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Inflation Debate

Amid global inflation concerns, economist Liu Yuanchun argues that a depression after the bubble bursts is more destructive than inflation

By Min Jie Updated Oct.1

Imported oil is unloaded from a tanker, Zhoushan, Zhejiang Province, April

A house is under construction in a housing development, Texas, US, May

The Producer Price Index (PPI) in the US rose by 6.6 percent in May 2021, the highest level since November 2010. Its Consumer Price Index (CPI) grew by 5 percent year-on-year, the highest growth since 2008.  

Some economists have criticized the US government for underestimating inflationary pressure, believing it was slow to respond, putting the US economy at risk of slipping into recession. US Federal Reserve (Fed) Chair Jerome Powell said the current inflation is only “transitory.”  

The Fed’s ballooning balance sheet has led to a flood of dollars, sparking soaring valuations in commodities, US stocks and real estate. NewsChina secured an exclusive interview with Liu Yuanchun, vice president of the Renmin University of China and a renowned economist, to shed light on the current inflationary trend in the US and the possibility of a major global economic crisis, as well as challenges for China’s economy in the second half of this year.  

NewsChina: The Fed believes that the current inflation is transitory. One important basis is that the supply chain will return to normal and prices will fall after the pandemic eases. What do you think of its stance?  

Liu Yuanchun: The Fed has made a series of changes over the past two months, which fully shows that although it insists that inflation is transitory to maintain the stability of overall economic policy, its policy monitoring objectives have been substantially adjusted.  

First, the Fed’s most closely watched macro indicator is employment, and the entire monetary policy framework was significantly adjusted during the epidemic. The US’s unemployment rate in May and June was worse than expected. From the Biden administration’s point of view, high unemployment in the second half of the year and early next year is bad for midterm elections, so the Fed’s strict adherence to the Biden administration’s job goal would be to some extent benign enough to ignore inflation.  

Second, there has been a marked change in the Fed’s attitude toward inflation. The Fed’s monetary policy framework, originally pegged to the inflation rate, is now pegged to the average rate of inflation. The target inflation rate will be raised from the traditional 2 percent per year to 2.6 percent in the second half of this year and next year, and the level of inflation tolerance will be raised across the board.  

Third, disagreements abound over whether the current US and global inflation is transitory or persistent. At present, the CPI in the US is as high as 5 percent. The core reasons are price increases in the used car market, increases in housing rent, the impact of commodity price growth and the imbalance of supply and demand due to the pandemic. Will these factors disappear as the pandemic eases? The Fed’s position on this is ambiguous.  

More importantly, the Fed’s withdrawal from future policy has already been laid out. There will be two interest rate rises by the end of 2023, which have already told the market that it is considering a full exit from the US’s unconventional monetary policy. Before raising rates, however, the Fed will gradually adjust its unconventional measures, including the size of bond purchases, the size of government deficits, and adjustment of other non-policy interest rates. 
The second is that the Fed has made minor changes to its operational interest rate to show its attitude.  

While the Fed has maintained some benign neglect on inflation, there has been a substantial change in US monetary policy, and I think a reduction in the amount of US asset purchases around September is inevitable.  

NC: Since the 2008 financial crisis to the emergence of Covid-19, Europe and the US have gone through several rounds of quantitative easing. After more than a decade of monetary accumulation, will there be super inflation in the future?  

LY: It’s unlikely at the moment. First, as long as there are no systemic supply problems in food and industries related to the national economy and people’s livelihoods, people will not use surplus money for daily expenses. Second, there has been a marked correction in M2 (easily accessible money supply, cash and checking deposits) growth this year. Third, although the assets and liabilities of central banks have expanded significantly, a lot of money has returned to the central bank system through redeposits and other means, instead of being directly converted into money and corresponding demand in the economic cycle. Fourth, although the rise of bulk commodity prices has several phases, the recovery rise is still the main factor, and the cost impact is still within an affordable range.  

