Western stimulus stoking Chinese inflation

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Economist Xie Interview on Stimulus, Inflation

In a recent article for Bloomberg he argued that the American stimulus package is having a nasty unintended consequence: it is stirring up inflation in the emerging economies. Since trade and foreign direct investment accounts for half of economic output it makes no sense to assume that modern economies are self-contained. Or, as Xie puts it:

“Just as water flows down, stimulus affects low-cost economies more, wherever it is initiated. As the West pours money into the global economy through large fiscal deficits or central banks expanding balance sheets, the emerging economies are drowning in excess liquidity. Everything is turning red-hot.”

What this is likely to mean in practice is that inflation will eventually spread back to developed economies. Rising commodity prices will probably be the immediate channel for this trend. Prices of consumer goods imported by the West will also start to rise. The impact of the West’s fiscal stimulus will turn out not to be benign. (article continues below)

At the root of the problem, argues Xie, is a decline in western competitiveness. The West must face a long and painful process in which it has to wait for the wages of the Wangs and Gandhis to rise to western levels.

If he is right the west faces a longer period of austerity than even the more pessimistic western commentators imagine.