Weekly global economic update

Week of December 12, 2022

• Semiconductor industry might be on the verge of diversifying
• The latest on China’s economy
• Japanese inflation accelerates
• EU attempts to shift the global oil market

Semiconductor industry might be on the verge of diversifying

• Semiconductors could be described as the new oil for the global economy, a commodity essential to the production of almost everything. Moreover, as the world continues to shift toward more digital interaction and new forms of energy and transportation, it is likely that global demand for semiconductors will grow rapidly. Thus, the fact that production of the most sophisticated semiconductors is highly concentrated, especially in Taiwan, is a source of concern to policymakers and purchasers of semiconductors—particularly given the geopolitical situation in Asia. As such, the US government is providing financial incentives for re-shoring of semiconductor fabrication through the CHIPS Act. Other governments are taking steps to boost their domestic industries. The US government is also taking steps to restrict technology transfers so as to prevent China from developing sophisticated chips.

Meanwhile, the chip industry is on the verge of a potential new diversification. For example, Indian conglomerate Tata now says that it intends to make a massive investment in producing semiconductors, likely in collaboration with an existing company from Japan, Taiwan, South Korea, or the United States. Tata’s chairman said that the company will “look into the possibility of eventually launching an upstream chip fabrication platform.” That is, it might start with assembly but later move toward the more complex process of fabrication. If successful, this could potentially be a game-changer for the industry, driving further diversification away from East Asia. It could make India a player in this key industry. It is already a major player in software and technology services. 

Meanwhile, one of the world’s largest and most important fabricators of semiconductors, Taiwan Semiconductor Manufacturing Company (TSMC), is boosting its investment in a fabrication factory in Arizona, with plans to spend US$40 billion. This will contribute to a sizable increase in US capacity. In addition, a major US-based chip manufacturer is investing in semiconductor facilities in Ohio, with an initial investment of US$20 billion possibly being boosted to US$100 billion. These investments were driven, in part, by the US CHIPS Act, which provides financial incentives.

Not everyone is pleased with the direction of things. This includes the founder of TSMC, Morris Chang. He warned that “globalization is almost dead and free trade is almost dead. A lot of people still wish they would come back, but I don’t think they will be back.” Chang, like others, is concerned that the troubled relationship between China and the West will lead to a technological decoupling. This, in turn, could stifle innovation, boost costs, and reduce productivity growth. He could be right about the direction of the semiconductor industry. However, my view is that globalization in the broader economy will likely continue. 

On the other hand, supporters believe that diversification enables the business world to effectively purchase an insurance policy against geopolitical risk. The CEO of a leading US-based tech company said that “the entire semiconductor ecosystem is ready to step up and work together. The industry has been through so much in the past few years. Having more geographically diversified capacity is so important. At the end of the day, what we want to do is ensure that our most important chips have a resilient supply chain.” Currently, about 90% of the world’s most sophisticated chips are made in one factory in Taiwan. That kind of concentration, while contributing to low costs and high efficiency, creates risk. 

Finally, supporters of diversification worry that the pace of change is insufficient, in part because they believe that the government incentives are too small. Critics have said that the US CHIPS Act, as big as it is, might not be big enough to truly transform the industry. Meanwhile, critics say that such industrial policy goes against the efficiency goals of a truly market-based economy.

The latest on China’s economy

• Evidence of further weakening of the Chinese economy has led authorities to significantly ease COVID-19–related restrictions. The government reported that exports, denominated in US dollars, fell 8.7% in November versus a year earlier. This was much worse than the modest decline in October and was the steepest decline since February 2020 at the start of the pandemic. Exports to the United States were down 25.4% while exports to the European Union were down 10.6%. Exports to Southeast Asia were up 5.2%—a substantial deceleration from the previous month. Meanwhile, imports also fell, declining 10.6% in November versus a year earlier, the worst performance since May 2020.

