If Fed Is Looking to Inflate, What Should Asia Do?

Andy Xie thinks the Fed is on an inflationary path. Last month, he wrote an article in Caijing which says that ‘stagflation lite’ is the Federal Reserve’s preferred outcome. What’s interesting is his recent article about the need for China and Japan to join forces under an ASEAN umbrella, rejecting the APEC umbrella shared with the U.S.

In last month’s article, Xie said:

The bottom line is that, regardless what central banks say and do, the world will be awash in a lot more money after the crisis than before — money that will lead to inflation. Even though all central banks talk about being tough on inflation now, they are unlikely to act tough. After a debt bubble bursts, there are two effective options for deleveraging: bankruptcy or inflation. Government actions over the past year show they cannot accept the first option. The second is likely.

Hyperinflation was used in Germany in the 1920s and Russia in late 1990s to wipe slates clean. The technique was essentially mass default by debtors. But robbing savers en masse has serious political consequences. Existing governments, at least, will fall. Most governments would rather find another way out. Mild stagflation is probably the best one can hope for after a debt bubble. A benefit is that stagflation can spread the pain over many years. A downside is that the pain lingers.

If a central bank can keep real interest rates at zero, and real growth rates at 2.5 percent, leverage could be decreased 22 percent in a decade. If real interest rates can be kept at minus 1 percent, leverage could drop 30 percent in a decade. The cost is probably a 5 percent inflation rate. It works, but slowly.

I certainly agree with him. You don’t have to be in the hyperinflation camp like Marc Faber to think the Fed takes Ken Rogoff’s suggestions about 6% inflation seriously. In a May post, I said:

Basically, the Fed wants to inflate our way out of this depression – that’s the dirty little secret. There is really no other policy choice because the mountain of debt in the United States is immense. And I think Bernanke, Geithner and Summers have proven they are willing to do anything to reflate this economy and avoid debt deflation dynamics.

And when I say anything, I mean create asset bubbles that are being given intellectual cover by the likes of Frederic Mishkin. This is a policy of economic weakness.

So what should the Asians do? China is desperate to employ its tens of millions of countryside transplants cruising its cities in search of urban employment. That’s a major reason it keeps its exchange rate fixed to a plummeting dollar, making not just Americans but Europeans irate? Japan has been in a modern day depression for twenty years. Its sovereign debt-to GDP is now over 200%, risking a downgrade.

Xie says the two should join forces – in part as a rejection of the U.S., which he basically calls a fading power (although the paragraph above points to serious weaknesses in China and Japan as well).

Here is an excerpt of Xie’s article:

Yet the fundamental case for Japan to increase integration with the rest of Asia and away from the United States grows stronger every day. Despite high per capita income, Japan remains an export-oriented economy, having missed an opportunity to develop a consumption-led economy in the 1980s and ’90s. In the foolish belief that rising property prices would spread wealth beyond the industrial heartland in the Tokyo-Osaka corridor, the government of former Prime Minister Kakuei Tanaka pursued a high-price land policy, discouraging the middle class from pursuing a consumer lifestyle as they saved for property purchases…

Today, the situation has changed. China has a capital surplus rather than a shortage. Demographic complementarity is still good and could last another decade. As China shifts its development model from resource intensive to environmentally friendly, a new complementarity is emerging. Japan has already made the transition, and its technologies that supported the transition need a new market such as China’s. So even without a new trade agreement, bilateral trade will continue growing.

An FTA between China and Japan would significantly accelerate their trade, resulting in an efficiency gain of more than US$ 1 trillion. Japan’s aging population lends urgency to increasing the investment returns. On the other hand, as China prepares to make a numerical commitment to limiting greenhouse gas emissions at the upcoming Copenhagen summit on global warming, heavy investment and rapid restructuring are needed for its economy. Japanese technology could come in quite handy.

An FTA involving Japan and China would be a serious threat to American economic power. You can imagine that policy makers in Washington are opposed to this idea. Let’s watch to see what kind of rhetoric comes out of Barack Obama’s China trip to see if this issue is discussed.

Xie’s article in its entirety is at the link below.

Source

Andy Xie: Why China and Japan Need an East Asia Bloc – Caijing

Comments

[Denis Gould:]

You may be right that the Fed wants to inflate its way out of the current situation. But the fact is that it can't. There is massive over-capacity in the world. Demand is only where it is because of massive fiscal and monetary stimulus.

Soon the world will have to begin the process of reining in crazy budget deficits. At that point we go from huge fiscal stimulus to fiscal headwinds. The impact on growth will be substantial, and will create a self-feeding mechanism of weaker growth leading to weaker public finances.

For as far as anyone can see (or until there are mass sovereign defaults - called "restructurings") the US and other developed economies will stagnate. Deflation will be the result.

Asia should indeed look inward for its economic prosperity.

Nov 11 01:23 AM

[Michael Clark:]

I think Denis is right. One of the reasons we go stagflation in the 1970's was because the consumer was not insolvent then. We had stagnation, which is a nice word for recession -- we had sustained recession, which is a nice word for depression -- and the Fed lowered rates and lured consumers into the debt trap, which helped to stimulate inflation (yes, there was demand for cheap money, something we don't have today, since we are insolvent today).

Today is like the 1930's: you can't re-inflate when the consumer is insolvent.

I agree that deflation wins, until about 2019.

Politically speaking, I don't see Japan joining up with China. Japan is going to use its relationship with America as a balancing force against Chinese domination in Asia. Japan might join with India -- which relationship makes sense. Japan will seek tighter relationships with Australia also. Just because Japan and China are both 'Asian' nations does not mean that they have shared national interests.


On Nov 11 01:23 AM Denis Gould wrote:

> You may be right that the Fed wants to inflate its way out of the
> current situation. But the fact is that it can't. There is massive
> over-capacity in the world. Demand is only where it is because of
> massive fiscal and monetary stimulus.
>
> Soon the world will have to begin the process of reining in crazy
> budget deficits. At that point we go from huge fiscal stimulus to
> fiscal headwinds. The impact on growth will be substantial, and will
> create a self-feeding mechanism of weaker growth leading to weaker
> public finances.
>
> For as far as anyone can see (or until there are mass sovereign defaults
> - called "restructurings") the US and other developed economies will
> stagnate. Deflation will be the result.
>
> Asia should indeed look inward for its economic prosperity.

Nov 11 07:24 AM

[James Lewis:]

Yes Michael,

Japan will strengthen ties with India. However Japan and India are already very close. I think Japan will make it seems they are moving towards China, but this can only really occur economically. As the USA has treaty with Japan to protect them if they come under nuclear attack. Nuclear treaty like this does not come undone in less than 10 years. Also Japan knows full well that China's friends dont do very well out the relationship.

In terms of where the economy goes. I think we get mild stagflation in places and some growth in others. I do not see deflation as lots of new money has been created and the world economy is growing in size as economies get more developed (think Africa/South Amercia/Middle East). This will add to the demand side of the equation.

The USA will inflate but not by too much. After all, a lot of USA money is invested abroad and the USA wants to carry on printing fiat money through the fed; feeding it into the financial system and buy up large parts of emerging economies. Destroying the value of the USD is counter-productive. However a strong USD policy also is wrong.

Nov 11 03:00 PM