What is worrisome for the US economy is not simply inflation, but depression after pricking the bubble, which is more frightening. China faces the same situation. Inflation below 5 percent won’t do real damage to the Chinese economy. Instead, it may help kickstart consumption and some reforms. On the contrary, if some risks and bubbles are pricked and the economy shrinks further and deflation sets in, it could be even more damaging to the Chinese economy.  

Monetary policy should maintain the relative stability of liquidity, so the challenges posed by financial risks can achieve a soft landing rather than a hard landing. There will be thorough consideration of the shift of monetary policy and recovery strength.  

NC: Is China facing pressure from inflation?  

LY: There is no obvious inflationary pressure in China at the moment, but the impact on the structure and people’s livelihoods is already obvious.  

First, the price rise of raw materials for upstream enterprises will bring obvious cost impacts to some industries. Downstream companies that use these raw materials for production have been hit hard. China’s market structure has a better system for absorbing the impact of raw material imports, and it will not immediately translate into an overall rise in CPI.  

Second, although prices for China’s imports have risen, a large part of that is a recovery rise. Since May, many prices were fluctuating, unlike in 2006 which was a straight climb. We have to wait and see how sustainable these price rises are.  

Third, although the recovery is good, the impact of two gray rhinos looms large. The first is the variation of external demand. The second is the collapse of the circular chain of regional debt formed by internal regional finance, State-owned enterprises, investment and financing platforms and government finance in some places with weak recovery.  

To deal with these changes, it is not appropriate to withdraw some of the policies in the short term. We should change from unconventional policies to conventional expansionary policies, rather than simply shift to a neutral and steady position. If it contracts too soon, it may be difficult to deal with these uncertainties.  

NC: Does China need to worry about imported inflation?  

LY: We need to be alert to this. Because of international factors, China faces a serious shock from imported inflation. We import a huge amount of raw materials, and the pricing power is not in China’s hands, resulting in the obvious deterioration of international trade. Related industries have suffered eroding profits.  

We should pay attention to three main tasks: strengthening international coordination, improving strategic reserves and overhauling the domestic market.  

Demand in China and domestic practices of hoarding and speculation have pushed up the prices of commodities. There should be a systematic approach to address the impact of imported inflation, rather than it simply coming down to monetary policy and aggregate policy.  

NC: The monetary policy committee of the People’s Bank of China recently warned about external shocks. What external shocks do you think should be guarded against? How should we prevent them?  

LY: The Fed’s policy shift led directly to a reversal in global liquidity and changes in the global financial market and even commodity markets, which has led to abnormal global capital flows. This is why we need to take precautions. As the pandemic comes increasingly under control and the industrial chain of all countries is restored, the basis for a substantial increase in exports may disappear.  

In the post-pandemic era, governments around the world will have to adjust their industrial and trade chains, and the entire export market will undergo drastic changes. The impact on China’s economy will be a gray rhino with systemic characteristics. We know there will be an adjustment in external demand, but we are likely to misjudge its strength and speed, leaving us unprepared.  

In addition, we will conduct a comprehensive review and assessment of the phase one China-US trade agreement and resume phase two trade negotiations this year. Can the retaliatory tariffs of the Trump era be removed and reduced? There is fierce competition. While the Biden administration recognizes the burden of retaliatory tariffs on American consumers, it will not adjust easily without a corresponding bargaining chip from China.  

There will be extreme volatility in finance and significant changes in the export, trade and investment. These factors could combine to produce a systemic impact by the end of this year and early next year. China’s central bank monetary policy committee pointed to an external complex situation, which, in my view, will be the biggest of the two gray rhinos facing the Chinese economy at the end of this year and early next year.  

Therefore, the recent policy of expanding domestic demand should not be slowed, and we should not wait for drastic changes in external demand before expanding domestic demand. 
We need to speed up internal circulation and expand domestic demand to offset the external risks. 

A trader checks information, New York Stock Exchange, May 18