The decline in exports likely reflected weakening global demand as well as the disruptive effect on production and distribution stemming from pandemic-related restrictions. Indeed, shipments of smartphones were down 25% from a year earlier, having been disrupted by lockdowns at key factories. The drop in imports, much of which includes inputs used by manufacturers to assemble exportable products, likely reflected the weakness of exports as well as weak domestic demand stemming from COVID-19 restrictions. Notably, the volume of semiconductors imported fell by more than 30% from a year earlier. This might also have been influenced by new US restrictions. The weakening of trade meant reduced demand for shipping services. The result was that the cost of shipping containers from China to the United States fell 21% from October to November. 

The trade data, as well as recent purchasing managers’ indices, suggest that the economic cost of the COVID-19 restrictions is substantial. Moreover, recent protests in multiple Chinese cities indicate that citizens are becoming frustrated in a way not seen in decades. Thus, China’s government announced that restrictions are being eased. Notably, home quarantining will now be permitted, rather than sending people to centralized quarantine facilities. In addition, people will not have to show proof of negative tests before being permitted to enter public facilities. 

Moreover, the government appeared to shift away from an all-out assault on the pandemic toward a more nuanced approach that recognizes the importance of economic stabilization. The new measures do not mean a complete end to all restrictions. Rather, they represent a move in a new direction. A lessening of restrictions on mobility will likely boost consumer spending, which has been stifled. That is important, especially given the weakness of the global economy. A renewal of domestic demand can help to offset negative external influences. 

• China’s level of debt is raising concerns. The amount of nonfinancial debt has hit a record level of US$51.8 trillion, or roughly 295% of GDP, according to the latest report from the Bank for International Settlements (BIS). This is up from 254% in 2018 and is a relatively high number for an emerging country. By comparison, consider the other BRIC economies. The debt-to-GDP ratio is 179% in Brazil, 170% in India, 120% in Russia, and 138% in South Africa. The ratio is 81% in both Mexico and Indonesia. 

Advanced economies tend to have higher levels of debt, but China’s is still relatively high. For example, the debt-to-GDP ratio is 264% in the United States, 257% in the United Kingdom, 263% in the Eurozone, and 426% in Japan. Thus, China has one of the highest ratios in the world. Moreover, while China’s debt-to-GDP ratio has risen since 2020, many other countries have seen a substantial decline since 2020, including the United States, the United Kingdom, and Eurozone.  

The good news is that most of China’s debt is not external debt. That is, there is no currency risk associated with the debt. It is mostly a case of Chinese households, businesses, or government entities owing to other Chinese. Still, high levels of debt can be challenging to service if economic growth is not strong. Given China’s declining working-age population, rising number of elderly citizens, struggling property market, and an economy distorted by excessive reliance on investment and exports, the current level of debt could become a problem. It might limit the ability to fund pensions and health care, continue infrastructure investment, and resolve property-market imbalances. 

The BIS says that the main culprit for the recent sharp rise in debt is government borrowing. Since 2020, the volume of debt owed by consumers and businesses is down. Instead, the increase in debt was due to the government. This partly reflected the cost of dealing with the pandemic and the cost of stabilizing the economy by investing in infrastructure. In addition, although lending to the private sector has been weak, lending to state-owned enterprises has recently grown strongly. 

• Earlier this year, inflation started to accelerate in China due to supply chain disruption and higher energy prices. This has now reversed. In November, consumer prices were up 1.6% from a year earlier. This was down from a peak of 2.8% in September and the lowest rate of inflation since March. In addition, consumer prices fell 0.2% in November from a year earlier. Core inflation (which excludes the impact of volatile food and energy prices) was only 0.6% in November versus a year earlier. Producer prices were down 1.3% in November, the second consecutive month of decline. Producer price inflation had been in double digits just a year ago. 

The deceleration of inflation, despite easy monetary policy, reflects two major factors. These are a decline in global commodity prices, including energy prices, in recent months. In addition, China’s domestic economy has been weakened by pandemic-related restrictions, which reduced domestic demand, thereby limiting price increase.

