Morning is the most important time in a day. I overslept yesterday and did not feel as energetic as I am used to for the whole day! Of course, I don’t want to be too harsh to myself, as humans are not machines and we all have ups and downs with our bodies.
Inflation: Diagnosis Vs. Forecast
I found the debate on overheating /inflation interesting, started by Larry Summers in his open-ed in Washington Post, followed by his reply to responses to his initial piece. The NYT picks it up and calls it the “Great Overheating Debate of 2021.” It gathers opinions from ten prominent economists. We also have seen this one by Krugman on not panic about inflation.
I like the pieces by Summers the most, both his original and his follow-up thoughts in response to comments of others. In general, I care more about how to understand inflation/overheat than how to tell an overheat or a stagnation when it arrives. That is not to say diagnosis does not matter, just that we want to cut deeper in developing a formula for inflation. Remember, good forecasting always requires deep understanding of the thing we are forecasting about.
The China Factor
Surprisingly nobody has mentioned China or even international economics, which to me will play an important role in an updated inflation formula in the US.
China and international economics matter in a post-globalization world because the Fed has become something of a central bank of the world, while the US economy has become something of a global economic platform similar to social platforms like Facebook or Twitter.
Sure, if it had a choice, China would like to start its own platform — at least to increase the global share of transactions using RMB the Chinese dollars — just like Donald Trump wants to establish his own social media. But China and Trump face the same uphill battle of challenging the existing —and strong — mainstream platforms. By the way this is another reason, among the most important ones, that the US does not need to lose its self confidence to China.
The notion of platform explains (1) why the US can effectively punish many leaders in other counties (2) why over-using the platform sanction will encourage countries to overthrow the system; (3) why international economics is the most important branch of the economic science today; (4) why the US can and will punish others for seemingly pure domestic violations of its values, just like Twitter did to Trump; and (5) why it is wrong for China to say that the US, UK and Canada only account for 5.7% of the world population, because it ignored the platform power possessed by the US and its allies. What the NATO boss Jens Stoltenberg said is closer to reality that the US and allies together “represent 50% of the world’s GDP and 50% of the world’s military market.” In addition to their platform power that China and Russia do not possess.
The Monkey & The Buddha
In the famous novel Journey to the West (西游记) that every Chinese knows, a rebellious monkey went up to the Heavenly Palace to make a big mess, and the Heavenly Emperor (玉皇大帝 in Chinese, a fictional figure in China’s Taoism) came to the end of his wisdom in figuring out ways to control the monkey. He then requested the help from the almighty Buddha.
Buddha came and made a bet with the monkey. He opened his palm and told the monkey if he could manage to jump out of his palm, he would be allowed to be the new Heavenly Emperor. The monkey was excited: “A single tumble of mine could reach a place 180,000km away, your small palm was nothing.” Guess what, the monkey had multiple tumbles just to be sure and in the end he saw five giant pink pillars. He thought he had reached the end of the universe. Then he heard the voice of Buddha, sounding from far far away: “You lost the bet!” The monkey protested: “What do you mean? I am at the end of the universe! You see, I am here!” But it turned out those five pink pillars were just the five fingers of Buddha. After all, the money was still in the palm of Buddha even after multiple tumbles.
This has long been the famous proverbial saying known to an average Chinese, “A money cannot jump out of the palm of Buddha.” (孙悟空翻不出如来佛的手心) The US is like the Buddha and China is like the monkey. The latter may be powerful, but it must play the game with rules set up by Buddha — at least for now and for the foreseeable future of five decades from now, when it is estimated that China will have the same or higher per capita GDP than the US, a forecast that may never materialize.
China May Not Want To Be The Monkey
But what makes China more powerful than Trump is that China (i.e., the “monkey”) does not have to jump out of the palm of the Buddha (the US), but instead is willing to work within the existing platforms. It can then play an important role even more so than having to start from scratch.
The biggest disadvantage of latecomers like China is the existing systems, brands, frameworks or platforms long before they came along, and it would cost too much to build something new, with no guarantee to success. Therefore, an approach of working within the existing platform will be far more efficient, far less risky and far more likely to bring out win-win outcomes — for both China and the US. China has made it clear that it knows that, what worries me is that some (or many?) Americans have fail to understand that. Implicitly or explicitly, they ask that US do what Buddha did: Burying the China monkey under the Mountain of Five Fingers (五指山) for 500 years until a good-hearted monk agreed to accept the monkey as one of his apprentices to protect him in the journey to Indian for learning the Buddhist bibles — how the story ended in the classic novel of Journey to the West.
The possibility that the “China monkey” would work within the palm or platform of the US Buddha is why I believe we cannot understand — and forecast — US inflation without adding the China factor to our formula or equation. If double negativity sentence is confusing, a better way to say it is we must add in the China factor in an updated inflation formula for the US.
Can The US Work With Two Goals?
