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Hyperinflation Hoax: China still cannot emport that much inflation to the U.S.

May 29, 2011 6 comments

We do not face much inflation threat here in the U.S.

It’s a never ending battle against the forces of willful ignorance over here at the Trader’s Crucible. We now have Soc Gen and The Business Insider warning about how we will be facing huge inflation from China.

One thing you’ll notice in many of these hyperinflation hyperventilation pieces is a distinct lack of math. Yes, the story sounds good – China and India are growing rapidly – but the math does not support the story that there is an ocean of inflation that will swamp the U.S.  The numbers do not support this narrative at all.

The math is simple: Take the total amount of inflation in the U.S. and China, and then divvy it up anyway you like.  The total amount of inflation will remain nearly the same no matter who gets it.  If you want 0% inflation in China and see what happens to inflation in the U.S., you can do this with math.

Note that the total size of the combined Chinese and U.S. economies is huge.  Some of the inflation that China is experiencing must be allocated to China as well.

Total Inflation Calculations for China and U.S.

I wrote a whole post on what to do and how to do it.  It is not hard work and requires nothing more than a few spreadsheet calculations.  I used extremely aggressive assumptions about inflation for China at 10% in my calculations.  But even using this very high 10% figure, there isn’t that much inflation in the world.    Unless something fundamentally changes, the U.S. does not face a huge inflation threat from China.

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Why China is not an inflation threat

February 15, 2011 1 comment

There is another whiff of panic – panic! – at a 5% China inflation print. I went through the math before in some detail. In my analysis, I assumed that China was lying and China had 10% inflation across the board – more than double the level given by the government.  Then, I also sized the Chinese economy at the maximum size.  Even if China does have 10% inflation, the inflation threat to the U.S. is very, very small.

The idea I used is that there is some amount of “total inflation” out there, and this inflation can be spread among countries.  It’s like an inflation pie – changing the cut of the pie doesn’t change the overall size of the pie.

To figure out how much total inflation we have in the inflation pie, just multiply the inflation rate by the size of the economy.  Then, you can take this “total inflation” and give it to anyplace you like.   This is similar to the idea of adjusting inflation rates through currency appreciation and depreciation – where the inflation does not go away, it just gets shifted to other places through the movement of currency prices.

Again, in the math I used the most aggressive inflation and size assumptions. I assumed an inflation rate in China that is literally double the inflation print from today.

Any reasonable assumptions about Chinese behavior, it is clear that the overall inflation threat from China is comically low.   Under the worst case for the U.S., China might be “hording” 1% of inflation from the United States.

I only included the U.S. in this analysis as a possible inflation sink.  If we include Europe and Japan as other possible sinks of inflation, the threat of China and emerging market inflation is almost nil.  Japan is changing their behavior and seem to be embracing inflation for the first time in memory, and Europe forced out the uber-hawk Axel Weber.

These huge economies are much more open to importing inflation from offshore then they may have been just a few months ago.  And they have very, very low inflation.

There just isn’t a real threat to G-7 countries from emerging market inflation.  The economies are too small to be of concern to the larger world economy.

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Too late, Saudi Arabia Opens the Spigot to prevent a wave of Regime change

February 1, 2011 Comments off

Highest production in 2 years is due to Tunisia/Egypt Overthrows

The transfer of government that is about to happen in Egypt was expected to have a bigger fallout in the markets than it did. So far the result have been a bit higher in oil, but all the other markets have shrugged their shoulders and got on with whatever they were doing before.

But we cannot pretend that this transfer of power will go unnoticed.  China has noticed.  Jordan dismissed their cabinet and is looking to hold on to power.  But undoubtedly the biggest risks in the world right now are Saudi Arabia and Iran.  Each of these countries face have something like a dictatorship, lots of oil, and a population that is grumbling and not exactly happy with the current arrangement.

Saudi Arabia is in better shape than Iran simply because they have spread the some of the wealth to the average citizen.  But that doesn’t mean that they are immune to the threat of overthrow.

To be clear – these protests/riots/overthrows have been due to high food inflation.  Without food inflation, these revolutions wouldn’t be happening.   Food inflation hits poor people and countries much harder, because a much higher percentage of income goes for food.  Egypt spent more of their income on food than anywhere else in the world, with nearly 40% of the average persons budget going to food.  So for richer countries, food inflation is not a risk.

Saudi Arabia has been setting the price of oil and letting the quantity adjust. This strategy created oil prices in a band from $70 to $90.  Unfortunately, it has also created substantial food price inflation.  Oil at these prices makes food production expensive.

Much of the cost of food production is dependent upon the price of oil with modern farming techniques. There is exactly 1 country that is able to swing their production of oil enough to impact world oil prices.  That is Saudi Arabia, and they have turned on the spigot.  The amount supplied last month was the highest in nearly 2 years – since Saudi arabia started pumping (again late) to try combat the price spike.

