I’ve been thinking a lot about inflation, banks and China. After reading “France, Gold and the Great Depression”, I was wondering how the western world’s “secular stagnation” could be related to China’s rise. Before the Great Depression, France and the rest of the developed world had opposite problems. France had just gone through a strong inflation, and didn’t want more. The rest of the world was dealing with deflation. By sterilizing gold inflows, the Banque de France essentially forced the rest of the world to deflate down to French prices with disastrous consequences for credit.
See related articles:
- Is more inflation just around the corner? What bank balance sheets say
- The Tremendous Value In Chinese Banks (If You Can Stomach The Risk)
In a sense, the same has been true during the last 10 years. China has been dealing with inflationary pressures while Japan, Europe and the United States have had the opposite. Lower interest rates have chased lower and lower inflation. To deal with this problem, China has accumulated huge reserves of US dollars rather than let the exchange rate take care of ‘inflationary’ pressure, essentially treating dollars like gold. Chinese prices have adjusted upwards to some extent, but American working class wages have adjusted downwards towards Chinese levels as well.
What has been great for consumers has hurt those without the skills to compete against the Chinese millions joining the global economy. The Federal Reserve has tried to keep aggregate demand stable, but faces calls to tighten whenever some class of assets bubbles upward (internet stocks in the 1990’s, houses in the 2000’s, the whole stock market now). The addition of millions of low-cost workers into the global supply chain means lower prices. This helps consumers. But it also means lower expectations of prices and wages, which helps companies, but hurts prices and debtors.
The Federal Reserve chasing interest rates lower to keep demand stable has meant asset prices keep soaring in different places. So the chain of causation runs from China lowering prices –> US wages adjusting to new competition –> low interest rates raising asset prices. You’re willing to buy more stocks (savings pay nothing) and take out more debt (servicing doesn’t cost as much).
Inflation is starting to look like a balloon animal. The Federal Reserve blows one balloon to raise wages, but instead raises housing prices or stock market indices. With so much new capacity, it seems like the Fed is powerless to raise inflation where its needed.
In the 1920’s we fetish-ized gold. Today we fetish-ize cash. The Fed and ECB and Bank of Japan have been so good at keeping inflation at 2%, we have greater and greater incentive to horde cash because we don’t expect its value to inflate away. So now when the Fed pumps more money into the economy, it shows up as investments in assets rather than increases in wages. Too many dollars chasing too few assets, but not chasing wages because its so cheap to make stuff.
In the end, it seems like there are two choices for this economy: either the Fed will lay off rate increases until wages inflate to reach asset prices, or the Fed will increase rates too soon and asset prices will fall (once again) back to wage rates. When markets expect the former, they react with joy. But when they fear the latter, they become rightfully very afraid.