In recent times, the role of Jerome Powell as Federal Reserve Chairman has come under scrutiny. While the function of Fed Chairs often benefits member banks, it frequently comes at a cost to wage earners and savers. As Powell grapples with escalating price inflation, the challenge of maintaining credit at a fixed rate becomes increasingly precarious. Currently, consumer price inflation, indicated by the Consumer Price Index (CPI), is rising at an annual rate of 4.2 percent, surpassing the interest rate on a 30-year fixed mortgage, which currently stands at 3.1 percent.
It isn’t difficult to anticipate a CPI exceeding 6 percent. At such a level, a mortgage yielding only 3 percent loses its appeal to banks. This situation is contributing to Powell’s diminishing credibility.
Powell’s tenure has been characterized by a tendency to conform to prevailing expectations. He has significantly expanded the Fed’s balance sheet, financing substantial government deficits and supporting the mortgage market.
However, he is not acting alone. Central planners in both the U.S. and internationally have fostered this price inflation through decades of aggressive money printing, credit interventions, and currency devaluations. It was always conceivable that an excess of money and credit would eventually lead to elevated consumer prices. The real question is, why did it take so long?
This inquiry is complex and perhaps beyond full understanding. Yet, today we aim to untangle one aspect of this intricacy: the previously harmonious trade relationship between the U.S. and China, which kept U.S. consumer prices stable for the past thirty years, and how this relationship has now shifted, contributing to increasing consumer prices.
Paper Lanterns
Recent reports from the Wall Street Journal indicate that rising costs for raw materials and worker shortages are pressuring small manufacturers in China. Some have opted to pass on the increased costs to overseas customers, including those in the U.S. Others are halting new orders entirely.
For instance, Zhongshan Xiliwang Electrical Appliances Co., a manufacturer of kitchen ventilators based in southern China, has reported operating at a loss since April. Escalating prices for metals, glass, and switches have significantly reduced profit margins, prompting the company to announce a temporary halt on new orders in mid-May.
This strategy stems from the hope that raw material costs will decline alongside consumer demand. However, if raw material prices continue to surge while consumer demand shrinks, it could exacerbate shortages of goods and consequently boost consumer prices further.
As raw material prices rise for Chinese manufacturers, so do consumer prices in the U.S. At the same time, these increasing costs are resulting in delays and shortages. This dual effect further propels consumer prices upward in America.
For several decades, U.S. consumer prices remained stable largely due to a managed exchange rate that favored inexpensive labor costs in China. That dynamic now appears to have shifted, as a shortage of manufacturing workers in China emerges.
For example, a major aluminum processing company has reported difficulties in finding enough workers to fulfill orders, despite offering salary increases of 10 percent—significantly higher than the usual annual raise of around 3 percent. Many young people in China prefer jobs as delivery workers over traditional factory roles.
As raw material prices rise and consumer prices follow suit in the U.S., the Chinese yuan has reached a three-year high against the dollar, which poses a challenge for the country’s central planners.
Why Consumer Price Inflation Is Here To Stay
Consequently, on Monday, the People’s Bank of China (PBOC) announced its decision to increase the foreign exchange reserve requirement ratio for financial institutions from 5 percent to 7 percent. This adjustment aims to make holding dollars more costly for banks, thereby attempting to slow the appreciation of the yuan by curbing the inflow of U.S. dollars.
How this goal can be achieved given China’s substantial trade surplus with the U.S. remains uncertain. Nevertheless, the PBOC is committed to pursuing this course of action. A peculiar situation is unfolding, illustrated by Michael Every of Rabobank, which sheds light on the current dynamics.
“Countries usually resist currency appreciation due to its deflationary nature and favor depreciation since it tends to be inflationary. However, the U.S. is wary of a weaker dollar, as it also heightens commodity prices, partly due to demand from China: they want the advantage of a stimulus-driven weaker dollar without the consequences of inflation. Conversely, China disapproves of a stronger yuan because it can fuel commodity inflation by making dollar-priced imports cheaper in yuan terms, thereby keeping demand elevated even as dollar prices rise.
“Both parties may temporarily agree that a signal of a weaker yuan benefits their efforts against inflation. Yet, in the broader context, they each desire a reflationary weaker currency and lower commodity prices, which can only occur if the other’s commodity demand significantly decreases. How will foreign exchange cooperation play out in this scenario? ‘Success has many parents, but failure is an orphan’ as the saying goes.”
The ability of U.S. policymakers to shift price inflation to China is finally waning. For decades, this strategy masked the consequences of lax fiscal and monetary policies in the U.S., as these policies were mitigated by affordable consumer goods. Those times appear to be a thing of the past.
Fed Chair Jay Powell maintains that the rise in consumer prices is merely temporary. Such assertions seem misguided. Consumer price inflation is likely to persist for the next decade, possibly even longer.
This reality is something to consider seriously.
Sincerely,
MN Gordon
for Economic Prism
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