The price/wage spiral represents a vicious cycle in which different sides of the wage bargain try to keep up with inflation to protect real incomes. Thus, this process is one possible result of inflation. It can start either due to high aggregate demand combined with near full employment combined with an increase in the credit and money supply. As the spiral evolves, business owners raise prices to protect profit margins from rising costs, including nominal wage costs, and to keep the real value of profit margins from falling. At the same time wage earners try to push their nominal after-tax wages upward to catch up with rising prices, to prevent real wages from falling. So "wages chase prices and prices chase wages," persisting even in the face of a recession. The spiral is also limited if labor productivity rises at a quick rate. Rising labor productivity compensates employers for higher wages costs while allowing employees to receive rising real wages, and allowing the company's margin to stay the same.
Of course, if the money supply does not expand, then the "price wage spiral" would not occur. Business, after all, does not attempt to "protect profit margins", it tries to maximize profits. The reason that high economic growth and inflation are often observed together is that when the government creates inflation by printing fiat money, the inflation tricks capitalists into increasing production, which created the illusion of an economic boom. The "spiral" of increasing prices and wages, however, can only continue as long as the government continues to intervene in the economy by inflating the money supply.
If it were not preceded, accompanied, or quickly followed by an increase in the supply of money, an increase in wages above the "equilibrium level" would not cause inflation; it would merely cause unemployment. And an increase in prices without an increase of cash in peoples' pockets would merely cause a falling off in sales. Wage and price rises, in brief, are usually a consequence of inflation. They can cause it only to the extent that they force an increase in the money supply.
Well, China has been printing a lot of money for a long time in order to keep the Yuan low which befitted their export sector. As a result of their policy they accumulated massive foreign exchange reserves, and had giant trade surplus. Since China has over one billion people and since most of them were farmers up until the 1990's the money printing didn't cause wages to rise dramatically. (Money flows to places where supply is tight and China had abundant labour.)
So the money went into commodity, real estate, and stock prices in China. But now something totally different is happening. China trade surplus is gone, food prices are rising and wages are too. This, combined with weak exports, and a weak euro is killing China corporations' margins and we have a classic wage and price spiral.
Since China produces simple products and since China has focused on quantity and not on quality, there is no significant productivity growth to offset the money printing once the movement to the cities was exhausted (there is no demand for more Chinese peasants producing more Nike (NYSE:NKE) shoes).
China must slow the money printing or risk hyperinflation.
Inflation in emerging countries is higher, demand-pull in nature, and advanced to the stage of a wage-price spiral; in developed countries, it is lower, cost-push in nature, and not advanced to a wage-price spiral.
This is the reason for the unwinding of the secular growth stories of the emerging countries. Central banks in the west let the deflationary forces of the stagflation slow the economy to deflation, as they did in July 2008-September 2008 and as Fed is doing now (Q.E has stopped), until Q.E 2.0 comes with a vengeance.
But demand-pull inflation and wage-price spirals tend to be more stubborn. Taming them usually requires a substantial tightening of monetary policy. Emerging countries have mismanaged their economies to the extent they killed off their vaunted secular growth stories. And they are not the first: in the 1980s, Japan was said to be on a path to overtake the U.S. but then it fell into a two-decade deflationary period.
Like Japan in its heyday, China and India have been enhancing export competitiveness by maintaining artificially low currency rates. Their well publicized growth trajectories will be proved to be chimeras.
The only difference is that China's has no trade surplus anymore, unlike Japan in the 1980's, so the world will be shocked by a Yuan devaluation.
Disclosure: Short Europe, China, Australia, Canada and long Gold