The question raised by Summers is essentially whether — and how — the US could have the cake (stimulating the economy, helping the vulnerable and fighting the pandemic) and eat it (avoiding run-away inflation, recession or stagnation). Given the size of the stimulus package (13% of GDP) so far, with an even bigger public spending package to follow, Summers was definitely right to be concerned. We should all thank him for sounding the alarm.
Furthermore, Summers presented an open-ended question, not a definite conclusion. In his own words, “I was careful to speak of inflation risks rather than to confidently predict that inflation will happen.” I believe he maintains an open mind, again in his original words, “the proposed fiscal program seems extremely generous, but perhaps it can be justified in the debates that are ahead.” He is definitely not one of the conservative thinkers that any government intervention is bad, crisis or not. Instead, he has sincerely hoped the current project would work out nicely.
These things allow Summers to win my respects. But still, we must address his questions and see if we can add some new insights toward the answer.
A Two-Key Solution
There are two keys for a good solution of meeting both goals. Summers already proposed a good one, that is “a substantial part of the program should be directed at promoting sustainable and inclusive economic growth for the remainder of the decade and beyond, not simply supporting incomes this year and next.” In other words, go easy, slow and aim something in the longer term, more investment than consumption or spending. The risk of jumping in too quickly, with a lump sum too large at a time is that inflation may jump out and eat up the gains sometimes in 2022-2023. Worse, permanent expectation of inflation may lead to stagnation and hard-landing.
Put simply, if we go easy in, we may come out easy.
So far we are assuming that the US is facing the challenge alone by itself, without anyone else coming to its assistance. Of course this is not true with the reality in today’s world. The other key therefore is to leverage helps from others, especially from China.
Why China Would Help
China will play important and multidimensional roles to help the US. The nice thing here is that China does not have to be a good hearted international Samaritan, because for the most part helping the US is to the best interests of China.
For one thing, given the US economy is a platform of the global economy, saving the shared platform is good for all of us. Xi, Jinping was right to propose and promote the notion of “A humane community of shared destiny” (人类命运共同体) because like it or like, we are all on the same boat together, especially when crises hit. Americans have seen these words as empty propaganda and nobody gives a damn. To make things worse, Xi and China are inconsistent: They speak like Confucius when they talk about shared destiny, but act like Marx when they promote the “Wolf Warrior” diplomacy. We have seen China like a “Sphinx”: A Confucian face but with a Marxist body.
It is possible sometimes for China to consciously offer help — with reasons of its own. After the 2008 financial crisis in the US, China had an economic stimulus plan at the size of RMB 4 trillion (US$586 billion). The financial crisis by the way was the first time for China to recognize that the US management of economy was not perfect, before then Beijing had treated Washington as a perfect tutor in economics. Beijing then wanted to show the world it can do better than the US, in addition to minimize the impact of the US financial crisis on its economy.
How China Can Ease the Supply of Goods
First of all, an important and straightforward driver for inflation is when demand is higher than supply of goods. If we only count on domestic supply, the US demand will be always higher than supply. But higher US demand is music to China’s ears and they would happy to help solve that problem, while keeping the US inflation rate in control by doing that.
This is not to say that short term price hikes can be ruled out, because to use an accounting term, the cost of goods sold or COGS will be higher even for China. But it would be much more reasonable relative to the price if goods were made in the US.
Lower COGS is a short term phenomenon, but in the long run, China has had a record of significantly lowering the price of goods once it figured out the technologies behind for making them. Thus in the long run this is how China contributes to the world. The harder that China tries to overcome the bottleneck technologies, the better for the world because China will quickly get up its economy of scale to lower the global price. This applies to almost everything that China can make on its own, without paying the loyalty fees for the technologies.
And it is not just capacity of supply, but matching capacity of supply. Summers cited Jared Bernstein “that balancing risks associated with insufficient and excessive stimulus is essential.” To the extend that the Biden package aims at low income individuals, China will provide the right supply of goods.
Keeping The Labor Cost At Bay
China will also help control wage growth rate in the US, because US employers now will always be mindful that they can move the jobs overseas if the local wage is too high. In that sense China is the best friend for the US economy to prevent stagnation, featuring high price and high unemployment at the same time. When the unemployment is high, it means jobs have been shifted overseas, which will keep the price low. On the other hand if the price is high, the demand for overseas supply will be pushed higher, which in turn will lower the price in the future.
In the age of globalization it is harder for the inflation to last long. China and US will become the buffer zone for each other, especially for the US with is power in international reserve money and with Fed being the de facto central bank of the world.
Another way for the US to control inflation is to invest in the growth oriented stocks overseas like China. Investors no longer are only limited to TIPS in this country.
Overall, I believe Biden has (or is) taken (or taking) advantage of the pandemic and a majority in the Congress to push for liberal agenda that normally would be hard to do. To the extent that it emphasizes long term investment to better compete with China, this is a healthy plan and with the help from China we may be able to get away from historical overheat. If we could have the Fed that is more vigilant than Greenspan was before the financial crisis, we just may have a good chance of getting two goals accomplished this time.