With the government now simultaneously reducing pandemic-related restrictions and easing monetary and fiscal policy, the hope is that growth will accelerate in 2023. With inflation still very low, the central bank has plenty of room to engage in aggressive policy in the months to come.  

Japanese inflation accelerates

• For several decades, Japanese policymakers have struggled to boost inflation and avert deflation. In the past decade, the Bank of Japan (BOJ) has engaged in an unusually aggressive monetary policy meant to boost inflation and expectations of inflation. Yet, until the pandemic, inflation remained relatively muted. Yet in the past year, as the global economy has emerged from the pandemic, leading to supply chain disruption, and as the war in Ukraine boosted energy prices, inflation in Japan has accelerated. Thus, the BOJ is now close to achieving its goal of steadily higher inflation.

However, the Japanese government is now pursuing a fiscal policy meant to stifle inflation by providing subsidies that stabilize energy prices. This policy is meant to cut 1.2 percentage points from inflation. Japanese Prime Minister Kishida said that “we will do our best to ensure that Japanese people will benefit from our efforts, including cutting electricity prices, as soon as possible.” This will involve more than US$200 billion in subsidies. Also, 10 Japanese electric utility companies have already applied for rate decreases.

In any event, inflation has risen sharply. In October, consumer prices were up 3.7% from a year earlier, the biggest increase since January 1991. Core consumer prices were up 3.6%, the highest since February 1982. Consumer prices were up 0.6% from the previous month, an unusually high increase. 

One of the factors that had held back inflation in the past several decades was the expectation that inflation would remain low. This affected the behavior of market participants in ways that reinforced low inflation. Businesses were reluctant to raise prices because consumers expected stable prices. Workers were satisfied with stable wages because prices were not rising. Yet now, with inflation becoming a factor in daily life, expectations of inflation are changing, which could lead to changes in labor-market behavior. BOJ Governor Kuroda has said that “monetary policy will become more effective as deflationary expectations weaken. Working on expectations will be very important when engaging in quantitative easing and making short-term interest rates zero.”

With inflation now significant, the question is whether the BOJ will continue with its easy monetary policy. Given that the government is attempting to cool the inflationary impact of high energy prices, it might put pressure on the BOJ to shift policy. Yet a shift would mean a tightening of policy that could potentially have a negative impact on growth. In addition, it could strengthen the value of the yen. That, in turn, would be disinflationary and would help to ease the cost of imported commodities. But it would also potentially hurt the competitiveness of Japanese exports.  

EU attempts to shift the global oil market

• Oil price futures initially surged and then fell sharply as investors struggled to figure out the potential outcome of EU efforts to cap prices and Russian efforts to undermine caps. There is, in effect, a kabuki dance between Russia and the EU that could either lead to lower oil prices combined with weakened oil revenue for Russia, or much higher prices and restricted supply. The West has divergent goals. It wants to starve Russia of funds needed to wage war. Yet it also wants to assure a reasonably priced supply of oil. It is now on the verge of attempting to reconcile these goals. 

Here is what we know so far. In June, the EU pledged that, by December 5 (last week), it would ban imports of Russian oil sent by ship (which accounts for about 40% of Russian oil exports) unless the oil is priced below a cap of US$60 per barrel. In addition, the EU is banning European companies from shipping Russian oil to non-EU buyers, as well as providing insurance for such shipments, unless the oil is priced below a cap of US$60 per barrel (the current market price is roughly US$85 per barrel). This would allow oil to flow but would limit the revenue that Russia would accrue. However, given that the price cap would be above Russia’s cost of production, Russia will still have an incentive to continue producing. Some countries, such as Poland and Ukraine, have objected to the US$60 cap saying it is too high and allows Russia to receive too much revenue. The EU hopes that this policy will help to ease inflationary pressures in Europe while also hurting Russia’s ability to wage war. Since the war began, EU consumption of Russian oil has fallen sharply but Russian revenue from oil has been relatively steady. 

