My Blog

May 30, 2008

According to today’s Credit Suisse Emerging Markets Economics Daily, a government official for the first time suggested that we are not going to see inflation peak this year.  Earlier this year most commentators and nearly all government officials suggested that inflation would peak in the second quarter before coming down over the rest of 2008.  More recently, as my student Shang Ning pointed out to me last week, the same commentators have shifted their forecast and have suggested that inflation would peak around August or September before starting to decline.

Now it seems that at least one official is suggesting that the peak might not come until some time next year.  According to Dong Tao, of credit Suisse:

Xu Xianchun, deputy director of the National Bureau of Statistics, has suggested that inflation might not peak until 2009.  Xu made this comment on 28 May at an investment forum in Shanghai. He said that historically the peak of inflation lags two years behind the peak of growth.  With GDP growth peaking out   in 2007, Xu argued that the worst in the inflation cycle has yet to arrive. This is the first public comment coming from the government that suggests inflation may rise further.  It is in contrast to the government's   target of a meaningful moderation in CPI inflation to 4.8% as food prices start to decline.

Dong Tao argues that there is a lot of evidence that inflation is spilling over into wages, which should result in another round of rising inflation towards the end of this year or the beginning of next.  He argues that the recent decline in certain food prices might result in an inflation “valley”, but that lower inflation in the next few months will not mean that the inflation problem is over.

I agree.  When you look at the trajectory of US inflation in the early 1970s, which in some ways resembles China today, the monetary looseness of the 1960s fed first into the “gogo” period of low inflation, low unemployment, rapid productivity growth and booming asset markets, before slowly showing up as persistent inflation in the early 1970s.  At the time, as in China today, there were strong arguments made that US inflation was not monetary but rather was caused by a series of supply shocks (the first and second big oil shocks, for example), and the US even imposed price controls in the hopes of breaking inflationary expectations. 

These didn’t work, and US inflation rose inexorably, not in a straight line (it almost never does), but with periodic declines until by the mid-1970s it became clear that the US was experiencing a monetary inflation.  Needless to say it took pretty brutal steps in the late 1970s before US inflation was finally broken.

History doesn’t repeat itself with great precision, of course, and there is no reason to assume that China today is necessarily like the US in the early 1970s, but it is worth remembering the mistaken analysis back then and consequent policy mistakes.  I am afraid that if we do see Dong Tao’s inflation “valley,” it will seriously discredit the monetary alarmists in the short run and result in yet another excuse to ignore the consequences of China’s massive monetary inflows.  One positive impact of a decline in the next month or two, if indeed this happens, is that it might make the authorities a little more willing to relax some of the price subsidies, especially on refined oil products.  Of course this would immediately feed into headline CPI inflation, but price freezes are very costly and are simply forcing inflation to spread in other ways.

The PBoC, however, continues to insist on fighting inflation.  On a report released on their website today, they warned that local governments needed to keep the fight against inflation as a priority.  If you believe, as I do, that inflation is caused not so much by nasty local hoarders and price gougers, but rather by excess monetary growth, it is hard to see what local governments can do to keep inflation down, but clearly the PBoC is still very concerned.

On a completely different topic, I saw a report on Bloomberg today about engineering studies in the US and China.  There is a lot of rather excited talk about the astonishing development of science and engineering in China, and as someone who has taught in the top two schools in the country, I am always a little bemused by the fascination the West has of the Chinese “threat” in science. 

My students at Peking University are easily some of the most brilliant students I have ever taught, but they and their professors don't seem terribly impressed by the threat they pose.  Although scientific and engineering education in China is improving, it still has a long way to go even to catch up with certain other developing countries, let alone with scientific and technological powerhouses. 

The most excited talk nonetheless revolves around the enormous hordes of science and engineering students being produced in China, and no matter how many times it is pointed out that the quality of teaching is relatively low and the educational system one that systematically discourages innovative thinking, the counterargument is always the one of sheer numbers.  On that note:

Harvard and Yale…following the lead of Princeton University and Columbia University, added to the status, staffing and visibility of the engineering schools in the past year.

...U.S. engineering and technology degrees peaked at 97,122 in 1986, and fell 16 percent to 81,610 in 2006, according to the website of the Washington-based National Center for Education Statistics.  

…Data provided by the Chinese government showed that 575,000 undergraduate engineering degrees were awarded in 2006, said Vivek Wadhwa, an adjunct professor at Duke, in Durham, North Carolina. That figure was inflated because China uses the term engineer to include auto technicians and other jobs not deemed engineers in the U.S., he said.

