We didn't expect that at this point in the century, we've been living under the impact of COVID-19 for more than two years, and we didn't expect that there would be new high inflation data in the United States.
Since April 2021, U.S. inflation has continued to rise, with CPI up 7% year-on-year in December, a nearly 40-year high.
Will high inflation in the United States affect China?
On February 7, the First Institute of Finance and Economics released a report entitled "Once in Forty Years of Great Inflation in the United States: Analysis of the Impact on China and Countermeasures", which analyzed the trend of INFLATION in the United States and its possible impact on the mainland, and put forward countermeasures and suggestions.
The report shows that from a sub-item point of view, the price of energy and transportation that has been greatly affected by the epidemic has increased the fastest. Recently, high inflation has severely affected the daily lives of U.S. residents; consumer confidence continues to weaken; economic growth expectations have been sharply reduced; biden's approval rating has reached a new low.
As for the reasons for the rapid rise in inflation in the United States, the report argues that, from the demand side, unlike during the 2008 global financial crisis, a large amount of money under the framework of modern monetary theory (MMT) is directly transferred to businesses and residents; from the supply side, it is mainly the impact of the new crown epidemic on global supply chains and labor force participation rates.
Curbing inflation has become the primary goal of the Fed's monetary policy at present, and the epidemic has determined that there is great uncertainty about the trend of inflation in the short term. According to the report, there are three scenarios:
The first scenario: the epidemic has improved significantly, the pressure on global supply chains has eased, the level of inflation in the United States has dropped significantly, and the Fed may slow down the pace of monetary tightening.
The second scenario: the epidemic has not changed much overall, supply chain pressures remain the same, inflation levels have not changed much, and the Fed may raise interest rates and shrink its balance sheet at a faster pace to curb inflation.
The third scenario: the epidemic has worsened significantly, however, as the global vaccine coverage and the proportion of severe covid-19 cases have declined, the likelihood of countries restarting a full lockdown response has been greatly reduced, and the demand side has been hit less than the supply side. As inflation rises further, the Fed will have to accelerate the pace of interest rate hikes and balance sheet reductions to curb inflation.
The report believes that the future trend of US inflation will have an impact on China.
In the first scenario, exports slowed and the renminbi faced depreciation pressure. On the one hand, due to the significant improvement in the epidemic, the pressure on the global supply chain will ease, and the global commodity supply is expected to recover rapidly, which will make China's export growth rate slow down significantly; on the other hand, the trade surplus factors that have driven the strengthening of the renminbi in the past year will weaken, thus exposing the renminbi to depreciation pressure.
In the second scenario, exports slowed, capital outflows, and financial market volatility. First, as the Fed tightens monetary policy at a faster rate, external demand will decline and mainland exports will slow down; second, China will face certain capital outflow pressures, and there will be a certain degree of volatility in the RMB exchange rate, bond market and stock market.
In the third scenario, there will be greater capital outflows and financial market volatility pressures. In this scenario, the Fed will have to accelerate interest rate hikes as inflation accelerates as the pandemic worsens. The United States faces the risk of a recession, the global financial market will fluctuate sharply, and the mainland will also face greater capital outflows and financial market volatility pressures.
The report believes that in the context of stability in the overall economic and social situation in 2022, it is necessary to actively deal with the impact of changes in the us inflation trend on the mainland. Therefore, four recommendations were made:
First, macro policies adhere to the principle of "taking me as the mainstay", pay close attention to changes in the situation, and actively and flexibly respond;
Second, maintain the flexibility of the RMB exchange rate and play the role of an automatic exchange rate stabilizer;
Third, adhere to expanding financial opening up and continue to attract foreign investors who allocate Chinese assets for a long time;
Fourth, China and the United States should strengthen communication, eliminate tariffs, and strengthen coordination at the global supply chain level.
The following is the full text of the report:
"Once in 40 Years, The Great Inflation in the United States: An Analysis of the Impact on China and Countermeasures"
Before the COVID-19 outbreak, low inflation in the United States lasted for nearly a decade. However, since April 2021, the level of inflation in the United States has continued to rise, causing widespread concern in the market. What is the current inflation situation in the United States? What is the driving force behind it? What impact will its future trend have on the mainland? How to deal with it?
First, inflation in the United States hit a 40-year high, and residents, the economy, and Biden's support rate were greatly affected
1. Inflation in the United States hit a 40-year high, with energy and transportation prices rising the most
Since April 2021, U.S. inflation has accelerated. According to data released by the U.S. Bureau of Labor Statistics recently, in December 2021, the U.S. Consumer Price Index (CPI) rose 7% year-on-year, a growth rate of 0.2 percentage points higher than the previous month, more than 5% for eight consecutive months, the fastest increase since June 1982. Excluding food and energy prices, the core CPI rose 5.5% year-on-year, up 0.6 percentage points from the previous month and the highest level since February 1991 (Figure 1).
