Stagflation: a conceptual framework
First, we must define stagflation, which is a compound word of "stagnation" and "inflation". In 1965, British Conservative Party Member Iain MacLeod (Iain MacLeod) coined the term when speaking in the House of Commons. Economics guru Keynes believes that strong growth will lead to rapid price increases, while a weak economy is usually accompanied by low inflation. Economic slowdown and upward inflation are mutually exclusive. However, there was a rare phenomenon in the United States in the 1970s. The economic recession and price increase occurred at the same time, which lasted for 10 years.
Now, whether the global economy has entered a new round of stagflation has aroused widespread discussion. On the one hand, the global economy is still affected by the new crown epidemic; on the other hand, the trend of rising prices is obvious. However, most economists disagree with this judgment, mainly because the fundamentals of the current economy are different from those in the 1970s. They believe that the global economy is recovering, consistent with the upward direction of inflation.
The description of stagflation may be more suitable for the current China. In the second half of this year, China's economic growth has slowed down significantly, while prices, especially PPI, have risen sharply. In my opinion, we should not be pedantically obsessed with the similarities and differences between China and the United States in the 1970s. When we observe that the economic downturn and the inflation rise simultaneously, we can use "stagflation" or "quasi-stagflation" (quasi -stagflation) to describe the state of this economic operation.
Stagflation is an extremely undesirable economic form because it restricts the policy response space. To solve the problem of "inflation", we must pay the price of "stagnation"; to solve the problem of "stagnation", we must pay the price of "inflation".
The main contradiction of the US and European economies is "inflation"
Since the beginning of this year, the Fed has systematically underestimated the inflation situation, and internal opinions on inflation and future interest rate hike paths have increased. In October, the US consumer price index rose to 6.2% year-on-year, and the Eurozone rose 4.1%, of which Germany rose 4.5%, both hitting new highs in nearly 30 years. Financial markets have become pessimistic about the outlook for medium- and long-term inflation. The current 5-year breakeven inflation rate in the United States has exceeded 3%, far exceeding the Fed’s 2% inflation target (Figure 1).
The main reason for this phenomenon lies in the supply disorder. Developed countries were the first to vaccinate vaccines, and economic repairs promoted faster demand growth; while in developing countries, vaccines were limited, epidemics repeatedly led to production stagnation, and the global industrial chain was blocked everywhere. At present, logistics has become the weakest link in the global industrial chain. U.S. shipping, land transportation and ports are malfunctioning, labor shortages, commodity accumulation, freighter congestion, containers nowhere to be placed, and retail inventories have fallen to historical lows before the Christmas season. In addition to the problem of supply chain disorder, there are also some new factors that drive prices up. After Biden came to power, typical "leftist" issues such as "decarbonization" have been put on the table, superimposed on the shortage of energy such as oil and natural gas caused by extreme weather, and commodity prices have risen sharply.
There is a view that shortage of supply is a short-term phenomenon, and therefore inflation is also a short-term problem. With the gradual easing of the epidemic, the chaotic situation of the global supply chain will gradually improve; Southeast Asian export-oriented countries will get out of the haze of the Delta variant virus, and the supply will be repaired. In the first quarter of next year, after the peak consumption season in Europe and the United States and the peak transportation season before the Chinese New Year, the tension in ports and shipping will be eased, and the global supply bottleneck is expected to be alleviated. In addition, after a high-profile announcement by politicians, the “decarbonization” constraints of various countries may loosen marginally, and the supply of fossil energy is expected to rise. Although this judgment is reasonable, it still has great uncertainty.
Uncertainty comes from two aspects. One is that the evolution of the epidemic is inconsistent with the epidemic prevention policies of various countries, and the supply chain disorder may not disappear soon; the other is the spiral increase of wages and prices, which continues to raise the level of inflation. In October, the US nominal hourly wage growth rate has reached 4.9% year-on-year, but the actual hourly wage growth rate has dropped to -1.2%. Under the "employment shortage" in the United States, the bargaining power of labor has increased, and the future hourly wage growth rate is likely to further increase.