Meanwhile, Russia has said that it will not accept the price cap and will not sell oil below the market price. It has started to amass a fleet of oil tankers meant to distribute oil without the help of European shippers or insurers. However, it remains unclear if this will have any impact. After all, Russian oil exports to Europe are already down sharply. This has partly been offset by increased shipments to other countries such as China and India, but often at a discount. Recent oil-price volatility reflects uncertainty about whether the new EU policy will suppress or boost oil prices.

Also, several events are adding to uncertainty. For example, Japan announced that it will impose a US$60 per barrel cap on the price it pays for Russian oil, aligning with the EU, G7, and Australia. Also, the Organization of the Petroleum Exporting Countries announced that it is prepared to take “immediate” action to offset the impact of EU actions if prices start to decline. In any event, it will take some time to determine the net impact of the new EU policy. Furthermore, it will be hard to identify the impact on oil prices from the EU policy given that other factors, such as the state of global demand, will also drive prices.

Week of December 5, 2022

• Central bankers talk the talk
• Favorable US economic data could lead to shift in monetary policy
• Inflation in the eurozone stops accelerating
• Global manufacturing industry contracts

Central bankers talk the talk

• In the world of central bankers, words can matter more than actual policy implementation. Investors sit on the edge of their seats awaiting the latest pronouncements by central bankers, which might provide hints about the future direction of policy. That fact was on display recently. John Williams, president of the Federal Reserve Bank of New York, and one of the three most important officials in the Federal Reserve system, said that the Fed is likely to continue raising its benchmark interest rate and that, as a result, the unemployment rate is likely to reach between 4.5 and 5.0% (it is currently 3.7%). He said that “inflation is far too high, and persistently high inflation undermines the ability of our economy to perform at its full potential.” He added that he expects the Fed to start cutting rates in 2024, assuming that inflation is coming down by then. Investors might have reasonably hoped for a different viewpoint. Inflation has decelerated lately by more than expected. This caused hope that the Fed might soon pause its tightening of monetary policy, thereby limiting damage to the economy. Williams’ comments suggest otherwise.

Meanwhile, other Fed leaders have said that the cost of not tightening remains higher than the cost of tightening. Fed Vice Chairman Lael Brainard said as much recently. In addition, Loretta Mester, president of the Federal Reserve Bank of Cleveland, said that “to be so far away from price stability really distorts investment decisions and peoples’ investments in their own education, and that has implications for the long-run health of the economy. If we allow inflation to continue at high levels, inflation expectations could start moving up again in the long-run horizon. And that would then raise the cost of getting back to price stability.” She placed considerable emphasis on the Fed’s role in anchoring expectations of inflation. This is important because, if expectations get out of hand, it can lead to changes in behavior that exacerbate inflation. Thus, Mester’s view appears to be that there is greater risk in pausing and avoiding recession than in continuing to tighten and causing a recession.

This viewpoint is not unique to the Federal Reserve. Christine Lagarde, president of the European Central Bank (ECB), said that the ECB is “not done” raising interest rates and that high inflation “still has a way to go.” Although eurozone inflation has not evidently peaked, there is hope that this might happen soon given a sharp decline in natural gas prices and evidence of easing supply chain difficulties. Yet Lagarde is clearly not yet moved by these events. She said that, although the ECB has already raised interest rates rapidly, they remain too low. Specifically, she said that current monetary policy remains accommodative and that only further rate hikes will likely suppress aggregate demand in the economy. That is because rates remain historically low. In addition, she noted that, although spot gas prices have fallen sharply, prices on futures markets have not. Thus, energy disruption remains a risk.

Favorable US economic data could lead to shift in monetary policy

• US economic data for October indicates a surprisingly resilient economy combined with an easing of inflation. Employment continued to grow at a healthy pace in November, faster than most analysts anticipated. Wages decelerated. In addition, real (inflation-adjusted) consumer income increased in October. That, combined with a further decline in savings, led to a robust increase in real consumer spending, especially spending on durable goods that had previously been declining. It is likely that, in part, this reflected strong automobile sales now that the semiconductor shortage is easing. (I should add, for those interested, that my new car is ready for pickup now that the missing chip has been delivered. Thus, my own automotive transaction will be completed next week.)

