Global Economic Snapshot

The falling dollar and market expectations of further Fed rate cuts next Wednesday puts inflationary pressure on oil exporting nations in the GCC (Gulf Cooperation Council) whose currencies are pegged to the U.S. dollar. (Kuwait dropped its peg to the dollar in March of 2007 and remains the only GCC that does not peg its currency.) Inflationary pressure in the countries that retain their pegs is two fold: One, countries are forced to accept easing U.S. monetary policy. Two, rising commodity prices, in part due to a falling dollar, cause further inflation.

Snapshot asks, will other GCC states drop their dollar pegs?

Financial Times - Plummeting dollar a big headache for pegged currencies
Oxford Business Group - Oman and Inflation
Jadwa Investment Group - Saudi Arabia The Inflation Alleviation Plan
National Bank of Dubai - Should GCC Countries Opt for Inflation Targeting

China’s inflation surged 8.7% in February on the back of food prices, which rose 23%. Snowstorms crippled transportation networks and damaged crops, temporary adding to inflation. But some believe food inflation will bleed into other sectors. The instability that results from this type of broad-based inflation is at the forefront of the leadership's concern. At the National People's Congress last week, Premier Wen Jiabao announced inflation as the first priority of the central government.

Snapshot asks, does China have a temporary problem with food inflation or will inflation spread to other sectors of the economy?

Bloomberg - China's Inflation Surges to 8.7% as Food Prices Soar
Kenneth Rogoff - China may yet be economy to lose sleep over
New York Time - China to Focus on Reducing Inflation, Prime Minister Says
Caijing - Taming Inflation
Societe Generale - China’s policy challenges come to the fore at the National People’s Congress

Higher than average inflation in the United States is but a fraction of the inflationary pressures that emerging markets currently face. This week, Snapshot will investigate inflationary pressure from various regions around the world.

In many countries large foreign exchange reserves are putting enormous pressure on monetary growth, which many economists believe is primary cause of inflation. In other countries, it appears rising global food and energy prices are increasing prices.

Snapshot asks, what is the leading cause of inflation, monetary growth or an increase in global demand?

It is unclear what response, if any, will right the U.S. economy. Chairman of the Federal Reserve, Ben Bernanke, gave a speech today calling for "a vigorous response" to the mortgage crisis and suggested reinvigorating government-sponsored enterprises, like Fannie Mae and Freddie Mac, with increased regulation and possibly writing down the principal on home mortgages. Treasury Secretary Henry Paulson said in a speech yesterday, "Let me be clear: I oppose any bailout." It appears policy makers, officials, and economists still cannot agree on appropriate solutions to the mortgage crisis.

Snapshot asks, what policy will get the U.S. economy out of its current slump and not threaten long run growth?

Soaring commodity prices and relative stability during global market turmoil has made Brazil the largest share of the MSCI Emerging Market Index, edging China out with a 14.95 per cent share (China holds 14.15 per cent share). While the Chinese stock markets have corrected, the Brazilian market, led by juggernauts Vale and Petrobras, remains high.

Snapshot asks, will commodity prices fall and cause a correction in Brazil's market or will they stay high enabling Brazil to sustain its current rise?

The costs of financing state and municipal projects such as hospitals, schools and public transit, are rising as the credit crisis cripples states’ often used source of credit – auction-rate bonds. The lack of demand for these bonds, which allow states to finance long-term projects over a period of time, has frozen the market and forced states to pay much higher interest to creditors.

Snapshot asks, when will liquidity return to the state and municipal bond market?

Ben Bernanke said this morning that the Federal Reserve “will act in a timely manner as needed” to keep the economy growing, implying more interest rate cuts in March. In today's speech before the House Financial Services Committee, Bernanke said the threat of core inflation and overall inflation has risen, but that growth and stability are now the immediate priorities.

Snapshot asks, will the Federal Reserve make inflation an equal priority again? Is recent Fed policy emblematic of a global move away from inflation targeting?

Food prices have risen dramatically during the past year forcing many countries to implement food rationing, price controls, and export bans. The United Nations Food and Agriculture Organization warned that lower income countries, reliant on food aid, will face severe cutbacks in staple items. Supply shortages are partially a result of dramatic increase in demand from countries like Brazil, Russia, India, and China.

Snapshot asks, what can be done to prevent rising demand for food in middle income countries from constraining supply to low income countries?

U.S. housing prices are down 5-10% from their peak and many analysts predict prices will grind down another 20%. If this is the case, 10 million homeowners will have negative home equity and 2 million homeowners will be forced to foreclose on their homes.

Snapshot asks, should the Federal government bail out the housing market and if so, what bailout plan would be most beneficial to the U.S. economy?

The threat of a recession occurring at the same time as higher than expected inflation raises concerns about stagflation, a combination of inflation and stagnant growth not seen since the 1970s. Minutes from the January Open Market Committee meeting indicate the Fed will raise rates quickly to avoid inflationary pressures when concerns over slow growth subside. Despite inflationary pressure, investors predict the Fed will ease rates 50 basis points during their next meeting on March 18th.

Snapshot asks, are we or will we experience stagflation?