However, a reduction in oil prices will take weeks and months to begin to impact food prices.  Food price inflation tomorrow will not be contained through pumping oil last week.  Food price inflation in Q3 and Q4 will be impacted through beginning to supply more oil to the market today.

Saudi Arabia moved too late to prevent the wave of regime change due to food price inflation. We’ll have to see now what happens.  I am not an expert on this type of risk, but the markets are still very relaxed about the entire situation.  So far, most people are not worried about significant supply disruptions – otherwise the price would be $15 right now.

I fully expect Saudi Arabia to continue to flood the market with oil in an attempt to head off more price increases in oil.

China is only slightly richer on average than Egypt. However, it is common knowledge that there are wide disparities in wealth in China, and that the rural countryside is extremely poor.  What happens now with China?

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MMTer’s and Austrians kinda sorta agree: China isn’t absorbing that much Inflation

January 13, 2011 1 comment

One of my favorites, Mish, is talking about the impossibility of Cost-Push Inflation, and how China’s price level doesn’t make a difference to the level of Inflation to the United States.  He talks about cost-push inflation from an Austrian perspective.  The argument is that in an economy with a constant supply of money, an increase in the cost of one good immediately means a decrease in the cost of some other good.  I think this is a place where Austrians have a small patch of common ground with the MMT crowd.

But how can we demonstrate this minor agreement?  Well, I used a similar idea in my post to estimate how much inflation China was absorbing.  My model is more useful, and just as easy to understand.

Here is simplified model Mish is using:

Total Money Available:  $100

Good A Price: $50

Good B: Price: $50

If the price of Good A goes up to $60, then there is only $40 left for Good B.  Total cost to live in this society is still $100.  So no matter what happens to the one price, the total cost to live in this society must be $100.

Mr. Shedlock then goes on to add the demand for money to this, so there is really a third commodity, money.  We can put this into the model quite easily.  Imagine the demand for money goes from $0 to $10.  Now the Mish model looks like this:

Money Demand: $10 (aka Demand for Savings)

Good A: $60

Good B: $30

This increased demand for money causes deflation, because the total amount paid in the economy is only $90 for the same goods we had in the first scenario.

MMTers agree with this to an extent.  The major difference is the idea about how money is created. Overall, they (or is it we?) do not disagree about that demand for savings being a huge factor in determining the inflation level in the world.

I think my model is a bit more useful. Instead of just thinking about the U.S., I considered China and the U.S. as one country that could divvy up the inflation between them in a variety of levels.

Here is more on the math:

To do this exercise, I will treat China as a U.S. state that uses U.S. currency exclusively, and size China’s economy at its 2009 Purchasing Power Parity (PPP) size relative to the United States.  If we do this, we just add the two economies together to get the total size of the USD economy.  Then, we take the amount of inflation in each country and multiply it by the size of the economy to get the total amount of inflation.  After that we can play with how much inflation the U.S. would have with various China scenarios.

The math is basic, and it is as easy adding up two pies and dividing them in different ways.  My 3rd grade son was doing exercises like this the other day. I just use real world numbers that he would find more boring than watching a unicorn cartoon, but he could do the math.

The total amount of inflation out there for China and the U.S. is about 4.5%. I even used a high number for China 10% instead of the official inflation rate.  So even if China was to allow us to fully experience the inflation we should, we would have at 4.5% inflation. I think this is so unlikely as to be impossible because China will not allow their currency to float.  A more reasonable assumption – that China will allow a limited rise in the Renminbi – results in roughly 2% inflation.

Whatever China does, Inflation will be tame in the United States.

More on Inflation:

Mish ignores credit in this post.  Mish has a good idea about credit, and he has a regular ongoing dialog with Steve Keen.  Steve Keen is not quite a MMT guy, but closer to MMT with his idea of endogenous money than he is to the Austrians by any measure.   And for the MMT crew, let’s not forget that Randall Wray was a PHD student under Minsky.  Keen also is a huge fan of Minsky.  Credit and its implications are etched on the bones of every MMT person out there.  Mish talks enough about credit that I am not going to call  Mish out for ignoring credit in this one post.

Also, I think this very simple mental model leaves out many important aspects of the real world.  Importantly, it leaves out the ever improving quality of goods, and their relative worth over time.  Is the minivan (I am not a car guy) I drive today worth a huge amount more than the 1967 Buick LaSabre that my uncle gave me?  Even if they  were both new, and I could choose freely between them?

Everything about the Minivan is much, much nicer – except maybe the low purr of the LaSabre engine down the highway on a Tuesday afternoon in the Summer.

