Buried Lede

From Business Week, April 7, 2008, "China's Factory Blues", by Dexter Roberts (pp. 78 - 82):

"'Unlike in the last 20 years, when China exported deflation, from now on, China will export inflation,' says Peter Lau, CEO of Hong Kong retailer Giordano International, which has extensive operations in China. (p. 82).

The article describes how Chinese producers have hit the cost floor: the rising yuan, cancellation of preferential policies for exporters, and increased labor and environmental regulations are raising the cost of production in China. This is probably a good policy for China because it squeezes out the lowest cost producers who pay the lowest wages and contribute disproportionately to pollution. However, it's potentially bad new for us because low cost imports have kept inflation in check even as the economy expands. Now, with the economy contracting, the closing of this inflationary safety valve means that the Fed has less flexibility to stimulate the economy. Until now, the Fed has thrown considerable weight behind economic stimulus policies with a rapid series of large rate cuts. Now, that approach is much more likely to cause inflation.