Although the Fed hopes to tolerate inflation "overshooting" within a certain period of time to achieve a "broad and inclusive" repair of the job market, Powell has also begun to admit that the length and intensity of inflation in the United States has exceeded expectations, and said that inflation has met the conditions for raising interest rates. We predict that under the benchmark situation, the Fed will raise interest rates once in the middle of next year. If inflation fails to fall as scheduled, the Fed may have to accelerate the reduction of bond purchases and raise interest rates ahead of schedule. The European Central Bank also has the possibility of changing its monetary policy attitude and raising interest rates early, thus threatening the recovery of the global economy and the sustainability of national finances.
Figure 1: U.S. inflation expectations far exceed the Fed’s target
Source: Macrobond, China Merchants Bank Research Institute
Figure 2: The manufacturing new orders index continues to stay in the contraction range
Source: Wind, China Merchants Bank Research Institute
Figure 3: Mid- and downstream companies' profits are squeezed
Source: Macrobond, China Merchants Bank Research Institute
Relatively speaking, the economic growth of the United States and Europe next year may be between 4%-4.5%, which is not a big problem. Their main contradiction is obviously "inflation", that is, inflation may rise more than expected.
The main contradiction of China's economy is "stagnation"
At present, the main contradiction of my country's economy is increasing downward pressure.
Let's first look at exports. Since the beginning of this year, my country's terms of trade have shown a deteriorating trend, which is the opposite of last year. Since May, the manufacturing PMI new export order index has continued to stay in the contraction range (Figure 2). With the restoration of the US service industry, consumer demand for goods has begun to slow; the production of Southeast Asian export economies has been restored, and China's export market share is under pressure; the RMB exchange rate is at a high level, and the negative impact on exports has gradually emerged. Taking into account the base effect and seasonality, next year's export growth rate is expected to slow down significantly in the first half of the year, and hit a full-year low in the third quarter.
Look at investment again. First, real estate investment may decline significantly next year. This year's real estate company debt risks continued to ferment, intensifying the downward pressure on the real estate market. Next year, there is a high probability that the income from land transfer and the amount of commercial housing sales will experience negative growth. Real estate investment is also facing great pressure. Due to the shrinking land transaction area, the premium rate is suppressed, and negative growth may occur. In terms of construction and installation investment, real estate companies are facing the bottom line requirement of "guaranteeing the building", and it is expected that the growth rate of construction completion next year will increase The restoration has partially supported real estate investment. The second is the marginal decline of manufacturing investment momentum. Rising prices of commodities and raw materials have squeezed the profits of mid- and downstream companies (Figure 3) and curbed capital expenditures in the manufacturing industry, while the expansion of upstream companies has been subject to "dual carbon" and "dual control" constraints. On the bright side, high-tech industries and “green” related investments under policy support are expected to accelerate. Third, infrastructure investment is expected to rise. The central government requires that the issuance of local government bonds be accelerated in the second half of this year to form a physical workload as soon as possible. This means that infrastructure investment is expected to bottom out and rebound, with a significant increase in the first half of next year.
Finally, there is consumption. There is a high probability that a weak recovery will continue next year. There are three reasons. First, the income recovery of residents, the government, and the corporate sector is not satisfactory. Residents’ income uncertainty is rising, and there is a K-shaped differentiation between industries and income levels; the mid- and downstream profits of the manufacturing industry are severely squeezed, coupled with the difficulty of turnover of some real estate companies, and the lack of corporate consumption capacity; real estate enters a downturn period leading to the government Land transfer revenue is under pressure, which limits the government's ability to spend. Second, strict epidemic prevention and "double reduction" policies have restricted the recovery of service consumption. The month-on-month growth rate of consumption is significantly negatively correlated with the number of newly confirmed cases, and the “double reduction” policy has led to a significant contraction of residents' expenditure on cultural, educational and entertainment services. Thirdly, in terms of commodity consumption, due to the declining real estate sales, the consumption of post-cyclical commodities such as furniture and home appliances has grown slowly. In addition, despite the strong demand, the “lack of cores” limits the growth momentum of new energy vehicle consumption. The good news is that the consumption of new economy-related commodities represented by communication equipment has grown strongly.
