May 07, 2012 11:53 AM

Andy Xie: Nothing Left for a Vanquished Virtuous Cycle


Industrial production is stalling in India, and its credit rating may be downgraded to junk. Power consumption in China has slowed to about half of last year's level, while consumer price inflation remains stubbornly high.

It's obvious the world's largest emerging economies are no longer in a position to carry the global economy through tough times, as they did during the "recovery" years of 2009-'11. And that spells trouble for the United States and Europe.

The euro zone economy may have contracted again in the first quarter; its data fits the stagflation model quite well. Inflation grew 2.6 percent in the first quarter, and GDP is expected to grow no more than 0.8 percent this year, rising from a low base due to a contraction in the second half 2011.

Stagflation also seems to be settling over the U.S. economy. A much-hyped recovery delivered a disappointing first quarter, with preliminary estimated GDP growth up 2.2 percent from the previous three months and the consumer price index climbing 0.9 percent, or 3.6 percent on an annual basis.

Policymakers and analysts say inflation's not a problem when growth is sluggish. What they're overlooking, however, is that inflation figures reported in recent months around the world are higher than historical averages. No longer can one predict inflation based on output gaps.

Much of the output gap in the West is fictitious. It's actually outdated capacity. And high unemployment rates will not act as a disinflationary force as long as there's no flexibility in the labor market.

On the other hand, money supplies worldwide, especially in developing countries including China, are growing at a robust pace, fueling higher prices for energy and food. This monetary easing is no longer stimulating growth. Instead, it's proving to be an effective means of fueling inflation.

Central banks are pushing on a string. If they insist on more monetary stimulus, the world could head toward an inflation crisis with similarities to what happened in the 1970s.

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