By item, energy and transportation prices rose the most. In December 2021, the largest segments of CPI increases were energy, transportation, food and beverage, clothing and housing, with year-on-year increases of 29.3%, 21.1%, 6%, 5.8% and 5.1% respectively (Figure 2). From the perspective of growth momentum, energy price growth slowed down, the growth rate fell by 4 percentage points from the previous month; the growth rate of transportation prices was the same as that of the previous month; the growth rate of food and beverage prices increased by 0.2 percentage points from the previous month; the growth rate of clothing prices increased by 0.8 percentage points from the previous month; and the growth rate of residential prices increased by 0.3 percentage points from the previous month.
2. U.S. residents, the economy, and Biden's support rate have all been greatly affected
Inflation affects the lives of residents. At present, high inflation has seriously affected the daily lives of U.S. residents. A recent Gallup poll showed that the shock of inflation is hitting U.S. consumers. Overall, 45 percent of Americans say they have experienced economic hardship as a result of rising prices. By income level, price increases have particularly affected low-income households, with 71 percent of U.S. households earning less than $40,000 a year saying they experienced economic hardship as a result of recent price increases. Among middle- and high-income households, the proportion is 47 per cent and 29 per cent, respectively. Gallup noted in his report that about 79 percent expect inflation in the U.S. to rise to "some degree" and about 50 percent expect inflation to "rise substantially." It was the largest percentage of people predicting an increase in inflation since polls on the issue were first conducted in 2001.
Consumer confidence continues to weaken. U.S. consumer confidence continues to weaken as inflation rises. The university of Michigan's consumer confidence index, which started at 68.8 in January, fell below 70 for the second time in three months, with the consumer confidence status index falling to a 10-year low of 73.2 (Figure 3).
Economic growth expectations have been sharply revised downward. Recently, the Wall Street Journal surveyed business and financial circles and found that due to the impact of inflation and other factors, respondents lowered their expectations for the economic growth of the United States in the first quarter and full year of 2022. In its Global Economic Prospects Report (WEO) released on January 25, the International Monetary Fund (IMF) slashed U.S. economic growth by 1.2 percentage points to 4 percent in 2022, the largest of all advanced economies. Inflation levels that exceed expectations and spread wider are important reasons.
Biden's approval rating is record low. The latest Pew Research Center findings show biden's approval ratings are at a record low. A January poll showed that 41 percent of adults affirmed Biden's job performance, down from 44 percent in September and 55 percent in August. Most of those surveyed said the U.S. economy had deteriorated as prices soared and had little or no confidence in Biden.
Second, demand is different from the previous expansion and the contraction of supply caused by the epidemic has driven inflation levels up
Inflation, as a measure of price change, is determined by supply and demand in the economy. When aggregate demand is greater than aggregate supply, inflation rises.
1. Demand expansion: Unlike during the 2008 global financial crisis, a large amount of money under the framework of modern monetary theory (MMT) is directly transferred to businesses and residents
In 2020, major economies around the world will adopt super-accommodative policy measures to deal with the impact of the COVID-19 pandemic. In this context, modern monetary theory (MMT) has aroused heated discussion in the market. Under the traditional monetary theory framework, fiscal deficits are an overdraft of future tax revenues. MmT, however, disagrees, and its core view is that as long as the government borrows in its local currency and there is no inflationary pressure, it can stimulate the economy by expanding the deficit and printing money by the central bank.
After the outbreak of the epidemic, on the one hand, the Fed implemented a more accommodative monetary policy than during the 2008 financial crisis. In March 2020, the Fed cut its policy rate to zero through two emergency rate cuts (Figure 4). Meanwhile, the Fed began implementing a quantitative easing (QE) program totaling $700 billion, and subsequently announced an increase in asset purchases to $125 billion per day (including $75 billion in Treasuries and $50 billion in MBS), with no upper limit on on-demand purchases. To provide liquidity to specific entities, the Fed has restarted and established a variety of policy tools since March 2020, including the Commercial Paper Financing Facility (CPFF), the Tier 1 Dealer Credit Facility (PDCF), and the Money Market Mutual Fund Liquidity Facility (MMLF). As of now, the Fed's assets are close to $9 trillion, double the amount before the outbreak (Figure 5).
