TOKYO – As Western economists brawl about when inflation might flare up, Chinese authorities are beating them to the punch.
This take-no-chances approach on upward price pressures from those imported via commodity markets to any froth in domestic property markets makes for quite a contrast with officials from Washington to Sydney.
The commodity risk moved to Beijing’s front-burner with news that producer prices jumped 4.4% in March from a year earlier – the biggest increase in two years. Though consumer prices are less worrisome, having risen only 0.4% in March, the question for Chinese President Xi Jinping is “for how long?”
Public responses have been both rhetorical and tangible. Last week, China’s Financial Stability and Development Committee urged authorities to “keep a close eye on commodities prices.”
Recent actions have included imposing supply constraints on metals like steel and aluminum and tightening controls on raw materials markets, both to cap costs for companies and keep factory-gate inflation from filtering into finished prices.
The incentives for China to act are even bigger than that.
As the world’s biggest single exporting power, Xi’s government hardly wants to be seen as exporting inflation around the world. Japan, of course, has barely lived down sharing deflation over the last two decades.
Xi’s Communist Party, still smarting from the damage Covid-19 did to China’s soft power, wants to avoid talk of “Chinese inflation” in trading pits and parliament floors.
One notable strategy is stepping up efforts to increase supply to clear bottlenecks fueling higher costs in markets like coal. This has also meant China approving the release of strategic stockpiles of everything from aluminum to animal feed.
Similar steps might be taken to increase the supply of copper with prices near 10-year highs. And futures exchanges are tightening limits on speculation in key products.
Chinese officials also are hinting at broader efforts to yank monetary and fiscal support from Asia’s biggest economy. Compared with the Federal Reserve in Washington, the People’s Bank of China has been the picture of monetary sobriety for the duration of the pandemic crisis.
For now, the odds of the PBOC “tapering” well before the Fed are quite high and growing as asset prices heat up. That also might require a fresh round of limits on leverage and macroprudential steps to tame property markets.
“This shows that China is in the midst of deleveraging reform, and will not expand credit in 2021,” says economist Iris Pang at Dutch bank ING.
If recent policy responses in Beijing are any guide, China will be ahead of the curve should reflation fears become a financial reality. Yet China’s potential inflation troubles are the world’s.
Beyond Chinese shores
The real worry, says economist Raymond Yeung of Australia and New Zealand Banking Group, is evidence that Chinese producer price trends are closely linked with where top-line US consumer costs are headed. This “high positive correlation,” Yeung says, “could impact people’s judgment of inflation pressure in the US and globally.”
Hence the increased level of stress in global debt markets. Hedge fund whale Ray Dalio, for example, has a rather blunt description for the state of global bond markets in 2021: “stupid.”
That might be the kindest thing Dalio and his ilk end up thinking this year as yields threaten to surge from Washington to Beijing at the worst possible moment. Turns out, a decade-plus of commandeering debt markets via record central bank stimuli and purchases has its costs.
Make that three costs.
One: The risk of higher inflation that’s now making life intensely difficult for officials at the Fed, the Reserve Bank of Australia and elsewhere. Two: Rising yields amid fears governments are overborrowing while debt burdens are already elevated. Three: Central banks may be about to lose control of broader market forces.
Because of these tensions, says Bridgewater Associates founder Dalio, “the economics of investing in bonds (and most financial assets) has become stupid. Rather than get paid less than inflation why not instead buy stuff – any stuff – that will equal inflation or better?”
Dalio is particularly frustrated by the “ridiculously low yields” of bonds everywhere. Yet bond gurus may hate the alternative even more should it materialize in the months ahead.
Two of the last three US Treasury debt auctions have been dangerously weak affairs, suggesting that the Fed’s ultralow interest rates – and their myriad side effects – are about to backfire. That means the yields Dalio complains are too low, could spike ridiculously quickly and sharply in ways that upend stock markets.
What we’re seeing, really, is bond markets remembering what they do. The gang doing most of that remembering are the “bond vigilantes.” Historically, such punters punish wayward governments and risky central bank policies by bribing up yield levels.
We saw them in action in New York in the early 1990s when US budget deficits widened. In 1997 and 1998, they let authorities in Bangkok, Jakarta and Seoul know that manipulated currencies can be a dangerous thing. In 2008, they punished Wall Street for its addiction to packaging subprime loans into ever-less-credible securities.
Black Swan author Nassim Nicholas Taleb hit the nail on the proverbial head as well as anyone, concluding: “We humans lack imagination, to the point of not even knowing what tomorrow’s important things will look like.”
These days, Taleb is making the rounds stressing that Covid-19 was not a black swan event. That is defined as a high-impact event that comes out of nowhere and experts try to rationalize, often futilely, with the benefit of hindsight.
To Taleb, the pandemic that wracked the global economy’s 2020 was no more unpredictable than today’s market tremors.
If the sudden resurrection of the bond vigilantes now was so predictable, though, why do governments seem flat-footed by the turmoil and the risks ahead?
In the case of US President Joe Biden, Treasury Secretary Janet Yellen can make the reasonable case that his administration only just came into being. Under predecessor Steven Mnuchin, the Donald Trump administration did everything it could to imperil Washington’s balance sheet short of defaulting on debt. (Which is something Trump actually thought about doing.)
The nearly $2 trillion Covid-19 rescue package and plans for an even bigger infrastructure boom have bond traders in a whirl. Many fear 10-year US Treasury yields are headed to 2% and beyond.
This has some top academics not known for dramatic prognostications to start ringing the alarms. Case in point: Harvard economist Kenneth Rogoff telling Bloomberg News that yield surges amid the global pandemic recovery would “turn the world upside down.”
As Jamie Dimon, CEO of JPMorgan Chase & Co notes, “it’s hard to justify the price of US debt.” Coming from a man who back in 2018 said 10-year yields hitting 5% “is a higher probability than most people think,” that’s a worrisome statement indeed.
So is, of course, Mike Novogratz, CEO of Galaxy Digital Holdings, making it a point last week to publicize that he’s “short a lot of interest rates.”
Central banks on the brink
The trouble is that he speaks for many. And that may include the ranks of the most pivotal financiers of all: Asia’s central banks.
Japan and China alone hold some $2.4 trillion of US Treasury debt, an amount comparable to the size of Biden’s coming infrastructure spending plan. Any move by the institutions that essentially hold Washington’s mortgage could devastate global markets.
The cracks are already showing here in Asia, though. Consider what’s afoot in debt markets from Australia to India.
In the meantime, inflation risks are perking up in all major economies. Given the correlation between Chinese prices and flareups elsewhere, it wouldn’t be surprising if markets “become increasingly concerned about pressures from rising inflation on Beijing’s policy stance,” says economist Ting Lu at Nomura Holdings.
The good news, though, is that officials in Beijing are being more proactive in cracking down on inflation than the US or other peers. That forward planning could come in handy if the inflation-phobes turn out to be correct about 2021.