Inflation won’t peak yet

According to today’s Credit Suisse Emerging Markets Economics Daily, a government official for the first time suggested that we are not going to see inflation peak this year. Earlier this year most commentators and nearly all government officials suggested that inflation would peak in the second quarter before coming down over the rest of 2008. More recently, as my student Shang Ning pointed out to me last week, the same commentators have shifted their forecast and have suggested that inflation would peak around August or September before starting to decline.

Now it seems that at least one official is suggesting that the peak might not come until some time next year. According to Dong Tao, of credit Suisse:

Xu Xianchun, deputy director of the National Bureau of Statistics, has suggested that inflation might not peak until 2009. Xu made this comment on 28 May at an investment forum in Shanghai. He said that historically the peak of inflation lags two years behind the peak of growth. With GDP growth peaking out in 2007, Xu argued that the worst in the inflation cycle has yet to arrive. This is the first public comment coming from the government that suggests inflation may rise further. It is in contrast to the government’s target of a meaningful moderation in CPI inflation to 4.8% as food prices start to decline.

Dong Tao argues that there is a lot of evidence that inflation is spilling over into wages, which should result in another round of rising inflation towards the end of this year or the beginning of next. He argues that the recent decline in certain food prices might result in an inflation “valley”, but that lower inflation in the next few months will not mean that the inflation problem is over.

I agree. When you look at the trajectory of US inflation in the early 1970s, which in some ways resembles China today, the monetary looseness of the 1960s fed first into the “gogo” period of low inflation, low unemployment, rapid productivity growth and booming asset markets, before slowly showing up as persistent inflation in the early 1970s. At the time, as in China today, there were strong arguments made that US inflation was not monetary but rather was caused by a series of supply shocks (the first and second big oil shocks, for example), and the US even imposed price controls in the hopes of breaking inflationary expectations.

These didn’t work, and US inflation rose inexorably, not in a straight line (it almost never does), but with periodic declines until by the mid-1970s it became clear that the US was experiencing a monetary inflation. Needless to say it took pretty brutal steps in the late 1970s before US inflation was finally broken.

History doesn’t repeat itself with great precision, of course, and there is no reason to assume that China today is necessarily like the US in the early 1970s, but it is worth remembering the mistaken analysis back then and consequent policy mistakes. I am afraid that if we do see Dong Tao’s inflation “valley,” it will seriously discredit the monetary alarmists in the short run and result in yet another excuse to ignore the consequences of China’s massive monetary inflows. One positive impact of a decline in the next month or two, if indeed this happens, is that it might make the authorities a little more willing to relax some of the price subsidies, especially on refined oil products. Of course this would immediately feed into headline CPI inflation, but price freezes are very costly and are simply forcing inflation to spread in other ways.

The PBoC, however, continues to insist on fighting inflation. On a report released on their website today, they warned that local governments needed to keep the fight against inflation as a priority. If you believe, as I do, that inflation is caused not so much by nasty local hoarders and price gougers, but rather by excess monetary growth, it is hard to see what local governments can do to keep inflation down, but clearly the PBoC is still very concerned.

On a completely different topic, I saw a report on Bloomberg today about engineering studies in the US and China. There is a lot of rather excited talk about the astonishing development of science and engineering in China, and as someone who has taught in the top two schools in the country, I am always a little bemused by the fascination the West has of the Chinese “threat” in science.

My students at Peking University are easily some of the most brilliant students I have ever taught, but although scientific and engineering education in China is improving, it still has a long way to go even to catch up with certain other developing countries, let alone with scientific and technological powerhouses. Here in Beijing my Chinese academic colleagues and my students generally don’t see how they are a threat.

The most excited talk nonetheless revolves around the enormous hordes of science and engineering students being produced in China, and no matter how many times it is pointed out that the quality of teaching is relatively low and the educational system one that systematically discourages innovative thinking, the counterargument is always the one of sheer numbers. On that note:

Harvard and Yale…following the lead of Princeton University and Columbia University, added to the status, staffing and visibility of the engineering schools in the past year.

…U.S. engineering and technology degrees peaked at 97,122 in 1986, and fell 16 percent to 81,610 in 2006, according to the website of the Washington-based National Center for Education Statistics.

…Data provided by the Chinese government showed that 575,000 undergraduate engineering degrees were awarded in 2006, said Vivek Wadhwa, an adjunct professor at Duke, in Durham, North Carolina. That figure was inflated because China uses the term engineer to include auto technicians and other jobs not deemed engineers in the U.S., he said.

The actual number of engineers comparable in quality to those graduating in the U.S. may have been closer to 60,000 in 2006, Wadhwa said in a May 28 telephone interview. That’s less than half of the number of U.S. graduates in 2006, he said, citing figures that include computer scientists not in the National Science Foundation survey.