On the other hand, unlike in 2008, the U.S. government launched several rounds of fiscal bailout programs, directly distributing cash to businesses and residents. After the outbreak of the new crown epidemic, the Trump administration introduced several rounds of economic relief plans. The third round of stimulus packages amounted to $2.2 trillion, including assistance to governments at all levels, schools, the unemployed, and industries affected by the epidemic. On December 27, 2020, the soon-to-be-ounce Trump signed the $900 billion COVID-19 bailout bill, which includes more than $300 billion in relief for small businesses; $300 a week in federal supplementary unemployment insurance until mid-March 2021; and a one-time cash check for $600 to most Americans. In 2021, the Biden administration launched the $1.9 trillion "U.S. Bailout Program," in which nearly $1 trillion directly or indirectly subsidized residents, including a $1,400 grant to most Americans, an increase in federal unemployment benefits to $400/week, and so on.
According to the IMF, as of July 2021, the United States has mobilized more than 25% of its annual GDP to respond to the COVID-19 pandemic, accounting for the highest proportion of major economies in the world. In 2020, transfer payment income accounted for 21.6% of the total personal income in the United States, an increase of 4.6 percentage points over 2019, the highest after World War II. In the first three quarters of 2021, the proportion rose to 22.9%.
Compared with the 2008 financial crisis, this time the monetary and fiscal cooperation is more like MMT. After the global financial crisis broke out in 2008, from 2008 to 2014, the Fed expanded its balance sheet by $3.61 trillion. Among them, the net increase in US Treasury bonds was $1.7 trillion, accounting for 47.3% of the Fed's balance sheet expansion, equivalent to 19.2% of the new US Treasury bond increase in the same period. After the outbreak of the new crown epidemic, by the end of 2021, the Fed expanded its balance sheet by $4.39 trillion from the end of 2019. Among them, the net increase in US Treasury bonds was $3.18 trillion, accounting for 72.5% of the Fed's expansion of the balance sheet, equivalent to 55.8% of the new US Treasury bonds in the same period.
It can be seen that this round of rapid expansion of the Fed is mainly through the purchase of US Treasuries, contributing more than half of the new US Treasury bonds in the same period, providing important help for government deficit financing, much like MMT. And unlike the 2008 fiscal funds used to inject capital into problem financial institutions, this time the US government's deficit financing chose to directly issue cash subsidies to enterprises and residents. In terms of results achieved, M2 in the United States has increased significantly since the epidemic compared to the 2008 global financial crisis (Figure 6).
2. Supply contraction: Mainly the impact of the new crown epidemic on the global supply chain and labor force participation rate
The COVID-19 pandemic has had an impact on major commodity-supplying countries. On the one hand, the epidemic has had an impact on commodity suppliers represented by Brazil and Chile, restricting supply capacity. On the other hand, the epidemic has had a clear impact on countries outside China where manufacturing is concentrated. As can be seen from Figure 7, the manufacturing PMI in Vietnam and Malaysia plummeted during the early stages of the outbreak and the rapid spread of delta virus in the second half of 2021. Some production has encountered obstacles, output has declined, and delivery times have been extended. This is more evident in intermediate inputs such as key components. Since 2021, the global chip supply shortage has intensified, and the delivery cycle has been extended from the usual 9-12 weeks to more than 22 weeks.
Affected by the epidemic, there have been many blockages in the global supply chain. The global port congestion caused by the epidemic has intensified, and trade and logistics costs have risen sharply. Since 2021, the Baltic Freight Index (FBX), which measures container freight prices, has risen more than 2 times (Figure 8). According to a report by market research firm IHS Markit, congestion in major ports around the world has gradually surged since the second half of 2020, with ships handling more than 6,000 containers taking an average of more than 83 hours in ports, a 20% year-on-year increase in time consumption. In the united states, as the two most important ports in the United States, the ports of Long Beach and Los Angeles together account for about 40% of the U.S. sea container throughput. But since the outbreak, the two ports have been inefficient in operation. Affected by this, the China Export Container Freight Rate Index (CCFI) of the US-West route and the US-East route has remained at a high level since 2021 (Figure 9).
The pandemic has led to labor shortages. After the outbreak, the labor force participation rate in the United States declined. According to the U.S. Department of Labor, the U.S. labor force participation rate was 61.9 percent in December 2021, 1.5 percentage points lower than before the pandemic. According to the American Trucking Association, about 70 percent of the goods in the United States depend on trucks. The number of truck driver shortages in the U.S. is now 30 percent higher than before COVID-19 (61,500), with a shortfall of 80,000. As for the reasons for the decline in the labor force participation rate, the Fed pointed out in its monetary policy report released in July 2021, mainly including the surge in retirement due to the epidemic, the increase in childcare pressure, and the fear of contracting the virus. According to the U.S. Census Bureau's Family Pulse Survey, about 8.8 million Americans were unable to work in the 13 days from December 29, 2021 to January 10, 2022, due to COVID-19 or caring for patients, the highest figure since the launch of the Family Pulse Survey. The survey also revealed that another 3.2 million Americans are unable to work for fear of being infected or being infected to others.
