US ‘peak’ inflation talk misses the China point

Cost of everything from oil to food to to consumer goods will spike everywhere as China reopens from zero-Covid lockdowns

WASHINGTON — Euphoria over a “cooldown” in US inflation ignores a vital variable: how China’s reopening process is about to propel commodities prices even higher.

This cooldown argument is fast gaining currency following reports that showed prices rose just 7.1% in November year-on-year. US Treasury Secretary Janet Yellen has hit the news circuit to make the cooldown case.

With the most aggressive Federal Reserve tightening cycle since the 1990s and the inflation-reduction scheme enacted by US President Joe Biden’s Democratic Party, Yellen says prices are going to continue surprising to the downside.

But not if China’s Covid reopening trade has anything to say about it. The sheer speed of President Xi Jinping’s pivot away from “zero-Covid” lockdowns is about to reintroduce the power of Chinese demand into global goods markets.

As 1.4 billion Chinese move around more and spend more freely, the cost of everything from oil to food to airfares to lodging to consumer goods everywhere will soon experience one of history’s greatest demand-pull inflation surges.

“Surely it will push up global inflation if China reopens fully,” says economist Iris Pang at ING Bank. “There will be more international travel, more sales, more production.”

In a recent report, economists at the New York Federal Reserve argued that “what happens in China does not stay in China.” They conclude that “specifically, we find that expansionary credit policies in China lead to notable increases in commodity prices, global production, and GDP outside of China driven by higher Chinese demand.”

New York Fed economist William Barcelona says that “because of China’s importance for global consumption, stronger Chinese growth raises global growth prospects, inducing an increase in global risk sentiment and an expansion in global asset prices and global credit.”

Sung Won Sohn, an economics professor at Loyola Marymount University, thinks China’s rebound along with an intensifying conflict between Russia and Ukraine will put upward pressure on costs everywhere. He adds that there’s another “800-pound gorilla” in the mix: the cost of labor.

“The job market is hot, especially in services including health care as well as leisure and hospitality,” Sohn says. “There are a lot more job openings than the available labor supply, leading to a low jobless rate and rapid wage growth. To be sure, the Federal Reserve’s campaign to slow economic growth eventually will have a dampening effect on the job market, but it will take time.”

Jerome Powell faces an inflation-recession dilemma. Photo: AFP / Graeme Jennings

Analyst Edward Moya at OANDA notes that the China effect may explain why the Fed is not letting down its guard on runaway inflation. In the statement surrounding the Fed’s 0.5% tightening move on Wednesday, policymakers signaled more rate hikes to come.

“The Fed did not welcome the disinflation trends that have just started to emerge and focused on robust job gains and elevated inflation,” says analyst Edward Moya at OANDA. “Any hopes of a soft landing disappeared as the Fed seems like they are committed to taking rates much higher.”

A key problem is the US has been trying to curb supply-side-driven inflation with monetary tools better suited to addressing demand-side pressures.

Biden did indeed enact legislation to curb consumer prices. Moody’s Investors Service and Fitch Ratings think a US$430 billion bill he signed in September to lower the cost of healthcare, prescription drugs and energy will cap inflation over time.

But the real heavy lifting needs to be rekindling US innovation and raising productivity. Biden’s earlier $300 billion investment in research and development plan to raise America’s economic game came along with moves to improve physical infrastructure and add momentum to clean energy innovation.

Some economists think it might already be bearing fruit. “Another downside inflation surprise not only validates a Fed decision to slow the pace of rate hikes, it also raises hopes that the inflation surge may actually be tamed within the next 12 months,” says economist Seema Shah at Principal Asset Management.

Economist Bill Adams at Comerica Bank adds that “inflation was terrible in 2022, but the outlook for 2023 is much better. Supply chains are working better, business inventories are higher, ending most of the shortages that fueled inflation in 2020.”

Unlike his predecessor Donald Trump, Biden wants to rebuild economic muscle at home, not just tweet at China and spin Washington’s wheels for show. Still, Biden’s efforts to resurrect America’s animal spirits have only just begun.

