Thursday, January 27, 2011

Inflation Increasing ... Except in the U.S

From the WSJ:

With the risks of a double-dip recession apparently receding in most parts of the world, another economic challenge is emerging: inflation.

Rising prices for food, energy and other commodities are reducing the disposable incomes of poor people across the planet, providing a trigger for street protests in North Africa and posing a deep conundrum for policy makers world-wide.


In the euro zone, rising prices could lead the European Central Bank to increase interest rates, intensifying pressures on weak economies such as Greece and Ireland that use the common currency. On Wednesday, new data showed the prices of German imports rose at their fastest clip for two decades.

Simon Johnson, a professor at Massachusetts Institute of Technology and a former chief economist at the International Monetary Fund, said the only major country where commodity-price inflation isn't an important concern is the U.S., because imported food accounts for a tiny proportion of U.S. consumer spending.

This is something we've been looking at for some time. As the FT noted today, the current situation directly mirrors the 2008 price spikes: crop failures led to export restrictions which led to food riots which led to government policies such as price caps. However, it is very important to note that this problem is as much based on supply/demand issues as it is on the cheap dollar. In other words, the causes and therefore the solutions will be complicated. Here are some thoughts.

1.) A regular commenter suggested that the only people who can participate in the futures markets are those who can physically deliver the commodity, thereby returning the futures markets to their origins as a hedge against crop price fluctuations. While I see his point, I think this would be too restrictive. I do think something has to be done to balance the speculator/hedger dynamic, but am unsure what the final solution would look like.

2.) Move to some type of currency basket to price commodities rather than the dollar. I don't think this should go so far as to create a world currency, but I do think the reliance on the dollar as the primary store of value in the commodity markets is outdated.

3.) Last years crop failure in Russia was the result of extreme weather conditions in Russia: the entire country was literally on fire. The cause was probably due to global warming. In other words, we need to deal realistically with climate change -- like acknowledging that when a 1000 square mile area of China can't be viewed from space because of pollution in the air, or when the average life expectancy of a traffic cop in Beijing is under 50 because of complications from air pollution a problem just might exist.