The Global Economy ... an interesting time ahead!

It is really interesting these days to be a commentator on the global economy and markets. So many things are happening and it is unclear where we are going exactly. Now, if I were to give a quick synopsis on what was happening what would the main ingredients of the global economy be? A useful excercise in this respect is to look at what I wrote 77 days ago (based on a general article from The Economist) in a post  which, a bit like this, tried to summarize the major trends of the global markets and economy. The important quote concerning what we are going to talk about today is ...

(My summary) 

'Joint rate hikes by the major central banks (The Fed, ECB and BOJ) in order to scoop up excess liquidity and quell inflationary pressures. See more about the excess liquidity argument here and here. I have argued that the ECB and BOJ will face difficulties and boundaries towards any substantial raising but the broad picture still points to a tightening cycle.'

Now even though I wrote this back in July it seems as if we are able to see things a bit clearer now. In fact, not only the ECB and BOJ will face problems raising rates but it also seems as if the Fed will hold and perhaps even begin to look down in the beginning of 2007. So what is all this then? What happened to all that excess liquidity? In fact, have global interest rates peaked at this point which must be considered a farcry away from how conventional wisdom had it not so very long ago. Actually global interest rates may very well be peaking but why? Well in terms of the headcount of the three major central banks you have the argument in the links above. So can we get any closer to understanding this? An interesting way to go here is to look at inflation and globalization and the relationship between the two. The classical discourse on this is that globalization is keeping inflation down because of the emergence of countries like China and India augmenting the global labour supply. A more direct way to explain this is to invoke the 'china effect' which is exemplified through the idea of emerging economies exportating deflation which allows the importing economy to grow without harboring inflation. Yet this effect neglects the distinction between core and headline inflation where the 'china effect' affects the former by brining it down but actually exacerbates the latter through the increased demand for primary resources and commodities.

The important question here seems to be what implications the relatively low levels of interest rates will have as the slowdown sets in?

Comments

[pantom]

I thought the classical discourse on this was that it would keep inflation up because of all those commodities increasing in price.
What I've seen is that we'd see a return to the stagflation of the seventies, which was brought about, in my opinion, by the peak cohort of the baby boom (I'm in it) looking for jobs. In the Carter Admin, which ran from Jan 77 - Jan 81, jobs were created at a clip of about three million a year, over all, but the unemployment rate in the US when he left office was actually higher than when he was inaugurated. So, you had a bunch of people entering the labor force, loosening the labor market, depressing productivity and raising inflation because of the aggregate of their increased demand.
On the surface it looks like a similar situation, but the difference is where it's happening. As commodities rise, so too is productivity, at least in the US, although the signs from Europe are starting to look promising too. My theory for why this is happening is simple: the boomers are starting to retire, which is now having the effect of tightening the labor force, the exact opposite of the late seventies situation, and as the labor force tightens, Western companies will need to increase productivity, which dampens inflation and raises living standards.
Over in China and India, their economies are growing so rapidly that inflation is being overtaken by rising living standards there as well.