The happy coincidence of strong growth with low inflation that we have enjoyed until now was the result of a number of factors, including a move towards inflation targeting and the associated greater central bank credibility across many countries. But we believe China also has played a critical role in how globalization has evolved economically and that this could explain why inflation has, until recently, remained so tame. In our view, the globalization process is still in its early days and may help central banks in their efforts to keep inflation low and stable for a long time to come...However, with the possible exception of India, it appears that none of the countries can "do a China" on their own. In aggregate, the scope does exist, but individually none of the others are big enough.
If you look at size alone, India is the only country that can match China. By 2030, India is likely to have a bigger population than China. If you aggregate the populations of Brazil, Russia and India with that of the N11, the total is around 2.5 billion, more than 1 billion above that of China. In theory, if the N11 countries all acted similarly at the same time, they could "do a China." In reality, it is highly unlikely. Removing India, Brazil and Russia from the equation, the combined population of the N11 is slightly less than China's, and the N11 countries are a very diverse group geographically, culturally and socially...
Probably of greater importance is the degree to which the population is urbanized and/or industrialized. In terms of future potential, arguably the bigger the population (but the lower the degree of urbanization), the better—because that means the potential is bigger.
Once more, India is the only country where the potential for urbanization is anywhere near comparable to China. It is currently less urbanized than China, at around 30%. If India were to boost its urban population to 50% over the next 20 years, that would result in an additional 200-million-plus people in cities. Given India's strong demographics, India could probably match China within 30 years or so, if it chose to.
Now, the often insightful Bloomberg columnist Andy Mukherjee is asking again if India can export deflation to help save FRB Chairman Ben Bernanke. As Bernanke slashes key interest rates, there is concern that inflationary pressures will grow Stateside because of a plummeting dollar, among other things. My answer is in the negative; India too needs to source higher-cost raw materials to fuel its expansion, so it's doubtful whether it too can export deflation when it needs to import raw material price inflation. But, just because I am skeptical doesn't mean that a provocative idea shouldn't garner more attention:
Goldman Sachs Group Inc. economist Jim O'Neill wrote a paper last year, titled ``Globalization and Disinflation: Can Anyone Else `Do a China'?''The full weight of that question is becoming evident now.
In their report, O'Neill and his team argued that China's rapid urbanization, industrialization and rising openness to trade and capital flows had all contributed to keeping inflation in the developed world lower than expected for a decade [see paper in the link above].
The Goldman analysts said China would continue offering an ``inflation discount'' to the world with a nascent pickup in Chinese consumer prices and wages stabilizing in 2007.
``If we're wrong and Chinese inflation continues to rise, the consequences for the rest of the world may be profound,'' the economists wrote. ``The search, in terms of disinflationary forces, would be on to discover `another China.'''
Ben S. Bernanke should take note. The Federal Reserve chairman and his colleagues on the open market committee cut interest rates 50 basis points last month. Expectations of a similar reduction during the two rate-setting meetings scheduled for 2007 are gaining ground, options prices show.
The Fed may have discounted the inflation threat; the market hasn't. Barclays Capital has a gauge for how bond traders expect to be compensated for what they perceive to be future inflation. The 5-year-ahead forward rate shot up as much as 20 basis points last month, before stabilizing somewhat.
To avoid a surge in consumer prices, Bernanke may end up needing India to produce the disinflation that China is no longer willing or able to export.
Not only did consumer prices in China rise at their fastest pace in a decade in August, there's also growing evidence that Chinese manufacturers are able to pass on their rising costs to U.S. consumers. The U.S. Bureau of Labor Statistics reported a 1.1 percent increase in the average U.S. dollar cost of goods imported from China in August, the fourth straight month of accelerating price gains.
There are several reasons why Chinese companies are pulling back their discounts. Local wages are rising because of the increased cost of nutrition: Pork prices in China soared 87 percent from a year earlier in August.
The backlash against Chinese-made poisonous toys and inflammable clothes also suggests that China's disinflationary potential is now running out.
As consumers worldwide seek better quality in Chinese-made goods, and as regulators insist that manufacturers in that country do more to allay product-safety concerns, Chinese exports will get more expensive.
With China's help, George W. Bush's administration has managed to weaken the U.S. dollar without importing inflation. Excluding 2005, the trade-weighted real broad dollar has fallen steadily since mid-2002. But the response of U.S. import prices to the dollar's fall ``has been slow and apparently muted,'' as a Federal Reserve study has pointed out.
And while it's difficult to pinpoint exactly what caused U.S. import prices to stay resilient against adverse currency movements, the Fed study noted that those products in which China has increased its presence in the U.S. market have become more immune to exchange-rate shocks.
Globalization has been a ``potent disinflationary force,'' former Fed Chairman Alan Greenspan says in his book ``The Age of Turbulence: Adventures in a New World.'' He also predicts that the increase in the price of imports from China may be a first sign that the disinflationary force is receding.
To be sure, it isn't a view that everyone supports. Fed Governor Frederic Mishkin is in the camp that doesn't believe globalization has played a big role in keeping prices low. He would like the credit to go to central bankers.
``Tighter monetary policy and a commitment to price stability by central banks throughout the world have led to lower inflation and an anchoring of inflation expectations,'' Mishkin said in a speech in Washington last week.
We'll see how successful the Fed is in managing inflation when China withdraws its helping hand.
The real concern is that if China stops supplying disinflation to the U.S. and Bernanke ends up needing a replacement, he may not find too many suitable candidates...
India is, in many ways, the China of 10 years ago.
The country's openness to global commerce, measured as its annual merchandise trade as a ratio of gross domestic product, is 0.37, compared with 0.69 for China. That leaves India -- a large, labor-surplus country just like China -- with an opportunity to play catch-up.
Hundreds of millions of Indians who work as farmhands or run their own small businesses are stuck in low-productivity occupations that are sustained purely by domestic demand. If India can plug its infrastructure gaps -- from ports and airports to electricity and urban services -- it could become a low-cost manufacturing hub for the world.
As Goldman's O'Neill noted in his study, ``India is the only country where the potential for urbanization is anywhere near comparable to China.''
However, if the dollar keeps weakening and food and energy costs stay high, even India won't be able to export disinflation to the U.S. Exporters, after all, need to turn a profit, and workers need to eat.
