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Friday, May 09, 2003

On the So-Called Sars Paradox

Here's a really good example of a really bad argument. SARS, apparently, is good for you, economically speaking. Why? Because if SARS means that the supply lines to China are cut, then this will be inflationary as supply fails to live up to the needs of demand. You see, every cloud has a silver lining.

Or does it? Let's think about this for a moment. On this argument the Iraq war, and the rise in petrol prices, was a plus. But it wasn't was it. I mean if the problem was to create inflation however, well we could all pick up spanners, go out and unbolt some of those precious petro-ducts, and bingo, the true technical solution......... Now why wouldn't this work. It wouldn't work because productivity isn't a bad thing, it's a good thing. The problem is not too much productivity, but too little growth. The fix we need involves unblocking the the structural imbalances which are a brake on growth - and in my book the main one of these is having a global population which is too old in the developed countries and too young in the developing ones. Cutting off supplies won't help here. In any event this would only be even more deflationary inside China, and hence even more deflationary for the rest of the planet once the supply resumes.

There is a second bad link in this argument, and that is the idea that it is the growth in China itself which is producing the problem. The extraordinary growth which is taking place in China is a product of US overcapacity and lack of pricing leverage, not the cause of it. Here Stephen Roach is undoubtedly right. China is growing because global corporations are franically looking for ways to cut costs in order to maintain momentum. Without China thinks would only be even worse. If you're climibing Everest and feeling scared, it's best not to look down. The only way forward is up............

Call it the SARS paradox: while the killer disease is set to depress prices across Asia, it could have the opposite effect globally and so help allay growing fears of deflation in the United States and Europe. Anecdotal evidence suggests the spread of SARS has so far had little impact on the Asian factories that form the critical links in global supply chains. But as long as the outbreak goes unchecked in China, the point of final assembly for a plethora of manufactured goods, economists see a risk of output disruptions that would push up prices worldwide of everything from toys to televisions. "If you really do have low-cost China no longer being a major supplier, even for a temporary period, that may actually have a positive ripple effect on inflation in the rest of the world," said William Lee, the International Monetary Fund's representative in Hong Kong.Apart from Motorola Inc's closure of its main office in Beijing, the impact of Severe Acute Respiratory Syndrome on multinational corporations has been conspicuous by its absence.

Economists worry, though, that exports will start tailing off if foreign engineers are unable to travel to China to rejig production lines. A failure to prevent SARS spreading to the Chinese countryside is another fear. "Disruption to China-based factories could cripple some Western companies and trigger surging prices for certain products, particularly PCs and related IT equipment," Richard Martin, managing director of International Market Assessment Asia, said in a report. Such an effect, though not the cause, would probably be welcomed in industrial countries worried about following Japan into a deflationary spiral. China's role as price-setter for a growing array of goods in a world glutted with supply is sure to be on the agenda when Chinese President Hu Jintao attends a forum on development issues with the Group of Eight leading nations in France next month. SARS was not detected until mid-March, so it is too early to deliver a verdict on the disease's economic impact on Asia.Beyond decimated sectors such as tourism and restaurants, though, data paint a picture of resilience. Singapore's purchasing managers' index, for instance, edged up in April even though it remained below the no-growth threshold.

Still, economists remain cautious. "The signal we got from the Singapore PMI, though encouraging, is simply not enough to relieve the global anxiety over the potential for the production chain to be disrupted," said David Fernandez of JP Morgan Chase. Whereas a supply-side SARS shock remains only a possibility, the impact on Asian demand and thus on inflation is all too real. Deutsche Bank expects consumer prices in China to rise 0.6 percent in 2003 assuming SARS is contained in three months. But an outbreak lasting nine months would result in deflation of 0.4 percent. Prior to SARS, Citigroup economist Joe Lo expected prices in Hong Kong to fall 1.5 percent this year. His forecast now is two percent. Although the tumbling U.S. dollar should push up prices because of Hong Kong's peg to the U.S. currency, Lo said demand is so weak that retailers cannot pass on higher costs. "The SARS shock will extend and deepen Hong Kong's deflation trend," Lo said.
Source: Forbes

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