First, a look at the employment report. There are two reports; one based on a survey of establishments, the other based on a survey of households. The establishment survey found that 263,000 new jobs were created in November, less than the 284,000 created in October, but still a healthy pace of expansion. Employment is up 3.2% from a year earlier. Most of the job growth was in services. Yet some services sectors experienced a loss of jobs. This included retail (especially department stores) as well as transportation and warehousing. Our own sector of professional and business services had very modest job growth. There was strong growth for leisure and hospitality, healthcare, and government.

The report also found that average hourly earnings for all workers were up 5.1% in November versus a year earlier, the second slowest pace of increase since 2021. This affirms that, although the labor market remains unusually tight (as evidenced by a high vacancy rate—see below), it is not generating an acceleration in wages that could be inflationary. On the contrary, annual wage gains are decelerating and remain well below inflation. On the other hand, wages were up 0.6% from the previous month, the strongest monthly gain since January 2022. This contradictory data suggests caution in interpretation.

Meanwhile, the government released its Job Openings and Labor Turnover Survey (JOLTS) for October. It found that the number of job openings fell from 10.687 million in September to 10.334 million in October. The vacancy rate (the share of available jobs not being filled) fell from 6.5% in October to 6.3% in November. The number and rate of vacancies is down sharply from a year ago, but both remain very high compared to recent history. Thus, the job market remains historically tight, but does show signs of easing.

The vacancy rates fell sharply for manufacturing, professional and business services, and for the Federal government. The vacancy rate increased for mining, wholesale trade, retail trade, and financial services while it remained unchanged for restaurants and hotels.

The separate survey of households, which includes self-employment, found that the size of the labor force declined modestly in November and that total employment declined as well. The unemployment rate remained unchanged at 3.7%, one of the lowest rates in the last half century.

Next, let’s look at the data on income and spending. In October, real disposable personal income increased 0.4% from the previous month. In addition, the household savings rate fell from 2.4% in September to 2.3% in October. The result was that real consumer expenditures increased 0.5% in October versus the previous month. Notably, this included a 2.7% increase in spending on durable goods, a 0.3% increase for nondurables, and a 0.2% increase for services.

The government also reported data on the Federal Reserve’s favorite measure of inflation, the personal consumption expenditure deflator, or PCE deflator. This measure was up 6.0% in October versus a year earlier, the lowest annual rate since December 2021. Prices were up 0.3% from the previous month. Excluding volatile food and energy prices, core prices were up 5.0% in October versus a year earlier, down from 5.2% the previous month. Core prices were up 0.2% from the previous month. This is consistent with data from the consumer price index which also indicates an easing of inflation. It is probably safe to say that inflation in the United States has already peaked.

The favorable data on jobs as well as income and spending means that the likelihood of an imminent recession for the United States has eased. Modest wage gains, combined with improvement in headline and core inflation in October, bode well for an easing of the pace of monetary tightening. Indeed, Fed Chairman Powell said last week that monetary tightening could be reduced soon. Specifically, he said that “it makes sense to moderate the pace of our rate increases as we approach the level of restraint that will be sufficient to bring inflation down. The time for moderating the pace of rate increases may come as soon as the December meeting.” On the other hand, he said that to defeat inflation, the Fed will need to keep rates at an elevated level “for some time.” Thus, the Fed is not about to reverse policy. Rather, Powell evidently feels that, given the trajectory of inflation, the Fed has probably gone almost far enough.