In addition, the energy transition has exacerbated the supply shortage. The energy transition has exacerbated this change by a sharp contraction in the global energy supply following the COVID-19 outbreak and the pace of recovery. At present, energy conservation and emission reduction have become a global consensus, and most countries have set "carbon neutral" goals. In September 2020, China proposed that it would strive to achieve "carbon peak" by 2030 and "carbon neutrality" by 2060, and formulated relevant action plans; the United States proposed in April 2021 that it would reduce greenhouse gas emissions by 50%-52% by 2030 from 2005 levels and achieve "carbon neutrality" by 2050; the European Union proposed in April 2021 that it would reduce greenhouse gas emissions by at least 55% by 2030 from 1990 levels. Achieve "carbon neutrality" by 2050. The epidemic superimposed on the energy transition has affected the investment momentum of traditional energy sources, and the recovery of energy supply has been slow (Figure 10). According to IEA estimates, crude oil demand rebounded rapidly in 2021, but the recovery of supply was relatively slow. Specifically, crude oil demand increased by about 5.2 million barrels per day compared with 2020; from the supply side, the increase in crude oil supply in 2021 is lower than the increase on the demand side on the one hand, and on the other hand, it is also much lower than the reduction under the impact of the epidemic in 2020.
U.S. tariffs on goods imported from China are passed on to U.S. consumers. Since the outbreak of the new crown epidemic, with excellent epidemic prevention and control, China's production side has taken the lead in recovering, becoming an important source for the United States to fill the gap in its commodity demand. Customs data show that China's exports to the United States in 2020 increased by 7.9% year-on-year against the trend, and in 2021, it increased by 27.5% year-on-year.
Due to the Sino-US trade friction during the Trump administration, the United States has imposed huge tariffs on goods imported from China, and these tariffs are currently passed on to American consumers. According to Moody's, in Sino-US trade, U.S. consumers bear the cost of imposing tariffs on Chinese goods by 92.4%, and only 7.6% of the cost is absorbed by the mainland. By industry, according to the Asian Development Bank (ADB), the price of leather and footwear, machinery, electronic optical instruments and other industry products has been greatly affected, with a year-on-year increase of more than 1 percentage point.
Three scenarios for inflation and the Fed's response
1. Curbing inflation has become the primary goal of the Fed's monetary policy at present
With inflation at a high level, Powell recently abandoned the "inflationary theory" that he had been adhering to, and containing inflation has become the fed's primary goal. Judging from the recent Fed interest rate meeting in January, given the current high level of inflation and the risk of further rise, it is likely that the Fed will start the monetary tightening process at a faster pace after the end of quantitative easing in March.
It is worth mentioning that, as analyzed above, an important reason for the rise in the level of inflation in the United States in this round is that a considerable part of the funds released by the Fed's expansion of the balance sheet have entered the currency circulation field through fiscal stimulus measures. Therefore, once the austerity process begins, the balance sheet reduction may come quickly, and the monetary tightening will be faster than in the past. During the last round of monetary policy tightening, the Fed's balance sheet drawdown began more than a year after the first rate hike. At the December 2021 interest-bearing meeting, participants discussed the possibility of shortening the time between balance sheet reduction and rate hikes.
2. The epidemic has determined that there is great uncertainty about the trend of inflation in the short term
With quantitative easing coming to an end and future monetary policy making a decision, the trend of inflation in the short term depends on changes on the supply side. As mentioned earlier, the supply side is mainly affected by the COVID-19 pandemic, so the trend of inflation in the short term will depend on changes in the epidemic.
From the current point of view, there is great uncertainty about the trend of the epidemic. On the one hand, as the Opichron variant replaces Delta in many countries as the mainstream strain of the new crown epidemic, the authoritative medical journal The Lancet recently published a blockbuster article "COVID-19 will continue but the end of the pandemic is near", and the author Chris Murray, director of the Institute of Health Indicators and Evaluation (IHME) at the University of Washington, believes that the global new crown "pandemic" is likely to end in the near future. March 2022 is a critical time.
