The IMF has waved the inflation warning card. Speaking yesterday, its First Deputy Managing Director John Lipsky said, “To put the issue starkly, inflation risks have re-emerged as a global challenge following a long absence.”
Actually, in some ways inflation is a little like nuclear power.
As you know, it takes a long time to build nuclear power stations – well, it is the same with inflation. Inflationary pressures can be years in the making.
But the real parallel is between the money supply and nuclear waste. Inflation, as opposed to rising costs, only really occurs when there is an over supply of money. But then, this money supply is a lot like waste – it has a very long shelf-life.
The money supply was boosted earlier this decade – in part thanks to rock bottom interest rates set in the wake of 9/11, and in part due to high lending to the US from countries such as China and the OPEC nations. Thanks to the policy in many countries of linking the exchange rate to the greenback, demand for dollars was insatiable – that didn’t help.
But, thanks to cheap imports from China, and the Internet promoting price competition, inflation stayed in check – but all this new money didn’t go away. It stayed in the system, like nuclear waste, its poison building up.
That surely is the real reason for all these inflationary pressures we keep reading about – it certainly explains the falling dollar and pound, which is of course inflationary.
But now there are two new worries. First is all this new money pumped out by the Fed and the Bank of England. It is not going to disappear, and when credit conditions are restored, it may come back and haunt us.
In fairness though, the recent Bank of England plan of swapping mortgage debt for Treasury bills should not be inflationary, the bank is merely swapping one asset that is usually liquid, for another that is always liquid – when credit conditions are restored, the banks won’t suddenly find they have more money thanks to that particular policy. But other injections of money, the rescue of Northern Rock, for example, or in the US, Helicopter Ben’s attempts to carpet bomb the system with money could, in the longer-term, be inflationary.
The second worry relates to China. There is no letup in inflation behind the Great Wall. Does that mean China will import inflation to the rest of us? Well, yes, but indirectly.
Chinese products are cheap, and as imports from the country grow, we will benefit even more from its cheap products. And while Chinese inflation will make these products more expensive, the deflationary effect of ever increasing imports from China should counteract the inflationary effect of their prices rising.
But that argument could fall down if China does what many believe is the sensible thing, and fights its internal inflation by allowing its currency, the yuan, to appreciate.
This is of course what many US politicians have been calling for. But if this were to occur, global inflation would jump quite severely.
The truth is that the economic miracle of the first half of this decade – low inflation and strong growth – was not down to savvy central bankers, as some would have you believe. It was down to external factors.
And while in many Western economies, the US and UK, especially, saving has been too low, saving was perhaps too high in China. This is why global inflation was low, this is why the UK and US had such massive deficits on their current accounts, and China such huge surpluses.
For years, many argued this was going to have to change, the sooner the better – and that is surely what is happening now.
The great irony of the credit crunch is that, actually, it is the manifestation of a global economy seeing its lack of balance being corrected.
But then again, all that real toxic waste – the excess credit of the last few years, is not going away – this means either more bad debts – or inflation.
You take your pick.
Comments
Trackbacks