TOKYO – First to recover, first to overheat? South Korea is suddenly grappling with this most dreaded of economic questions as inflation accelerates to the fastest pace since 2017.
Korea’s 2.3% consumer price jump, year-on-year, may be the vanguard of Asian economies suffering side effects from ultra-low interest rates prevailing from Washington to Frankfurt to Tokyo as they return to post-Covid-crisis growth.
Asian markets entered the week sensing the rubber hitting the road on a threat that has been months in the making. Along with China, which is sure to grow economically north of 6% this year, the US is offering upside growth surprises.
Case in point: IHS Markit’s manufacturing purchasing managers index rose to 60.5 in March, well above the 50-level denoting expansion. This suggests a widening gap between supply and demand of the kind that often fuels inflation.
In March, the US consumer price index rose 0.6% from the previous month and 2.6% from a year ago, the highest since August 2018.
Surging container shipping rates validate the trend and the risks.
Resurgent consumer demand in the US and parts of Europe is straining the global economy’s capacity to get goods across oceans fast enough. The Drewry World Container Index, for example, is registering the highest rate – US$4,403 last week – for a 40-foot container from Shanghai to California in a decade.
That line of ships is the physical embodiment of what many investors feared as they watched governments throw trillions of dollars of stimulus at economies.
Not only is recovering demand restoring pricing power, but scarcity dynamics afflicting several key commodities have producer costs spiking, too.
More? There is the softening US dollar, a harbinger of higher global inflation all its own.
All this means both “cost-push” and “demand-pull” pressures are beginning to stir simultaneously, complicating official response options.
Economic fragilities after 15 months of pandemic-related lockdowns, meantime, limit central banks’ ability to respond quickly and assertively.
It’s a balancing act sure to dominate markets for the remainder of 2021. And it coincides dangerously with Covid-era government debt buildups becoming more expensive by the day as yields rise.
Granted, some hyperbole may be at play here.
The shock to living standards since early 2020 continues to traumatize consumer sectors, limiting room to hike prices.
Korea shows why. It might be that “Korea is just experiencing the same base-comparison effects as countless other economies around the world when comparing today’s price level with the bombed-out price level in the early stages of the Covid-19 pandemic last year,” says Robert Carnell at Dutch bank ING.
With its sizable, open, trade-reliant economy, Korea is often a reliable weathervane for where global demand is headed. And, Carnell notes, the context of rising global commodity prices, higher electronics parts costs, myriad global supply chain interruptions and a recovering Korean service sector means 0.2% month-on-month increase in costs isn’t disastrous.
“We thought it could have been a little higher,” he says.
Still, markets are taking few chances amid signs of life in US pricing trends. However, there is no consensus view.
Markets on edge
Berkshire Hathaway billionaire Warren Buffett warns that the world’s largest economy is in “super high gear” thanks to massive government support, which is coming on the back of years of aggressive Federal Reserve easing.
“People,” the Sage of Omaha told shareholders over the weekend, “have money in their pocket and they’re paying higher prices.” So, it is no surprise that inflation is perking up faster than expected six months ago.
Lawrence Summers is even more worked up, citing what he calls the “least responsible” fiscal policy in 40 years. Summers, a former US Treasury secretary, warns that President Joe Biden is playing with fire by planning another $2 trillion of infrastructure spending on top of a recent $1.9 trillion Covid rescue package.
As Summers points out, past episodes where money supply growth outpaced private-sector investment rates – like now – ended in overheating and inflation.
Hence Summers’ warning of a “pretty dramatic fiscal-monetary collision.”
Janet Yellen, the current Treasury chief, and Fed Chairman Jerome Powell think the US has the opposite problem. They argue that the costs of inflation flaring up pale in comparison to the risk of a prolonged, Japan-like funk.
Others aren’t so sanguine.
Dallas Fed president Robert Kaplan suggests the central bank could soon consider tapering. “We’re now at a point where I’m observing excesses and imbalances in financial markets. I’m very attentive to that, and that’s why I do think at the earliest opportunity I think will be appropriate for us to start talking about adjusting those purchases.”
