Amidst news stories of Chinese truck drivers striking over the price of fuel, and 20% minimum wage rises, I wanted to see the actual data on Chinese inflation. The above graph is from Trading Economics, and shows the Chinese CPI. Looks like the economy there is indeed starting to overheat. However, it’s still rather below the 8% level reached in early 2008, before the great recession took the wind out of everyone’s sails. At historical rates of increase, it looks like that kind of level might be a year away. So perhaps it will be a little while before something gives in the global economy.
In general, I’m thinking a lot about the following mental model for oil prices and recessions. First of all, recessions are not linear phenomena. They represent trend breaks in the general path of improving economic productivity. I think of them as akin to a paradigm shift (in the Kuhnian sense) when global markets are forced to realize that some assumption they were implicitly making cannot continue to hold any longer.
We are in an era where the availability of natural resources is not sufficient to support the wealth levels that the developed world has grown accustomed to, along with the speed of growth with which the developing world is trying to approach those same levels. So, this is represented by oil prices rising (along with food and other commodity prices more generally). But the effect of this is not to place a uniform drag on growth, because the global mind has not accepted this truth yet. Instead, the global economy keeps trying to grow in a way that is inconsistent with the resource constraints, and then some part of the system tears and gives way.
So, in 2007/2008 the sector that gave way was the American subprime consumer, along with a significant chunk of the financial system that was predicated on the idea that poor Americans could continue to take on more and more debt indefinitely. Instead, rising gas and food prices eventually destabilized the finances of that sector of consumers, they started to default, then their lenders started to default, financial contagion set in, and the situation was only stabilized with massive extraordinary interventions by sovereign governments. That worked, but left a lot of the sovereigns in significantly weaker condition than before.
Now poor Americans borrowing more and more to bid house prices higher and higher was always an unsustainable trend that was going to end in tears one way or another. But the timing was likely determined by the oil/food price shock that ended in 2008.
So now, just three years later, here we are again with oil and food prices rising fast, and the question in my mind is this: what part of the global fabric tears next? And when?
Clearly, we have had some smallish rips in recent months. The instability in the Middle East this year has a similar character. The people there have been living under nasty authoritarian regimes for a long time, and that’s probably always been an unsustainable arrangement that was going to end badly some day. But rising fuel/food prices were a trigger, at least in part. But, so far, these events have not been sufficient to cause enough general distress and panic to get commodity prices to go lower. Indeed, because the region is such a critical oil producer, prices have gone higher (with Libya in particular seeming not likely to resume much in the way of oil production in the immediate future).
Whether the events in the Middle East have run their course, or are just smoldering in out of the way places (Syria) waiting to burst into larger flames again, I am not sure.
Then there is the issue of European sovereign defaults. The Greeks and the Irish, and maybe a few others, are not going to repay their debts in full. At some point, this is going to have to be recognized and the consequences worked through. Will this cause enough general panic and fear to get the global economy off track and lower commodity prices? I have a hard time believing it, since the whole situation has been so obvious for so long and you’d think the various institutions at risk (eg the French and German Banks) would have had time to mitigate their risks (but then I would have said the same about the US housing bubble, and that was clearly not right).
In a way, whatever happens in the end to stop global growth and drop commodity prices almost has to come as a surprise, at least to most of the global mind. It can’t be something that’s broadly accepted already.
A few other candidate issues:
- China’s authoritarian political system is probably not sustainable forever. Major political unrest in China would obviously send massive tremors through the global economy.
- The US government deficits are not sustainable forever. Obviously, elite opinion is that the crisis is not imminent and so the proposals for dealing with this are mostly not very serious, but it is receiving some attention.
- The US trade deficit is not sustainable. At some point the dollar has to get a lot weaker relative to currencies that are currently pegged to it (like the Renminbi and the Riyal).
- It’s probably also worth mentioning the whole derivative market mess (with outstanding contract face values some humungous multiple of the size of the global economy). I’m not sure that’s a likely cause of rips in the global fabric, but it does perhaps have the potential to cause unexpected transmission paths from an initial shock to other parts of the system.