Friday, February 4, 2011
The Ten PM Tutorial vi: Exporting Inflation
at 10:00 PM
It sounds confusing, but this is actually a simple concept.
The Federal Reserve has been printing money via Quantitative Easing (2008–09), QE-lite (August 2010–August 2011), and QE-2 (November 2010–June 2011). These policies have meant that the Fed has created money, then used it to buy toxic assets (QE-1), then Treasury bonds (lite and 2).
The reason the Fed did QE-1 was so that the toxic assets the American banks had on their balance sheets wouldn’t drive them broke—as they were threatening to do. When the Fed carried out QE-1, the banks got rid of their toxic assets, and got fresh money. They used this money to buy Treasury bonds.
When the Fed unleashed QE-lite and then QE-2, the Fed was worried about a deflationary spiral: Lower aggregate demand pushing prices of goods and services lower, forcing companies to lay off workers, which naturally curtails demand, pushing prices for goods and services lower still, and so on.
By flooding the economy with money via QE-lite and QE-2, prices of all asset classes would rise, thereby avoiding a deflationary death spiral.
This was a successful policy: There was no price deflation. Instead, markets have rallied: Stocks, bonds, commodities—
—and here’s the problem: Since late 2009, commodities of all classes—precious metals, industrial metals, oil, agro—have all been rising, and rising rather precipitously at that.
The rise in commodity prices in dollar terms has meant that foreign countries have to spend more dollars in order to import the same amount of a commodity, let’s say wheat. This rise in the price of wheat is passed on to the local population, in the form of higher prices for bread.
Since spending on food comprises a greater proportion of income in poor and developing countries than in richer countries, real-world inflation affects a population faster in poor and developing countries than in the U.S. or Europe.
Lately, we have been seeing this: The riots in Egypt were triggered by rises in food prices. Problems in Indonesia, Asia, Brazil. All food related.
Federal Reserve chairman Ben Bernanke claims that the rise in commodity prices has nothing to do with the various versions of QE—he claims instead that rising commodity prices is because of natural events curtailing commodity production (floods in Australia, drought in Argentina, fires in Russia) which of course makes prices rise, and is also a sign of a recovering economy, as stronger demand puts pressure on prices. Bernanke also claims that rising inflation in the developing world is a sign that those economies (China, India, Brazil, etc.) are leading the way out of this recession.
Bernanke’s explanation is pretty complicated, if you get right down to it. Apply Occam’s razor: The simpler explanation is that dollar creation by the Fed by way of the various QE’s has driven up commodities, whose price increase is being reflected in the rise of consumer goods in the poorer nations first.
Thus in order to “save” the U.S. economy, the Fed has “exported inflation” to the rest of the world.
The obvious problem, of course, is that this inflation won’t stay outside the U.S. for long. Like a boomerang, it’ll soon be coming back.