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| atbell |
More from the Economist.
This could become a real problem if the Gulf states and China choose to fight inflation by cutting thier pegs to the US$. It would cause a further sinking of the dollar and/or higher inflation (likely both).
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Economics focus
A tale of two worlds
May 8th 2008
From The Economist print edition
If emerging economies diverge from America's, monetary policy also needs to break free
POLICYMAKERS in Washington and London have been losing sleep over the risks of financial meltdown and recession. In sharp contrast, the biggest worry in Beijing, Moscow and other emerging-market capitals is rising inflation. China's inflation rate has jumped to 8.3% from 2.2% in early 2007; Russia's is running at 13.3% (see left-hand chart). HSBC forecasts that the average inflation rate in emerging economies will rise to 6.6% this year, its highest in ten years.
One reason is the surge in food and energy prices. Food accounts for a bigger slice of spending in poor countries than in rich ones, so rising grain and meat prices have a bigger impact on inflation. But this is only part of the story: core inflation rates are also creeping up, and lax monetary policies are to blame.
As America stumbles, growth in emerging economies seems to be holding up well. HSBC forecasts average GDP growth of 6.5% this year, more than four times as fast as in developed countries. The problem is that although economies may have decoupled, their monetary policies have not. Whereas the greater resilience of the emerging world is a source of stability for the global economy, the monetary linkages between rich and poor economies complicate matters.
Emerging economies were partly to blame for America's housing and credit bubble. As China and Gulf oil exporters purchased American Treasury bonds in order to hold down their currencies, this pushed down bond yields and helped to fuel the housing boom. Low yields also encouraged investors to seek higher returns in riskier assets, such as mortgage-backed securities. That bubble has burst, prompting the Federal Reserve to slash interest rates. Now, those same exchange-rate policies that helped to cause America's financial crisis are leading emerging economies to run overly loose monetary policies.
Apart from the Gulf states, few countries still peg their currencies to the dollar, but most try to limit the amount of appreciation. This means that as the Fed cuts rates there is pressure on emerging economies to do the same, to prevent capital inflows pushing up their exchange rates. Saudi Arabia, the United Arab Emirates, Qatar and Bahrain have all followed the Fed's April 30th rate cut. In the face of rising inflation, emerging economies should be lifting interest rates, not cutting them, but their rigid currency policies make this hard. In turn, continued surging demand in emerging economies boosts commodity prices, which reduces Americans' spending power and so encourages the Fed to cut rates further. The more the Fed cuts, the bigger the risk of inflation in emerging markets.
The right-hand chart shows just how loose monetary policy is. Joachim Fels and Manoj Pradhan, of Morgan Stanley, have made a stab at estimating neutral interest rates, ie, the short-term rates that would keep GDP growing at its trend pace and inflation on a stable path. The results are startling. In China and Russia, actual real rates are negative, against estimates of neutral real rates of 8% and 5% respectively. In India, real rates are close to zero�still far below the estimated neutral rate of 6%. Only in Brazil are real rates positive and above the neutral rate. Admittedly this ignores other tightening measures that central banks use, such as banks' reserve requirements (both India and China have been steadily increasing them). Nevertheless, it is no coincidence that Brazil has the lowest inflation rate of the four countries. Russia, with the lowest real interest rates, has the highest inflation.
Not so easy
The usual advice given to overheating emerging economies is that they must let their currencies rise. This would help to curb inflation by reducing import prices, and a flexible exchange rate would create more room for an independent monetary policy. Currency appreciation thus seems the obvious solution. However, Stephen King and Stuart Green, economists at HSBC, argue in a recent report that it raises many awkward questions.
How far should currencies rise in order to keep inflation in check? China has allowed the yuan to rise by 18% against the dollar since 2005. Brazil's currency has appreciated by more than 100% since 2003, yet even this has not stopped inflation from picking up. At 4.7%, the rate may be lower than other big developing countries, but it is still up from less than 3% a year ago, partly because of excessive growth in domestic demand. In the past two years real interest rates have fallen sharply (although they are still the highest in the world) and public spending has surged. In April the central bank raised interest rates for the first time in three years, but this is likely to lure in foreign capital. Should Brazil let its exchange rate rise further�when its current account has already moved back into deficit?
