http://www.marketwatch.com/story/chmericas-slippery-slope-to-stagflation-2011-05-13?dist=beforebell
By Andy Xie
BEIJING ( Caixin Online ) — The global economy is heading toward another double-dip scare, possibly in the third quarter, in what could be a repeat of summer 2010.
Financial markets may stumble in a few months, and that could prompt the U.S. Federal Reserve to introduce a third round of quantitative easing or an equivalent, which would be another step down the path toward stagflation. In this scenario, China’s current monetary-tightening policy would be difficult to sustain.
Caixin is a Beijing-based media group dedicated to providing high-quality and authoritative financial and business news and information through periodicals, online and TV/video programs.
• Get the Caixin e-newsletter
A decline for the U.S. property market is accelerating. It could fall another 20% over the next 12 months.
China’s economy could slow substantially in the second half due to liquidity constraints for the property industry and local-government financing.
These factors contributing to a double-dip scare may push the U.S. Federal Reserve to launch another round of stimulus, although it may not be called QE 3. At the same time, the scare may cause oil prices to dip, easing inflation concerns.
The main aim of a QE 3 would be the same as QE 2 — to support U.S. stock and property markets. While it may succeed in reviving these asset markets, it would also yield surging oil prices and inflation.
A real double dip would occur if either the U.S. Treasury bond market crashes or appreciation expectations for China’s currency reverse on expectations of depreciation. The timing for this scenario could be fourth quarter 2012, possibly after the U.S. presidential election and the Chinese Communist Party’s 18th Congress.
Stagflation entrenches
This year’s first-quarter economic data points to a continuation of last year’s trend toward stagflation. The most important data were the U.S. annualized gross domestic product growth rate of 1.8% for the first three months of this year, compared to 3.1% in the fourth quarter 2010, and 3.8% inflation for personal-consumption expenditures (PCE), up from 1.7% for the previous three months.
The Fed pays closest attention to PCE in gauging inflation. Now, while economic growth seems to be stalling, inflation is spreading unambiguously.
Even Fed Chairman Ben Bernanke says the trade-offs for monetary policy aren’t appealing, i.e., the cost of inflation from additional monetary stimulus is probably higher than job-creation benefits.
Euro-zone inflation continued its march upward to 2.8% in April, the highest since October 2008, when oil prices rose above $140 a barrel. The European Union has upgraded the euro zone’s GDP growth rate to 1.6% for 2011. The first quarter was probably better, possibly showing a 2% annual rate.
Still, growth is not strong compared to the inflation level in Europe. Odds are that the euro zone’s inflation rate will be twice the growth rate in 2011, which fits the stagflation scenario.
The picture in China is a little different. The world’s second-largest economy reported a strong first-quarter growth rate of nearly 10%. Electricity consumption rose 12.7% from last year, obviously confirming strong growth.
Yet while trade value rose, the price effect probably dominated. China’s ports are experiencing hard times, indicating weak trade-volume growth. Global consumption data correlates a relatively subdued trade picture for China. Growth seems to depend on government spending, especially in central and western provinces.
Inflation is obviously worsening. The Chinese government’s attention has been shifting from one product price to another while trying to address inflation, the overall trend is quite worrisome. When prices do jump, they often jump high.
For example, while vegetable prices have eased a bit recently in China, fruit prices seem to have risen to extreme levels. The bottom line is that a massive stock of money in China, due to a decade of rapid growth, is in the process of turning into inflation. While money-supply growth in China has slowed, it is still 50% to 60% above China’s potential GDP growth rate. It is still stoking, not decreasing, inflationary pressure.
Tumbling growth
The global economy may slow sharply in the second half of 2011 for several reasons. Global financial markets could experience a setback that’s more serious than what occurred in the middle of 2010. The Fed rescued the markets then by launching QE 2, and may try QE 3 if markets fall again, although it would be less effective.
Most people think the U.S. housing market has already collapsed. But prices haven’t fallen sufficiently. Thus, the U.S. economy will turn downward again on falling property prices and rising oil prices.
U.S. residential property lost $6.3 trillion in value, or 28%, between 2006 and last year. The current value of $16.4 trillion is 110% of GDP, which is still much higher than its historical average. During the previous property burst, total value declined to below 80% of GDP. Thus, the U.S. property-market adjustment may be only half done.
Homeowners had hoped for the best after the Fed cut interest rates aggressively and the federal government introduced tax incentives for first-time home buyers. But the bear market remains. Now, homeowners with negative equity have no reason not to default. The U.S. housing market is beginning its second collapse.