The actual number of engineers comparable in quality to those graduating in the U.S. may have been closer to 60,000 in 2006, Wadhwa said in a May 28 telephone interview. That's less than half of the number of U.S. graduates in 2006, he said, citing figures that include computer scientists not in the National Science Foundation survey.

Comments (7) for "Inflation won't peak yet"

The current priority of Chinese education is not innovation IMO. Innovation will happen when you have an edge. In another word, you got to master what are already been discovered first, then you can explore the unknown areas. Catching up with others in a large scale right now is a more realistic goal in China. On inflation, if we looked at the food price last year, August should be the best chance that they could control inflation this year if the food price has no big m-m jump, mathimetically speaking. By fatbrick - 5/29/2008 9:02 PM

I support your view that inflation in China is NOT going to drop later this year. In fact, I think it will spill into the core rate. The headline inflation and govt's policy on workers' wages and benefits have forced production costs to increase. This cost increase has prompted factories to negotiate higher export prices, on top of the already appreciated RMB. I experience this first hand because I have been buying products from China for my company for several years. By Ed - 5/29/2008 9:29 PM

Just wait until they have to raise the price of oil products. Sinopec says they are losing about $60/bbl on what they are selling w/ crude at $130-$135. So they have confirmed my previous estimate that at some point they are going to have to double prices. Why does the government wait ? Well, we all know why, but don't they get it that they longer they wait the bigger the oil price shock ? Will they wait until oil is at $200 and then triple the price?? The fuel subsidies in China( and elsewhere) is leading to excess consumption and thus is driving prices even higher. The irony here is that if they raise prices, they can halt the price rise. The longer they wait , the higher the market price will go as the price attempts to kill demand on a small base of consumers where prices are allowed to float. The more sinister effect of the subsidy is that they are not allowing oil consumers to become more efficient in its use. So eventually as we head to peak oil, the Chinese are going to find themselves very inefficient in energy use(esp in diesel transport it looks like). So they are going to face the mother of all energy price shocks, the longer they wait. Meanwhile everyone else is getting more energy efficient. Its also ironic that the fuel subsidy works against the government plans to try to get everyone to be more efficient. The real solution to raise prices to at least $6/gal in all countries - including the US. The tax can support alternatives while cutting down on consumption today. Secondly that money stay at home rather than going to the ME or Russia. Eventually the price is going to get there anyway. The European model seems much more sustainable. So again, the Chinese are going to get an oil price shock at some point and then the published numbers on inflation are going to run up again. By SuperDiesel - 5/29/2008 9:30 PM

The alarmist figures about people in the US not going into science and engineering are invariably in reports written by people with a vested interest in having more government funding in science and engineering. They need to be read quite critically, and with a view toward similar reports in the past that always predicted a vast shortage of scientists and engineers which all turned out to be incorrect. Something about predictions is that whenever someone makes a prediction, someone needs to archive them to see how close/far they are to what actually happened. By Twofish - 5/29/2008 11:10 PM

SuperDiesel, there is a bubble and war premium in oil price. The oil price is also determined by dollar's value. When Fed stops its monetary expansion policy, you will see the impact on oil price. Thus it will be a race about who blinks first. Also sinopec losing money is better result, economically and politically less damaging. I doubt that there is any relationship between energy efficiency and energy price. The electricity price in China is twice to three times of prices in US. I am sure that Chinese electricity useage is no more efficient than in US. By fatbrick - 5/29/2008 11:55 PM

fatbrick: if oil price is determined by dollar value why is it up in terms of all other currencies? (including the goldbugs' one) also, where does your stat on China's electricity price vis-a-vis US come from? in China residential prices are heavily subsidized and still amongst the lowest in the world. industrial prices - if we look at the NDRC prices - difference is more like 30-40%, not 2-3x. also there is a wide belief that not too many industrials end up paying the NDRC price, and cases of non-payments are systematic. in terms of energy efficiency, china is in the bottom of the league when it comes to GDP energy intensiveness measured by nominal terms (i don't see much point using PPP when it comes to physical stuff like commodity use, not much non-tradables involved here). so yes - there is a strong link, look at how Kazakhstan, Ukraine and Russia score on energy intensiveness. also look at what happened withe energy use efficiency in US, Europe and Japan in the 70s. that's electricity. in case of oil, link is even stronger than through simple demand curve price effect. if you could buy refined products at $60/bbl what would you do? buy as much as you can and resell in some shape and form abroad at $130. and you would want to buy as much as you can, i.e. increasing demand. that is why there are those diesel shortages in guangdong. this is why price controls don't work. By chegewara - 5/31/2008 6:34 AM

I have heard from a phd that US is over producing engineers and scientists. By jc - 5/31/2008 11:02 PM