In response to Powell’s comments and recent economic data, bond yields in the United States have been declining. In fact, the yield on the 10-year Treasury bond is currently at the lowest level since mid-September, or roughly 3.5%. Recall that the 10-year yield had reached 4.27% as recently as the first week in November. In part, the decline in bond yields reflects a decline in investor expectations of inflation as indicated by the so-called breakeven rate. Investors evidently feel confident that inflation will come down quickly. The 10-year breakeven rate is now 2.36%. This means investors believe that inflation will average 2.36% over the coming decade, close to the Fed’s target and well below the current rate of inflation. 

Inflation in the eurozone stops accelerating

• Inflation in the eurozone might be peaking. The latest numbers for November from the European Union (EU) suggest as much, although it is likely too early to draw a firm conclusion. Investors reacted with cautious optimism to the latest data, driving up equity and bond prices modestly on the assumption that the latest data portends a slightly slower pace of monetary policy tightening by the European Central Bank (ECB). 

Here are the numbers: the EU reports that, in November, consumer prices in the eurozone were up 10.0% from a year earlier, down from 10.6% in October. Prices were down 0.1% from the previous month, the first such decline since July 2021. The easing of inflation was entirely due to a deceleration in energy prices. Still, in November, energy prices were up 34.9% from a year earlier. 

Meanwhile, excluding volatile food and energy prices, core prices were up 5.0% from a year earlier, the same as in October following many months of acceleration. 

In addition, inflation decelerated in November in many important European countries. This included Belgium, Germany, Ireland, Greece, Austria, Portugal, and the Netherlands. Inflation remained stable in France and Greece but accelerated in Finland. The deceleration of inflation in Spain was especially pronounced, but core inflation in Spain accelerated.

Despite early evidence of a possible easing of eurozone inflation, the ECB remains committed to further tightening of monetary policy. Christine Lagarde, president of the ECB, is not yet ready to declare that inflation has peaked and worries that an inflationary psychology is taking hold. Moreover, she worries that the recent improvement due to a drop in energy prices could easily reverse. Still, investors evidently interpreted the news as boding a slightly less onerous tightening of monetary policy. 

Meanwhile, although the eurozone economy has decelerated and will likely soon slip into recession (if it hasn’t already), there are favorable factors that are limiting the damage to the regional economy. These include large government expenditures on energy subsidies for households and businesses and a greater-than-expected decline in energy prices. 

Global manufacturing industry contracts

• The global manufacturing industry continued to contract in November, according to the latest purchasing managers’ indices (PMIs) from IHS Markit. A PMI is a forward-looking indicator meant to signal the direction of activity in the industry. It is based on sub-indices such as output, new orders, export orders, employment, pricing, inventories, pipelines, and sentiment. A reading above 50 signals rising activity. The higher the number, the faster the growth—and vice versa.

The global manufacturing PMI from Markit fell from 49.4 in October to 48.8 in November, indicating a sharper decline in activity. This was the lowest number in 29 months and the third consecutive month in which activity declined. The worsening of the number in November was largely due to a sharp drop in the United States and Japan. Both countries went from growth in October to decline in November.

Of the 30 countries polled by Markit, all but six had PMIs below 50, indicating declining activity. The six countries with above-50 PMIs were, in order, India, Russia, Kazakhstan, Australia, Thailand, Mexico, and Indonesia. The lowest PMIs belonged to Czech Republic, Taiwan, Poland, and Brazil. With the exception of India, all major countries indicated declining activity, although some saw a higher PMI than in October, indicating slower decline. The PMIs were 47.7 for the United States, 46.5 for the United Kingdom, 47.1 for the eurozone, 49.4 for China, 49.0 for Japan, and 41.6 for Taiwan. On the other hand, the PMI for ASEAN was 50.7, entirely due to growth in Thailand and Indonesia. All other ASEAN countries experienced decline, especially Myanmar.

Markit commented that “the decline in output was accompanied by a tick down in new orders as rising inventories have put the brakes on production. There was some positive news on the price front, however, as price pressures continued to ease. The delivery times index also improved, consistent with the signal from high frequency shipping cost indicators that show supply chain conditions normalizing.”