Should we consider inflation a serious problem? I do think there are reasons for that. This article on Washington Post gives a good overview of the situation we are facing. The biggest question is whether the price hikes are temporary or longer term. So far despite the 5% hike of Consumer Price Index CPI — higher than expected — governmental officers and many economists are still claiming this is transitory and not to be worried about in the long run.
I agree that some higher prices are temporary, caused by short run reasons like the ingredients shortage in Starbucks stores and difficulties faced by the global shipping business. The whole world is gradually coming out of a deep hibernation for more than a year and things simply do not come back at the same time, especially at the global scale.
Although all pandemic relief measures are meant to be temporary, and although the number of new hires is temporarily lower than expected according to NYT, partly because some people are still waiting for their vaccination shots so they voluntarily withdrew themselves from the pool of available workers, we must face the reality that transitory measures and temporary problems can have ramifications and spillovers into the long run.
The Wage Hikes
Two things concern me more in the longer term. The first is wage. We all know wage hikes are less reversible, meaning once they increased, they don’t come down easily. It is true that the signing up bonuses are temporary but not higher wage offers.
Like everything else in the economy, this is a “people problem.” For example, while some people cannot wait to go back to their normal office hours, others are feeling entirely comfortable working from home from now on. We should be mindful of both groups of people.
“This latest report from the Labor Department highlighted the puzzling fact that millions remain on the jobless rolls even as many employers complain of worker shortages.” I think new hires falling short because of a “mindset disparity:” While employers are anxious to get back to their businesses, employees do not share that anxiety — both because of the relieve cash payments from Uncle Sam and because of waiting for vaccination shots. Facing a hard time finding available workers and trying to get ahead of others in having the best employees, what employers do? Raising wage offers of course, in addition to sign-up bonuses.
Something else also joined the latest wave of inflated prices to make it a perfect storm: The tech subsidy is or will be gone after the pandemic for firms like Uber/Lyft, MoviePass, DoorDash, AirBnb and Bird/Lime.
The China Effect
The other big and longer effect is related to China. Going back in the recent history should help us understand why this time is different. Quantitative easing (QE) increases money supply and lower interest rate from central banks purchasing long term government securities.
Other things equal, QE could create inflation or even hyperinflation but that’s not what we have observed. One important reason is that the money made available by the central banks like the Fed has been largely retained by the financial institutions to make their balance sheets looking better instead of turning them into M2 in the real economy. For example, according to Investopedia, “At its pre-coronavirus peak, U.S. banks held $2.7 trillion in excess reserves, which was an unexpected outcome of the Federal Reserve’s quantitative easing program.”
But inflation is not only caused by monetary policies. The old story of supply and demand in the real economy still matters. On the supply side, higher wages and more expensive raw materials will push up the prices down to the consumers — eventually if not immediately. On the demand side, after the pandemic, it is possible that both need-based demands (e.g., housing, foods, medical care and utilities) and want-based demands (e.g., cosmetics, automobiles, and jewelry) will see a spike. All it takes for inflation to occur is when demands are higher than supplies. If you read this article from the WSJ, you will see that demands this time come back faster than the past.
It is here that the China factor gets into play. This article in Chinese discussed something interesting to help us explain why in the past the QE has not resulted in hyperinflation or even mild inflation in the States. A domestic production overcapacity forced Beijing to push for more exports of goods, mainly to occupy the US market. Government thus provided subsidies to export-oriented firms so they will not raise the price even though their COGS (i.e., cost of goods sold) were somewhat higher. In a way, it is the Chinese fiscal spending that subsided the US consumers so they can buy super cheap goods through outlets like Costco, Walmart, Dollar Trees and the 99 Cents only stores — keeping the US inflation at bay over the years — even though for years Washington has been criticizing Beijing for state subsidies.
The story is believable because it has been a common knowledge among Chinese that many goods produced by Chinese firms have been selling at higher prices in China than in the US, even after converting by the official exchange rate.
I have another explanation to the same phenomenon: Chinese firms really take pride in being able to export to the US market. For decades it has been the case that if your products can be sold in the US, it is like putting a stamp of quality to that brand. It is kind of saying to the domestic consumers: Hey, our products have been exported to, and sold like crazy in, the US market! It’s your loss if you don’t buy it from us!
Guess what, it works in China because although Beijing has been selling Xi Jinping’s confidence doctrine, deep down the Chinese are not really confident. They still need the signal of appreciation by American consumers to help them decide what to purchase at home.
The Changed Conditions In China
Anyway, the above article discussed several conditions for the fiscal subsidy based anti-inflationary case to be sustainable. First of all, there is cheap labor supply to suppress inflation in China. Secondly, the environmental cost of producing exported goods is not too high. Thirdly, domestic resources such as electricity are in stable supply. Finally, fiscal capability is there to provide steady subsidy, which holds if no population aging and military spending is relatively low. None of these conditions seems to hold today.
I would add another two factors. The trade war is likely to lower the willingness of fiscal subsidy from Beijing, and with supply chain diversified to other South East Asian countries like Viet Nam and others, it is up to their governments to decide whether to subsidize the exports.
Long story short, this time I think China is unlikely to maintain its fiscal subsidy to goods sold to the US, which means the US will have to depend on itself to fight inflation. The first thing Washington can do is to get rid of the trade war tariffs from the Trump era to make the goods from China cheaper. It’s a lousy step anyway in the first place, because it is the Americans, not the Chinese, who shoulder the most of the tariff burden.