So far, Biden’s administration has had only modest success in raising America’s competitiveness. Meantime, the Fed’s rate hikes are working at cross purposes and discouraging investment in R&D.

Biden needs to make up for lost time during Trump’s 2017-2021 presidency. Trump’s massive $1.8 trillion stimulus package did zero to incentivize investments in semiconductors, innovation and productivity-enhancing technologies that might be curbing inflation pressures today.

Now that Trump’s acolytes in the Republican Party are about to control the House of Representatives, Biden can expect to pass little in the way of new legislation. That, as China spends trillions to be the dominant power in 5G, semiconductors, biotechnology, electric vehicles, artificial intelligence, consumer electronics and renewable energy.

A Beijing shop for Chinese telecom giant Huawei features a red sticker reading ‘5G.’ The company has been targeted by US bans. Photo: AFP / Nicolas Asfouri

As Nobel laureate Joseph Stiglitz at Columbia University observes: “The US might know how to make the world’s best bombers and missile systems, but they will not help us here.”

The West, Stiglitz notes, “must once again make our economic, social, and political systems the envy of the world. In the US, that starts with reducing gun violence, improving environmental regulations, combating inequality and racism, and protecting women’s reproductive rights. Until we have proven ourselves worthy to lead, we cannot expect others to march to our drum.”

The answer, he argues, is “we must offer concrete help to developing and emerging-market countries, starting with a waiver on all Covid-related intellectual property so that they can produce vaccines and treatments for themselves.”

Another inflation wildcard: whether Biden and Xi can put US-China trade relations on a more constructive footing.

Washington’s row with Beijing over technology intensified this week with Biden’s White House confirming talks with Japan and the Netherlands about shutting off the flow of semiconductor manufacturing equipment exports to China. Team Biden, meantime, is seeking to add another three dozen Chinese companies to its trade blacklist.

A bill in the US Senate bill has bipartisan support to constrain China’s tech ambitions. It aims to cut the access of Huawei Technologies Co and other foreign firms from the globe’s biggest economy. It comes amid broad support among US lawmakers to reduce Beijing’s influence, particularly where Huawei is concerned.

In November, the US Federal Communications Commission banned Huawei, ZTE Corp and certain telecom companies from selling to US consumers or working with American banks.

As US Senator Tom Cotton, an Arkansas Republican, puts it: “We cannot allow Huawei and the Chinese Communist Party to have access to Americans’ personal data and our country’s most sensitive defense systems. We must address the dire threat these Chinese companies pose to our national security.” 

Yet such moves might backfire as global tech prices increase in response. These odds increase as Xi’s government hits back. Earlier this week, Beijing challenged Biden’s move to end sales of advanced computer chips and chip-making equipment at the World Trade Organization, labeling the gambit “trade protectionism.”

For now, economists including Zhang Zhiwei at Pinpoint Asset Management think China’s muted domestic inflation rates leave room for the People’s Bank of China to ease policy.

Chinese consumer inflation was just 1.6% in November year-on-year from 2.1% in October. Core inflation, excluding erratic food and energy prices, was unchanged at 0.6%. Producer prices fell 1.3% in November.

As Zhang notes, odds are “the government will do more to boost market and household confidence.”

Demonstrators protesting against strict Covid measures gathered in the capital Beijing for a second night. The measures have since been rolled back. Image: Screengrab / RNZ

Asked on Wednesday, US Fed head Jerome Powell said it remains unclear how China’s lifting of Covid-19 curbs will influence inflation around the globe. Surely, Powell argues, China’s return to unfettered global trade will affect supply chains, but also increase demand for commodities that could prove inflationary.

On Thursday, China’s Central Economic Work Conference mulled economic goals for 2023, including setting a GDP target. Xi’s team has its work cut out for it.

“The November data were way below consensus, pointing to a worsening slowdown” sure to continue into year end, says economist Lu Ting at Nomura Holdings. “Surging Covid infections will offset some of the positive impact of the easing in the near term,” meaning that the “road to a full reopening may still be painful and bumpy.”

Nowhere more than investors buying into a US peak inflation narrative that China is almost certain to blow up in the months ahead.

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