The National Bureau of Statistics of China (NBS) has recently released the inflation-related data for December 2020 and the year. Both the CPI and PPI showed a turnaround trend from falling to rising, which aroused the market’s concern about China’s inflation. Some clients have also asked ANBOUND’s research team questions about inflation trends in China this year. I have a couple of views on inflation that can be seen to be somewhat “bizarre” when compared to what’s happening now. The important thing about think tank research work is to track information, find the logic behind, and form judgments and predictions. Unlike classical research, which relies on data charts and model analysis, the information analysis of ANBOUND is self-contained and often leads to the conclusion. Most of the time, as some people cannot see the logical process of prediction or judgment, they jokingly refer to such work as “wizardry”. In any case, we will make the inflation warning clear, based on logic and facts.
First, my view on inflation has been clear in the past that it is difficult to generate inflation in an environment of excess capital, because inflation translates into lower priced commodities and inventories, so none of the prices of commodities go up. This is a macro environmental judgment, but sometimes unpredictable events can occur. A period of inflation occurs when an “artificial shortage” of some commodities is created in several key commodity areas or during an emergency period, such as the surge in pork prices in China over the past two years that has driven up the price index. This kind of inflation can be called “price distortion inflation”. I expect this kind of inflation to return to the domestic market in China for some time to come. This time, the reason is that as the pandemic has gradually subsided, its impact has largely ended, the global economy has rebounded sharply, and as countries restructuring their production order, there has been an artificial shortage of products (raw materials, energy, or key components), which will result in inflation.
Second, the economic impact of the pandemic is complex and prone to misjudgment. Indeed, Wall Street admits that the vast majority of predictions and judgments made during the pandemic were “wrong”, with some major investment banks ruefully summarizing that their past forecasts were “all wrong”. Jan Hatzius, Chief Economist at Goldman Sachs for example, reflected at the end of 2020 that, almost all of his forecasts for 2020 at the end of 2019 were completely off the mark, as the pandemic had pushed the U.S. economy into its deepest and possibly shortest recession ever. In fact, it wasn’t just the investment banks that got their predictions wrong. As for the pandemic, the Governor of New York admitted, “Our experts were all wrong, and I’m sort of out of the guessing business.” Throughout history, several viral pandemics had a profound impact on the world. For example, the Black Death, which spread from Asia to Europe in 1346-1353, killed almost half of the European population and changed the course of European history; the “Spanish flu” outbreak of 1918-1920, which infected 500 million people from the South China Sea to the Arctic and killed one in five of them. The coronavirus pandemic has also brought about many changes, but the market has also made mistakes in judging the pandemic. In terms of the economy, the market generally underestimated the rebound of economic growth in the early stage, and overestimated the effect of this public health event on the suppression of inflation. Going forward, markets are underestimating the likely upside in growth and inflation. In short, over and over again, as the pandemic continues to ravage the world, people continue to make misjudgments.
Third, there is the risk of topping out the U.S. dollar and interest rates. The U.S. has implemented a series of massive economic stimulus packages, but has insisted on the condition that interest rates be close to zero, but not negative. This “topping out” of interest rates is a risk because it is very unstable and as the world situation and economic environment change, interest rates are bound to change, either up or down. More problematic is the fact that different changes in interest rates have opposite effects. An increase in interest rates would lead the world back to conventional finance; a decrease in interest rates would link to the MMT (Modern Monetary Theory) and would lead to the modern era of monetary excesses. The U.S. Federal Reserve is in effect the world’s central bank, making it difficult to keep interest rates at zero for long. According to the latest Dow Jones survey, economists expect the U.S. CPI to rise 0.4% month-on-month and 1.3% year-over-year in December 2020, and the core CPI, which excludes food and energy to rise 0.1% month-on-month and 1.6% year-over-year. With the Fed’s 2% inflation target, once inflation rises another 1-2 percentage points, the Fed could indeed raise interest rates. The U.S. Treasury Secretary nominee Janet Yellen, who advocated interest rate hikes, will have a significant impact on the U.S. under Joe Biden’s administration. Once the now seemingly impossible U.S. interest rate hike does occur, the dollar exchange rate will suddenly reverse and become stronger, while the RMB exchange rate will suddenly become weaker, and the burden on China’s imports will again increase, which amounts to imported inflation. Coupled with the fact that China’s economic demand will expand as the pandemic ends, an “artificial shortage” due to “misjudgment” could emerge and inflation would follow suit.
Fourth, inflation is dangerous for China. A prolonged period of excess capital and low inflation can easily lead to a loss of vigilance, which will put the country’s economy in danger. (1) China also seriously underestimates the rebound of the world market, and the main tone of domestic public opinion is “the only country with positive growth”, that is, “only China’s economy is doing well and other countries are not doing well”. If this view is over-reinforced, we fear that China may suffer from it in the future. (2) Food could become an effective weapon in a geopolitical war, which is China’s biggest weakness in terms of trade wars. China is the world’s largest importer of food, and it will lead to starvation if it does not import food, which will seriously reduce the quality of life and drive-up inflation. (3) The “pork cycle” that has been troubling prices in China has not yet ended. Even with more pigs being raised, the issue of pig feed is closely linked to inflation. As a result, the price of pig feed, such as corn price, is bound to rise, which in turn will drive-up inflation. (4) Policy formulation has nothing to do with forecasting. This has always been a problem in China, where policy is focused on what is under the radar of one’s own department, resulting in “macro imprudence” (the exact opposite of the monetary policy framework), so that domestic policy does exactly the opposite of what the situation requires, which is likely to exacerbate inflation problem. Therefore, I am not optimistic about China’s inflation in 2021.
Fifth, the Fed, which used to target inflation at an annual average of 2%, has generally tightened monetary policy before inflation has consistently stood above 2%. In September 2020, the Fed incorporated an “average inflation rate of 2%” into its monetary framework, and after assessing full employment and 2% inflation, the Fed will tighten its monetary policy. In 2021, however, the Fed may not have such a leisurely chance of making a policy change. How the Federal Reserve would respond to the impact of the pandemic has been determined by non-economic factors, and the economic lessons of the past no longer work now. For these reasons, I expect the dollar to undergo dramatic shifts in response to sharp policy shifts.
Sixth, when will inflation occur? It is risky to make a judgment on when this will happen, and even investment banks should be cautious about it, preferably vague. Given a non-normative “wizard” view, I believe that from the perspective of time, inflation is more related to the pandemic, and both factors are positively correlated. When will the pandemic situation improve? I think it is likely to be this summer, due to warmer temperatures and the widespread vaccination. As it stands now, it will take a few more months for the widespread vaccination.
Broadly speaking, this is as much of the situation as can be seen right now. While the stock market is surging, it is important not to forget that 2021 will see a sudden rebound in the economy, a rebound that is likely to exceed everyone’s expectations and lead to higher inflation, especially in China. Therefore, China must be highly alert to the risk of inflation in 2021. It is also important to realize that rising inflation must be a global event, the impact of which will be significant and its effects will be numerous. This issue is expected to be discussed continuously in the future market.
Final analysis conclusion:
China is likely to see “price distortion inflation” in the future, which will be fueled by artificial shortages caused by the restructuring of production order around the world as the impact of the COVID-19 pandemic ends and the economy rebounds sharply. For China’s economy, which has many internal problems, it is particularly important to be alert to the risk of rising inflation.
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