But in the $100 total world, if the car gets more valuable, then everything else gets less valuable. Should my food be worth less because my car is worth more?  But what if that other good cannot be produced at for profit at $30? Then, the world stays the same and no innovation happens.  We do not get a better car.

And everyone with kids knows that having the second kid doesn’t make the first kid less valuable.  I know I found a whole bunch of extra value in my world that simply didn’t exist before my second son was born.  To an Austrian, this innovation of the second son made me “value” my first son less.

This gets back to the very reason that Austrians hate inflation – the devaluing of things that have stable value. Should improvements in quality  for one good come at the expense of paying less for unrelated goods?  If the money supply doesn’t grow, then it must.

P.S. Can you imagine the ambulance bills if we were all perfect Austrians?  There is no doubt that the Ambulance drivers would show up and then evaluate the relative need of the person, and then quote a price to the family to take them to the hospital, especially in rural areas without easy natural competition.

Hugging PIIGS: Why China is “helping” the Eurozone Sovereign debt Crisis

December 21, 2010 Comments off

In the last few months, China has announced several times that they are helping the Eurozone with their debt crisis.

Oddly, China has not taken any steps to let the Yuan float. So – why help the Eurozone?  And why bother announcing it?

The only reason that makes any sense is because the EUR gets hammered by the debt crisis, and Germany drinks China’s milkshake when the Euro is below 1.3500 or so.   9% export driven German growth caught everyone’s eye, and China wants some of that juicy export driven growth.

Viewed through the lens of the ongoing Currency Conflict, this help does not seem to help the Eurozone as it does China.  They cannot lock the Yuan to two different currencies at the same time, but they can loudly proclaim they are purchasing PIIGS debt.  Hug a Pig!

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The Hyperinflation Hoax: How Much Inflation is China absorbing for the U.S.?

December 21, 2010 3 comments

The Chinese currency lock should be illegal, but we have to live with it today.  The currency lock has at least three major impacts on the United States.

  1. It sucks inflation from the United States
  2. It costs U.S. citizens jobs
  3. It allows me to purchase low priced toys for my children

The overall impact on the United States is debateable.  Warren Mosler believes that the trade deficit is a large net positive for the United States. The reason he thinks this is because we get real world goods for bits in a computer.  In terms of the real world, what “matters” (get it – matter?) more, the spreadsheet entries or the iPods?  Clearly, the iPod.

But I digress. Let us ask a question about inflation: How much inflation does China take away from the United States?  Or to be more precise:

If China allowed their exchange rate to float, what would the inflation rate be in the United States?

To do this exercise, I will treat China as a U.S. state that uses U.S. currency exclusively, and size China’s economy at its 2009 Purchasing Power Parity (PPP) size relative to the United States.  If we do this, we just add the two economies together to get the total size of the USD economy.  Then, we take the amount of inflation in each country and multiply it by the size of the economy to get the total amount of inflation.  After that we can play with how much inflation the U.S. would have with various China scenarios.

First, I assumed China is lying about its inflation rate and just gave it 10% inflation for the year. I used FRED data for the U.S.

The total amount of Inflation in 2010 was roughly $1.035T

Then, divvy up the inflation between the U.S. and China under different scenarios.  For example, if we gave all of the inflation to the United States, and none to China, the inflation rate is simply the total inflation divided by the size of the U.S.   economy.

This is the worst case scenario for the United States for inflation right now.  And the magic number is 7.26%.  This is pretty bad, but not hyper-inflation by any means. Of course, this will never happen – China is committed to its mercantilist economic strategy.

How about if we split the inflation normalized to the size of the economy?  The U.S. would get 61% of the inflation created in both countries – or 4.43% inflation here in the States.  Again, not bad.

However, China is mercantilist, so a more reasonable assumption would be that it slightly relaxes the currency lock and allows it to again appreciate at 3% a year.  I need to go back and do the math to determine exactly how much inflation this would push to the United States, but lets assume that it is 1/2 of the inflation sized by the economy.   We would experience about 2.2% inflation.

This post does not attempt to make any logical inferences about what might happen to the U.S. or Chinese economy, but is rather just trying to get back of the envelope estimates at how much deflation China is exporting to the United States.

Given that current Year over Year inflation is 1%, the amount of deflation China exports is significant to the United States.   However, China is not preventing hyperinflation in the United States.

Andy Xie mistakes cause and effect

November 8, 2010 Comments off

Xie gets cause and effect wrong. China locked their currency to the U.S. dollar, not the other way around. Blaming the U.S. for wanting to feel the effect of QE is projection – a basic psychological error.

QE I (thats right – the first round, much less QE II) would not be viewed as necessary without the Chinese Currency lock. If china had let their currency float 3 years ago, the Yuan would have been at least 10% stronger now. The first round of QE would have caused 2.5 to 3% inflation in the U.S. and other countries. Chinese inflation would be much less as well.

Read more…

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