On the other hand, the World Health Organization recently pointed out that if the current rate of spread of the epidemic is followed, more than 50% of the population in Europe will be infected with the Aumechjong variant in the next 6 to 8 weeks. The new coronavirus is a susceptible RNA virus, and the more people infected, the more likely it is that new dangerous variants will appear. The continued prevalence of variants can also lead to mutual transmission between animals and humans. Because the animal's internal environment is different from that of the human body, the direction of virus mutation will be more uncertain, and the probability of dangerous variants will be further increased.
3. Three scenarios for the future
Given the high uncertainty of the changes in the epidemic, there is uncertainty about the trend of US inflation in the short term. The Fed's response to different changes in inflation will also be different, and there are three scenarios:
The third scenario: the epidemic has worsened significantly, and as the global vaccine penetration and the proportion of severe covid-19 cases have declined, the likelihood of countries restarting a full lockdown response has been greatly reduced, and the demand side has been hit less than the supply side. As inflation rises further, the Fed will have to accelerate the pace of interest rate hikes and balance sheet reductions to curb inflation.
Fourth, the impact on China lies in exports, RMB exchange rate, capital outflows, market fluctuations and so on
1. In the first scenario, exports are slowing down and the renminbi is under depreciation pressure
On the one hand, due to the significant improvement of the epidemic, the pressure on the global supply chain will ease, and the global commodity supply is expected to recover rapidly, which will make China's export growth rate slow down significantly. On the other hand, the trade surplus factors that have driven the renminbi to strengthen over the past year will weaken, putting the renminbi under depreciation pressure.
2. In the second scenario, exports slow, capital outflows, and financial market volatility
First, as the Fed tightens its currency at a faster pace, external demand will decline and mainland exports will slow. Second, China will face certain pressures on capital outflows, with a certain degree of volatility in the RMB exchange rate, bond market and stock market.
3. In the third scenario, it will face greater capital outflows and financial market volatility pressures
In this scenario, the Fed will have to accelerate interest rate hikes as inflation accelerates as the pandemic worsens. The United States will be at risk of a recession, and global financial markets will also fluctuate sharply. The mainland will also face greater capital outflows and pressure from financial market volatility.
Fifth, the four-point countermeasure proposal under the background of stability as the main tone of the overall economic and social situation
In the context of stability in the overall economic and social situation in 2022, it is necessary to actively respond to the impact that high inflation in the United States may have on the mainland.
1. Macro policy adheres to the principle of "taking me as the mainstay", pays close attention to changes in the situation, and actively and flexibly responds
At present, the recovery of domestic demand on the mainland is not stable enough, the external environment is facing greater uncertainty, and the first quarter will be an important window of observation. At this stage, macro policies should comprehensively use monetary policy tools to guide market interest rates downward, strengthen domestic demand, and reduce dependence on external demand. At the same time, we should pay close attention to the changes in the external situation and flexibly adjust policies according to the actual situation.
2. Maintain the flexibility of the RMB exchange rate and play the role of an automatic stabilizer of the exchange rate
The exchange rate is the most important automatic stabilizer for open economies, and maintaining the flexibility of the RMB exchange rate can help reduce the impact of external shocks on mainland financial markets. Once the Fed raises interest rates lead to volatility in global financial markets, a fully resilient renminbi can take the lead in absorbing some of the external shocks, mitigating the impact on the domestic economy and financial markets.
3. Adhere to expanding financial opening up and continue to attract foreign investors who allocate Chinese assets for a long time
In recent years, China has actively promoted financial opening up, and major international indices have successively included China's stock and bond markets in the scope of compilation, attracting a large number of foreign capital into China. This part of foreign capital is mainly based on allocation needs and long-term optimism about China's economic fundamentals, which is less affected by short-term factors, which in turn makes the capital outflow pressure facing China more controllable. In the future, we should persist in expanding financial opening up and continue to attract foreign investors who are committed to the long-term allocation of Chinese assets.
4. China and the United States should strengthen communication, eliminate additional tariffs, and strengthen coordination at the global supply chain level
First, the U.S. side should remove tariffs on goods imported from China. China's Ministry of Commerce recently said that the cancellation of tariffs is beneficial to the United States and the world, and also reminded that "in the current inflationary situation", the cancellation of tariffs is in the fundamental interests of consumers and producers in China and the United States. Second, China and the United States need to strengthen coordination at the global supply chain level. A stable global supply chain is in the common interest of both China and the United States, and if the tension in the global supply chain is not alleviated, the United States will continue to face inflationary pressures.
Report Writer: Yu Ming/Researcher of First Institute of Finance and Economics
Report validation: Ma Shaozhi/Researcher of the First Institute of Finance and Economics
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