In terms of prices, under the influence of a high base, next year's PPI year-on-year growth rate is expected to decline steadily, while CPI slightly increases. The volatility of the consumer price index is still mainly determined by food prices. Pork prices are expected to stabilize and rebound in the middle of the year, which will push the CPI growth center upward. Relatively speaking, China's inflation situation is still stable and controllable. The year-on-year growth rate of PPI for the whole year of next year is expected to fall to 3.9%, and the year-on-year growth rate of CPI will be around 2%.
It can be seen that the downward pressure on China's economy next year will not be small. Currently, our baseline forecast is 5.2%, and the downside risk is greater than the upside down risk. In other words, the main contradiction of China's economy lies in "stagnation" rather than "inflation."
Increased constraints on macro policies
The first is monetary policy constraints. From the perspective of the United States and Europe, to manage the threat of "inflation", the monetary policy is bound to tighten; and in China, to prevent the possibility of "stagnation", the monetary policy needs to be relaxed. Therefore, between China and the United States and between China and Europe, the monetary policy is in the opposite direction. This may impose certain constraints on my country's monetary policy. The tightening of monetary policies in the United States and Europe may have a negative impact on cross-border capital flows and the RMB exchange rate. Generally speaking, at present, my country's monetary policy tools are sufficient, and there is still a sufficient safety cushion for the Sino-US interest rate differential. It is expected that the monetary policy will tend to be friendly in general, and the economy will be stabilized mainly by ensuring the stability of funds and structural lenient credit. In fact, the central bank recently launched a carbon reduction support tool, indicating that the structural characteristics of future monetary policy will be further highlighted in order to achieve "precise drip irrigation" in key areas and weak links. Looking forward to next year, the funding side is committed to maintaining stability, interest rates are expected to decline slightly, and the general liquidity margin will improve.
The second is fiscal policy constraints. The fiscal revenue and expenditure will be further tightened next year, limiting the effect of fiscal policy on economic expansion. In addition to the shrinking of the tax base due to the economic downturn, there is a high probability that local government land transfer revenue will experience negative growth, and the repayment of local government debt will usher in a peak. Looking forward to next year, taking into account the requirements of "steady growth", fiscal policy still needs to maintain a positive attitude. The target deficit rate is expected to return to the normal level of 3%, and the new local government special debt is expected to be 3.5 trillion yuan. Fiscal policy will present its pre-characteristics, the issuance of government bonds will continue at a high level in the first half of the year, and fiscal expenditures are also expected to accelerate, in order to play a key role in stabilizing investment and stabilizing growth.
The third is industrial policy constraints. Although the impact of "dual carbon" and "dual control" on my country's supply side has been eased in the fourth quarter of this year, it will still face tight constraints next year. On the one hand, the “dual control” policy is consistent, and the energy consumption intensity reduction target next year is expected to remain around 3%. This is also the year needed to achieve the energy consumption intensity reduction target of 13.5% by 2025 in the 14th Five-Year Plan. Both are decreasing. It is worth noting that my country's energy consumption intensity has basically been declining year by year since the "Eleventh Five-Year Plan", and further reduction at the current level of energy consumption will inevitably strengthen the constraints on the energy and manufacturing industries. The current assessment intensity of local government energy consumption intensity reduction indicators has also been greatly increased. On the other hand, some industries are also facing stricter administrative control, especially coal, steel and other high-energy-consuming and high-carbon emission industries.
The fourth is the restriction of the epidemic prevention policy. Under the zero-tolerance anti-epidemic policy, service consumption in my country's transportation, catering and other services will still be restricted, and will drag down the income restoration of the residential sector. The divergence of epidemic prevention policies between my country and major developed countries will also adversely affect my country's international exchanges and multilateral investment.
In short, the downward pressure on my country's economy next year will not be small, and macroeconomic policies will be restricted by many factors. Properly handling the relationship between "stagnation" and "inflation" in the economy requires extremely high policy levels and control skills of macro management departments.
