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China's January Prices: Does Inflation Equal Demand?

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Includes: CN, CXSE, FCA, FXI, FXP, GXC, MCHI, PGJ, XPP, YANG, YAO, YINN, YXI
by: Enzio von Pfeil

Globalization means stronger growth AND lower inflation. The resulting excess supply of money bodes well for asset markets.

  1. January inflation. China's rate of consumer price inflation has hit a five-year low. This feeds in to the general market disillusionment with China's growth prospects.
  2. Anachronisms. Back in my days of studying inter alia under von Hayek, we were weaned on the "demand breeds inflation" school. If demand is strong, inflation simply MUST rise; if demand is weak, inflation MUST fall. This argument assumes greedy producers (nothing new here), a constant/constrained supply of goods, and constant productivity, to mention but a few assumptions. But how can the supply of goods be constant/constrained if we are dealing in a globalized economy laced with 'just in time" production in goods as well as in services? And how can prices rise if productivity is rising, thanks to more lively technology transfer by multinationals' direct investments?
  3. The "new normal" is an "and-and". Surely the "new normal" has to be that in a globalized economy you can have rising demand AND falling prices, courtesy of multinationals increasing productivity in their direct investment host countries.
  4. Headlines deceive. Next to this "new normal", another reason for China's lowest inflation rate in five years has to be that food prices slowed by two-thirds when compared to December. Given that food carries enormous weight in China's inflation basket, it is of little surprise that overall inflation hit a five-year low. As always, then, the devil is in the details.
  5. Improving Economic Time®. We, too, believe that China's Economic Time® is characterized by an excess demand for money and an excess supply of goods. Indeed, this is precisely why the Central Bank cut the reserve ratio by 50 basis points last Wednesday, 4th February. Thereby, the PBOC hopes to re-kindle demand by increasing the supply of money. So far, so good.
  6. Myths deceive. But looking way ahead: don't expect the evolving "excess demand for goods" to result in higher inflation. Globalization + better productivity = more demand at lower prices.
  7. Investment implication. Despite gingerly rising demand, expect goods and services inflation to remain low for a long, long time, courtesy of globalization and direct investment fuelling productivity. But anachronistic central bankers, scared of their own mental independence, will keep going with the flock bleating "weak inflation means weak demand, so let's keep loosening." The result is an increased "excess supply of money". Our Economic Clock® dictates that any excess supply of money MUST flow in to asset markets. I'll let you figure out what asset classes you favour for your own portfolio. Mine are stocks, property and private equity.