial land prices down to keep or attract more factories.However, land inflation works into overall production cost neverthelessthrough rising living cost, which needs to be offset by wage increase.Many companies already consider local property prices in selectingexpansion locations. My guesstimate is that property price determineshalf of the wage level.

Last but not least,lax environmental protection has been a significant factor in China'slow cost expansion. When manufacturing expansion began two decades ago,the level of environmental degradation was low and the incrementalpollution was small relative to the environmental capacity. Now, theenvironmental degradation has reached the limits and, as manufacturingnow is ten times bigger than two decades ago, the incremental pollutionis large. China has to adopt stringent environmental protectionstandards to prevent a disaster. That is another factor in raisingproduction costs.

Emerging economiesinflate for many reasons. Excessive monetary expansion leads tocurrency depreciation and inflation. This is not necessarilyinflationary for the world. Depreciation and inflation can cancel eachother in terms of the effect on other countries. For example, China'sinflation was -4% in US dollar terms in the 1980s and zero in 1990s.Hence China was deflationary for the world. But, the dollar inflationhas averaged 5.1% since 2000, higher than the inflation rate in the US.The trend is still up. China is likely to be inflationary for theglobal economy in the next ten years, i.e., its dollar inflation ishigher than that of the rest of the world.

Therecoveries of the CEECs and Russia have removed a major deflationaryforce in commodity demand. If anything, their demand is rising fasterthan the world as a whole and is an inflationary force. Their labor isno longer deflationary due to aging and domestic demand recovery.China's manufacturing expansion is running into input constraints. Itsinflationary pressure cannot be removed by building more factories.

Themost important implication of the inflation conclusion is for the bondmarket. It experienced one quarter century of a bull market startingfrom early 1980s. The 10Y US treasury yield declined from a doubledigit rate to 3%. If my analysis is right, it is entering a prolongedbear market, possibly lasting for ten years.

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

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