Capital Flows and Asset Markets
Capital Flows and Asset Markets
GLOBALISATION AND BOND YIELDS
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GLOBALISATION AND BOND YIELDS

Or does the "intensity" of labour competition from globalisation determine interest rates?

There are many reasons given for why interest rates have been so low. In my posts, I have been coming more and more to the idea that if wages are not rising, then it is very difficult to have inflation. That is wages drive inflation, and the relative power of “labour” then determines inflation rates. Thinking about inflation this way has some benefits. It easily explains the post World War II inflation, as governments set policies to target full employment and rising wages, and also explains falling inflation, as labour markets were opened up to global competition. It also helps to explain how the last 60 years has seen the Bank of England set both the highest and lowest interest rates in its 300 plus years of setting interest rates.

Can we quantify labour competition? And if so, would it gives us a guide to where inflation might be going? Japan was the first market to suffer from deflation, and very low bond yields, so is a good candidate to look at first. Using the IMF Wage Tracker, we can see that Japanese wages began to inflect lower in the early 1990s.

After the Plaza accord of 1985, the Yen doubled in value against the dollar. This meant in USD terms, GDP per capita rose significantly. This put Japan at a significant disadvantage against then competitors South Korea and Malaysia, a disadvantage that was compounded by the currency devaluations of the Asian Financial Crisis. The problem for Japan workers was then further compounded by the entry of China to WTO in 2001. Given the relative population size of China, this would have had an even more negative effect on wages than the Asian Financial Crisis. Looking at below graph, and the rising GDP per capita of Korea, as well as Chinese GDP passing Malaysian levels, it is hard not to believe that the worst of the deflationary pressure on wages has passed by.

We can look at the EU and North America to gauge at what levels of income do low cost manufactures stop exerting wage deflation pressure in advance economies. The EU provides a good test case. Spain was a low cost manufacturing destination when it first joined the EU in 1986, and Poland is now a low cost manufacturing destination after joining the EU in 2004. Given freedom of movement, I would suggest labour deflation pressure in Europe are more intense in the short term, but can adjust quicker than Japan due to internal migration. Spain joining the EU seemed to put intense pressure on German wages, but Poland joining the EU seems to have affected Spain far more than Poland. Given the unlikelihood of any other nation joining the EU, it would seem that the worst of the deflationary labour pressures are over.

Mexico joined NAFTA in 1993, which should have put pressure on wages in the US. Compared to Japan and China, the relative populations would suggest much less wage pressure. Also without the free movement of labour that underpins the EU, you would expect the adjustment to be much milder. In GDP per capita terms, its hard to see any influence of NAFTA on the US. Even more intriguing is that Mexico GDP is flatlining around USD 10,000 for the last decade, with seemingly no negative effect on US GDP per capita.

To me it looks like wage competition in Japan and Europe are coming to an end. This is making the chances of rising wages and GDP in Europe and Japan much more likely in my view, after 30 years of stagnation in Japan and 10 years of stagnation in Europe.

It seems to me that in 1970s and 1980s politics and trade combined to create an environment that sought to weaken “labour” which has continued to this day. Both Europe and Japan had to make much bigger adjustments to collapse of socialism, given much closer trade links to Eastern Europe and China. From a trade perspective, the rising wages in outsourcing nations suggest the worst is behind us for labour deflation. The tendency towards nationalist and populist policy making suggest politics is also changing. Rising wages and inflation looks likely to me.

Discussion about this episode

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Zhaozhe's avatar

If the RMB is strong and China is Pro labor, and real chinese wages go up. Then wouldn't it trigger a commodity supercycle? It would also trigger a massive consumption boom because half the country still has low incomes. Would not it also force chinese corporates upgrade themselves in the value chain? because if they cannot compete internationally in a strong RMB environment they would have huge layoffs and massive unemployment.

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Russell Clark's avatar

China is the key. Their policies have been so different to policies I am used to. Actively seeking a strong currency as opposed to currency devaluation we see elsewhere. Looking to cut overcapacity in various industries and push up prices of key inputs such as steel, and now looking to regulate big tech and property developers. China's pro-labour policies seem to be driving inflation - but so far, pro labour policies seem not to have spread. Equities seem to change in coming in the west, but credit markets not so much...

China export data suggest China remain competitive, so this dynamic could run

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GGGGGGGGG's avatar

Would you assume from this, that wages and labour supply conditions could be manipulated to effect interest rates / currency?

As with quantitative peopling in Australia.

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Russell Clark's avatar

Well Covid has greatly reduced immigration to the states.... and wages seem to be moving up.

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Andy's avatar

I'd like to pushback a little on your article. I agree that the worst of the deflationary spiral due to global wage competition is behind us BUT doesn't necessarily mean a reversion is on the cards. I really can't see anywhere signs of political movements focused on a labour revolution. It's true that more inflationary policies have been proposed recently (direct cheques in lockdown) but politicians have already started to move in the opposite direction especially in the US. Also GDP per capita probably not the best metric to measure impact of labour dynamics given it's an average rather than a true measure of the income generated by those affected by globalisation. Labour is an important part in the inflation/deflation debate but not the only one. Negative impact of demographics and technology is still there. Long story short, labour no longer source of deflation but don't think turning point is round the corner.

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Russell Clark's avatar

Agree - wages are very tricky to compare. A lot of this thinking has been prompted by Chinese policy in recent years - which seems to.be favouring labour over capital.

Elections in the US and UK have been decided in rustbelt states - which are prolabour... so conditions looked primed for a move to labour. Of course if.China devalues - then wage competition returns... but i think we have moved on.

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Mike Cross's avatar

Y3000 an hour was pretty much the going rate in Tokyo in 1982.

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Russell Clark's avatar

2000 yen was the lowest rate. Nova teachers earnt that. Private lessons paid much more

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Mike Cross's avatar

Exactly same in 1982. Y3000 was what I got at small jukus, with a Tefl qualification.

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Therrien, Mario's avatar

Very insightful. Tks Russell.

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