Inflation in China

The thinking among some at the Fed, evident in several public speeches, is linked to a 1997 paper by then-professor Ben Bernanke in which he argued—along with two other academics— that the right response of the central bank to higher oil prices is to do nothing.

The paper argues that it's the central bank's reaction to oil price shocks that creates recessions, not the shock itself.

The best test for using the interest rate tool against commodity prices is whether:

1. There is a general wage/price spiral
   
2. The rise in commodity prices looks to be permanent
   
3. Inflation expectations get out of control

One gauge of the first measure is unit labor costs, or the cost of labor per some dollar amount of output. This essentially measures wages relative to productivity.

It is only inflationary for wages to rise if workers are not more productive. They have been very productive the past several years and yet wages have been stagnant. In the past two years, unit labor costs have fallen in five of eight quarters, including the most recent one in the fourth quarter of 2010.

This is a quotation from an article about inflation in the USA, but we can apply it to China:

1. There is a general wage/price spiral
   

Wages are going up, ostensibly by government fiat on minimum wages based on the rationale that food costs are going up. They have been going up pretty drastically, too. I am not sure if this is due to the minimum wage increases or those are just lagging actual increased prices for labor. I don't the productivity has gone up at all - maybe the old wages were too low and the new wages are NOT inflationary. But we do have a potential mechanism for a wage/price spiral in China, whereas we do not have that in the USA.

1. The rise in commodity prices looks to be permanent
   

Probably is the case if its due to additional demand from China, at least for oil, but maybe not for copper if they ever stop building buildings. But good news! Because houses cost so much, the government will build subsidized, low-cost housing. Doesn't that sound like it will increase the demand for building materials!

1. Inflation expectations get out of control

I think people in China already assume high growth, increase in prices, increases in land prices, etc. will go one forever. Why else would you buy empty apartment after empty apartment? Of course, the best evidence for this is the fact that interest rates have been hiked already - so the central bank must be worried, and they know more than me.

Fun Facts on Chinese price levels:

20 years or so ago, workers in Fujian province wanted RMB 8 / day in wages. Say RMB 200 a month. Now, the wage level in Dongguan is above RMB 2200.

A man-tou bun sold at 面点王, a chain restaurant, used to cost 1 RMB only a few months ago. Now it costs 4 RMB.

Now there are articles in China about how cheap Bangladesh is, or how cheap Myanmar is. They must be getting worried.