When Deflation Isn’t Deflation

It’s been an awfully long time since I wrote a post. There have been a lot of reasons for the hiatus, both professionally as well as personally. The change in government last year also caused some switches in senior management where I work, and my workload has risen as a result. At a personal level, the passing of my father in June and wrapping up his estate has taken a toll on the entire family, which obviously took up a lot of time. I’ve also been spending more time on my fitness level, since hitting the big 50 milestone last year. With all these things going on, blogging has taken a bit of a backseat for the past year. On the other hand, I first started writing this blog 10 years ago this month, and it has been a major part of my life, and I’m determined that it will continue to be. So as an entrée back into blogging regularly, I’m going to address the hot topic of the week: Deflation.

Exchange Rates Are Relative Prices: China Edition

Or Part Two: The Real Reason Why I Feel Snarky This Week

Last week, an article by Prof Xiao Geng and our very own Tan Sri Andrew Sheng appeared on Project Syndicate (excerpt):

China’s Lonely Fight Against Deflation
…the current battle over the renminbi’s exchange rate reflects a tension between the interests of the “financial engineers” (such as the managers of dollar-based hedge funds) and the “real engineers” (Chinese policymakers).

Foreign-exchange markets are, in theory, zero-sum games: the buyer’s loss is the seller’s gain, and vice versa. Financial engineers love speculating on these markets, because transaction costs are very low and leveraged naked shorts are allowed, without the need to hedge an underlying asset. The exchange rate, however, is an asset price that has huge economic spillovers, because it affects real trade and direct-investment flows....

This is a mix of a witch-hunt, denial of economic theory and reality, flawed analysis, and historical revisionism. It's perhaps a blessing (and telling) that this appeared under the business and finance section, and not under economics.

May CPI Disappoints (Me)

It’s a topsy-turvy world when an increase in the general price level is cause for celebration, yet that is the stage Malaysia (and the rest of the world) is in now. For nearly forty years, the primary thrust of macro-management has been taming the beast of inflation as the foundation for sustainable growth. Inflation causes many ills, not least of which is devaluing incomes and causing hardship for the poor and the old. But this global recession is unlike any other, with the threat of a deflationary spiral into full-scale depression always present, like a bad party guest who just won’t go away.

For that reason, I wish I could take comfort from the rise in May CPI, but unfortunately I can’t. Disinflation on an annual basis is still ongoing as expected (log annual changes; 2005=100):



But the level of the CPI itself has ticked up:



The source of the rise is what’s causing my discomfort: housing and utilities. While there’s a huge element of subsidy in utilities, I suspect that some pass through of higher energy prices is happening, in which case the rise in the CPI is supply driven rather than demand driven. That means it isn’t caused by the looked-for recovery in consumption that would signal a turnaround in economic activity.

I can’t confirm that of course and it could possibly be due to housing instead, which was potentially boosted as a result of refinancing activities prompted by lower interest rates (the housing component is approximated by rent and imputed rent, the latter of which should be proportional to house prices). That would be better from an economic standpoint, as it implies demand-driven inflation rather than supply-side.

So the search for “green shoots” goes on.