Monday, April 23, 2007
Is the China effect over?
For the last few years, the biggest risk to the strong performance of UK economy has been inflation. But the risk has long been that we would discover that underneath our strong economy, was brewing some hidden inflationary pressure. If that emerged, it would imply that some of our recent economic success had been built on shaky foundations: it would mean that interest rates had perhaps been "too low", that the borrowing we have done on the back of low interest rates was less affordable than we thought, that the house prices we have paid on the back of easy borrowing are unsustainably high, and that any sense of consumer wealth deriving from higher house prices is a mere illusion. Well, has this inflationary pressure now materialised, or is today's 3.1% rate just a blip? Certainly it could be a blip as inflation is volatile at the moment, largely as a result of energy price swings. So we have to see through that volatility and ask where inflation will settle. That should be well below three percent, but there is still room for concern.
It all comes down to the China effect. In recent years, our economy has been dependent on deflating imported goods prices. To some extent, we've been able to enjoy simultaneous fast domestic growth, strong consumer spending and low inflation, because the prices of manufactured goods have been falling each year. If the flow of cheap imports dries up, either because the Chinese export prices rise or because our exchange rate falls, then we have to adjust the domestic economy to slower growth and restrained consumer spending. One theory is these are going up in price now, as we've reach the end of the gains to be derived from out-sourcing our factories. When there are no more factories to send abroad, there are no more cost-savings to be found in manufactured goods prices. The other factor to watch is the exchange rate. It has been relatively high, and in recent days strengthening against the dollar. As most Chinese imports are priced in dollars, they are going to get cheaper not more expensive when converted into pounds. But unless the pound rises forever against the dollar - which is unlikely - the exchange rate provides just temporary shelter against import price rises. Don't learn to rely on it.
Read the full story at: http://www.bbc.co.uk/blogs/thereporters/evandavis/
Evan's blog entry raises a number of important issues: the UK boom may be built on unsustainable levels of borrowing, aided and abetted by cheap imports (in turn helped by a "stronger" pound). A "stronger pound" (a rise in the exchange rate defined as the foreign price of domestic currency) makes imports cheaper and exports less competitive. This worsens the domestic trade balance (see http://news.bbc.co.uk/2/hi/business/6547937.stm for some background on this). As the Chinese economy develops, and/or if the pound weakens, import prices rise, and this feeds through into domestic inflation.
The much acclaimed new interactive learning package LiveEcon can help you undertand the economics behind these important policy events. For example, Chapter 13 looks in depth about the effects of exchange rate movements on the economy as a whole. Find out how to get LiveEcon at http://www.liveecon.com/. Download this blog as a Blogcast via the website.
For the last few years, the biggest risk to the strong performance of UK economy has been inflation. But the risk has long been that we would discover that underneath our strong economy, was brewing some hidden inflationary pressure. If that emerged, it would imply that some of our recent economic success had been built on shaky foundations: it would mean that interest rates had perhaps been "too low", that the borrowing we have done on the back of low interest rates was less affordable than we thought, that the house prices we have paid on the back of easy borrowing are unsustainably high, and that any sense of consumer wealth deriving from higher house prices is a mere illusion. Well, has this inflationary pressure now materialised, or is today's 3.1% rate just a blip? Certainly it could be a blip as inflation is volatile at the moment, largely as a result of energy price swings. So we have to see through that volatility and ask where inflation will settle. That should be well below three percent, but there is still room for concern.
It all comes down to the China effect. In recent years, our economy has been dependent on deflating imported goods prices. To some extent, we've been able to enjoy simultaneous fast domestic growth, strong consumer spending and low inflation, because the prices of manufactured goods have been falling each year. If the flow of cheap imports dries up, either because the Chinese export prices rise or because our exchange rate falls, then we have to adjust the domestic economy to slower growth and restrained consumer spending. One theory is these are going up in price now, as we've reach the end of the gains to be derived from out-sourcing our factories. When there are no more factories to send abroad, there are no more cost-savings to be found in manufactured goods prices. The other factor to watch is the exchange rate. It has been relatively high, and in recent days strengthening against the dollar. As most Chinese imports are priced in dollars, they are going to get cheaper not more expensive when converted into pounds. But unless the pound rises forever against the dollar - which is unlikely - the exchange rate provides just temporary shelter against import price rises. Don't learn to rely on it.
Read the full story at: http://www.bbc.co.uk/blogs/thereporters/evandavis/
Evan's blog entry raises a number of important issues: the UK boom may be built on unsustainable levels of borrowing, aided and abetted by cheap imports (in turn helped by a "stronger" pound). A "stronger pound" (a rise in the exchange rate defined as the foreign price of domestic currency) makes imports cheaper and exports less competitive. This worsens the domestic trade balance (see http://news.bbc.co.uk/2/hi/business/6547937.stm for some background on this). As the Chinese economy develops, and/or if the pound weakens, import prices rise, and this feeds through into domestic inflation.
The much acclaimed new interactive learning package LiveEcon can help you undertand the economics behind these important policy events. For example, Chapter 13 looks in depth about the effects of exchange rate movements on the economy as a whole. Find out how to get LiveEcon at http://www.liveecon.com/. Download this blog as a Blogcast via the website.
# posted by Sam @ 15:59 