Such tension at Fed central, says National Australia Bank economist Ray Attrill, is sure to keep markets on edge from data report to data report.
“The main overarching rationale remains on the pace of the recovery,” Attrill says. That now looks “much faster” than previously expected, with unemployment forecasts being “4% by year’s end.”
If that scenario plays out, it is also conceivable rate rises may start earlier, with Kaplan stating the Fed may need to raise rates next year.
Asian fragilities to the fore
Asia is directly on the front lines of any Fed move to tap on the brakes – or an inflation-driven surge in debt yields, particularly in the US.
Though Asia has come a long way since the 1997-1998 crises, it remains more “dollarized” than governments admit. Most currency pegs are gone, but central banks go to great pains to keep exchange rates from rising versus the dollar.
And though East Asia generally handled Covid-19 better than the EU and US, public debt levels have soared in the 15 months since the pandemic hit, leaving finances highly vulnerable to spikes in borrowing costs.
There’s also more than $3 trillion in reserves sitting on East Asian central bank balance sheets.
“In the aftermath of the global pandemic, a number of countries will have to contend with debt burdens, possibly too large for them to manage,” notes Chang Yong Rhee, the International Monetary Fund’s (IMF) director of the Asia-Pacific region.
The pandemic savaged fiscal accounts. The combination of slower growth, lower tax and commodity revenues and increased spending to support growth widened deficits markedly. According to ING data, emerging economies ran an aggregated fiscal deficit of 9.5% GDP in 2020, with general government gross debt/GDP surging by 9 percentage points to 63%.
In Thailand, another economy upended by the 1997-98 Asian crisis, household debt is now at the highest since the central bank started tracking it in 2003. Economist Yunyong Thaicharoen at Siam Commercial Bank says household debt ratios may have hit 91% of GDP in the January-March quarter, a “level that has quite an impact on GDP and household spending.”
Korea had record-high household debt even before Covid-19 hit. Over-indebted consumers pose a clear and present danger not just to household spending, but financial stability if inflation worries drive up borrowing costs.
What’s more, Asian governments may have little choice but to continue adding stimuli, even as inflation risks increase. That puts policymakers in quite a bind.
“Growth is gaining momentum across developing Asia, but renewed Covid-19 outbreaks show the pandemic is still a threat,” says economist Yasuyuki Sawada at the Asian Development Bank.
He notes that 2021 is a spectacularly complicated year. Economic push-and-pull factors include: geopolitical tensions; far-reaching production bottlenecks; jittery markets; and the ways in which 15 months of millions of people were working and schooling at home impacts consumption, productivity and innovation. On top of that, new Covid-19 variants could flare up at any moment.
The jittery dollar
So could the dollar’s troubles.
Gold prices bounced this week as the US currency hit a nine-week low and without much of a fight from Yellen or Powell. Though neither the Fed nor Treasury officials are talking down exchange rates, they’ve also avoided formally restoring the decades-old “strong dollar” policy that Biden’s predecessor scrapped.
As such, notes strategist Chang Wei-Liang at DBS Bank, Asia currencies have seen “relief gains on the back of” Powell’s “sanguine outlook on inflation, which implies that US monetary policy is likely to remain accommodative and supportive of inflows into Asia.” Yet that could mean inflation continues heating up.
Here, Korea’s zigs and zags could prove instructive in the months ahead – and how the Bank of Korea responds.
Last month, Bank of Korea Governor Lee Ju-yeol said inflation will likely fluctuate around 2% – Seoul’s target – this quarter before moderating. Rather than hiking rates, Lee tried to conduct what economists call “open-mouth operations” – ie counseling caution while leaving rates alone.
As of now, says ING’s Carnell, the “rate of headline inflation has picked up, but from around zero at the beginning of the year.” This rate, he adds, “will have to pick up a lot further and then stay elevated to cause the BOK any concern about its current policy stance.”
But given the ultralow levels of global bond yields, the fast-widening supply-demand gap and all those export-laden ships setting a Westward course, an inflation surge can’t be ruled out.