Inflation

Falling currencies and rising prices for food and fuel are raising inflationary pressures to dangerous levels across Asia. Annualized inflation reached 4.9% in South Korea and over 11% in India. As domestic pressure mounts from consumers and labor unions, Asian central banks are reversing long standing policies designed to maintain weak currencies and benefit exports, and are instead actively intervening to push up currency values and lessen the blow from rising import costs.

The only nation not caught up in this wave is China. While consumer inflation reached its highest levels in a decade, the government has stifled domestic discontent and the trade surplus has held steady despite rising import costs.

Snapshot asks, will rising commodity and fuel prices force a greater Chinese response?

According to a report released yesterday by the IMF, high food and oil prices are having a devastating effect on import dependent, small and middle-income countries. Since January 2007, high food prices cost 33 net food importers $2.3bn or .5% of GDP, while oil cost 59 net oil importers $35.8bn or 2.2% of GDP. IMF head Strauss-Khan says many countries are at a "tipping point."

Inflation is driven by the integration of large emerging economies and is expected to continue even as the U.S. economy slows. Oil prices are expected to remain high for years due to the time needed to develop drilling and refining capacity, while food production will increase more quickly due to price incentives.

Snapshot asks, has the IMF done its part to help the world deal with high inflation?

IMF - Price Surge Driving Some Countries Close to Tipping Point
Financial Times – Trade has saved America from recession
Morgan Stanley – The Oil Shock Debate: Recession, Inflation or Both?
Oxford Energy – Why do oil price shocks, no longer shock?

China pushed up domestic prices of gasoline 16%-18%. Prices of jet kerosene will rise 25% while electricity will rise 4.7%. A gallon of gas in China now costs $3.29, just below the international market price. This increase in gas prices will have an impact on Chinese inflation, which edged slightly down in May and gave policy makers just enough room to increase energy prices.

Global crude prices fell following the announcement, but many still wonder whether pent up demand in China and the reduced costs to refiners who turn crude into petrol may actually increase consumption. Motorists who waited 6 hours in line for gas may actually buy more despite high prices.

Snapshot asks, if there is pent up demand, how much will higher energy prices push up global crude prices and Chinese inflation?

In response to growing inflationary pressure, Chinese officials increased banks' reserve ratio last weekend by 100bp to 17.5%. On Tuesday, the first day of trading following the weekend decision (Monday was a Chinese holiday), the Shanghai stock market fell 7.7%. In Asia excluding Japan, headline inflation for April rose to a nine-and-a-half-year high of 7.5%. As inflation pressures increase and tightening policies become necessary, Asian stock markets will continue to adjust downwards.

Snapshot asks, how much further do Asian equities have to fall as a response to increasing inflation?

Morgan Stanley - AXJ's Inflation Challenege
Bloomberg - Asian Economic Miracle Is at Risk All Over Again: William Pesek
Citigroup - Inflation Risk Invokes Divergence
Financial Times - Asia markets plunge as inflation looms

Food and energy prices are rising and inputs for producers grow more expensive by the day, putting enormous pressure on central bankers to keep inflation low. This is pressure is particularly acute for Mervyn King and Jean Claude Trichet, the heads of the Bank of England and European Central Bank, who promise their governments to keep inflation around 2%. With no sign of a break in energy prices, the Bernanke Fed has also been warned by former Fed Chairman Paul Volker to keep inflation low. Volker said last week that there is a resemblance between today and the 1970s and that the Fed already introduced enough liquidity into the market.

Snapshot asks, are central bankers recklessly abandoning their inflation targets?

Martin Wolf - Britain Must not cut loose its anchor
Financial Times - Higher inflation stems from official neglect
Paul Volker - Act now to avoid inflation
Janet Yellen Federal Reserve Bank of San Francisco - Combination of Risks

A 0.2% overall decline in April retail sales masked divergent patterns in U.S. consumer spending. While auto spending decreased by 2.8%, spending on non-auto goods actually rose by 0.5%, a larger than expected increase. With consumer spending accounting for over 70% of the U.S. economy, some see this resiliency as a sign the economy may be closer to recovery than previously thought. Others say it's a statistical blip and expect continued contraction throughout 2008 as gas prices and inflation increase.

Snapshot asks, will high gas prices and weak auto sales further drag down consumers in 2008?

Economists concerned anout rising oil and food prices can add another item to their list of fears, Chinese wage growth. In 2007, unit labor costs increased for the sixth consecutive year while the price of Chinese imports to the U.S. surged by 4%. With a global economy that has become reliant upon inexpensive Chinese manufactures, the question of whether Chinese wage inflation is transitory or part of a long term structural change is of great importance.

Snapshot asks, will wage growth add to China's inflationary threat?

Bureau of Labor Statistics - U.S. Import and Export Price Indexes
New York Times - Asian Inflation Begins to Sting
China Daily - China's 'Demographic Dividend' to End in 2010
Goldman Sachs - Globalization and Disinflation: Can Anyone Else ' Do a China'?
Business Week - How Rising Wages are Changing the Game in China

Rioting has broken out in Egypt, Senegal, Ivory Coast, Cameroon, and Ethiopia and 33 more countries around the world may face instability due to rising food prices. During IMF/World Bank meetings last week, leaders cited the U.S. demand for bio fuels as a major reason for high grain prices. Throughout the weeklong meetings, World Bank President Robert Zoellick repeated the need for more food assistance to poor countries. To date, the United Nations has only received half of the $500 million it said it needed to sustain assistance through the World Food Program.

Snapshot asks, will cutting the U.S. demand for bio fuels sufficiently curb inflation in food prices?

World Bank - Rising food prices: policy options and World Bank Response
Wall Street Journal - Food Inflation, Riots Spark Worries for World Leaders
European Bank for Reconstruction and Development - Fighting Food Inflation through Sustainable Investment
Time - The Clean Energy Scam

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