The danger of allowing these currencies to float is that they could overshoot as foreign capital floods in, eroding competitiveness and leaving economies vulnerable to a future reversal in capital flows. Another concern is whether it is wise to allow exchange rates to rise sharply when emerging-market exports are being hurt by an American recession.
There are no easy solutions. One alternative to a free float is a one-off appreciation. The danger is that this could encourage the expectation of further appreciation, attract even bigger capital inflows and so exacerbate inflation. To work, the revaluation would need to be so big that speculators no longer expected a further rise. But a big increase might not be politically feasible. Another solution is to tighten fiscal policy. This would cool domestic demand without the need for a big rise in interest rates. The snag is that it would boost domestic saving and hence lead to larger current-account surpluses�the opposite of what America requires.
The third option, and the one most likely to be pursued, is to do nothing apart from slapping on some temporary price controls, and hope that inflation pressures will soon ease. The risk is that if inflation continues to rise, policymakers will eventually have to slam on the monetary brakes.
http://www.economist.com/finance/ec...ory_id=11328631
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| jerZ07002 |
| quote: | Originally posted by atbell
More from the Economist.
This could become a real problem if the Gulf states and China choose to fight inflation by cutting thier pegs to the US$. It would cause a further sinking of the dollar and/or higher inflation (likely both). |
it's not all bad. it makes paying back our national debt cheaper. |
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| Krypton |
| I'm not all against a falling dollar anymore. Exports are increasing. The trade deficit will fall. People will save more. Foreign investment will increase. Manufacturing will rise again. Short term of course, we suffer from higher inflation in food and gas. |
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| jerZ07002 |
| quote: | Originally posted by Krypton
I'm not all against a falling dollar anymore. Exports are increasing. The trade deficit will fall. People will save more. Foreign investment will increase. Manufacturing will rise again. Short term of course, we suffer from higher inflation in food and gas. |
the main damaging factor in a falling dollar value is our energy costs will increase. but that will also cause policy changes to find internal sources of energy production. unlike many countries, food prices won't rise as much because we produce most of the food we need. the rise in food costs is mostly due to transportation. many other countries aren't as fortunate to produce all the foodstuff they need.
i'm not against a falling dollar at all. in the short term it can actually be a very good thing. not if you want to travel to europe, but i've been a few times, so i'm set for a while. |
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| atbell |
Good points.
I don't like the fact that it will make Americans even less likely to go abroad but if it helps stem the contries consumption then it might be a good thing (maybe the Canadian dollar could stand a bit of the same.)
It's also good to see that manufacturing is picking up as Krypton pointed out. I wasn't sure how responsive the economy would be to that stimulus but having a few real products that the US exports can't be a bad thing. |
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| Krypton |
Here is a perfect example of how the falling dollar might benefit America...
Volkswagen has lost over $1 billion in American sales in 2006-7. The falling dollar exasperates this loss because now German cars are more expensive to Americans to buy. VW sold on around 200,000 cars in 2006. Their production plant in Mexico is at full capacity. Get this...
VW plans to increase auto sales 3-fold in the next 10 years. From 200,000 cars sold in 2006-7-8 to over 800,000 being sold by 2018. How will they do this? WELL, they are going to build a new production plant in AMERICA. This will make foreign cars cheaper to buy, bring in manufacturing jobs, and decrease exports because the cars are produced IN AMERICA, not exported in.
The falling dollar will revamp our manufacturing sector. Sure inflation is up. But not so much it cripples the economy. What needs to happen is the policy makers need to find a healthy level for the dollar to be at and stabilize it against the other currencies. Clearly the high dollar was a catalyst for excessive spending, little saving, exodus of manufacturing, and trade deficits. |
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