Inflation is the new monster that every country is dreading. But there is a difference in the potential damage that inflation can do to the US and other emerging countries.Why ? That is because now the emerging countries are undergoing some fundamental changes that put the emerging countries in different perspective calls for individual actions on the part of each such economies as far as their monetary policies are concerned and how can this can be done..?By not pegging against the US dollar.
US endured the credit crunch, credit crunch affected the economic growth and consequently to relieve the situation ,the monetary policies were eased off in US. At that time the concern was growth and not inflation but now concern has shifted to inflation but still at this stage, in US, it seems like the easing would be stopped i.e.no more rate cuts but it does not make it apparent that the interest rates would be increased.There are two reasons for it ;firstly ,the imminent election and secondly the expectation of the shrinking of the US economy which will help in offsetting the inflationary pressure .As emerging economies like India and China have pegged their currency with US dollar ,this has led to the brewing of high inflationary situation in these countries too.
But ,this time around , Emerging Economies(EE) should react and behave in the manner suitable to their current economic situation.To be more precise-as i mentioned earlier that EE economies are undergoing sea change and so this change should be incorporated in their monetary policies. The internal demand curve in the countries like India and China has shifted rightwards and hence the equilibrium is expected to change and also it implies that the economic development of emerging countries is not only depended on the US and other developed countries but also on their own internal growth and so any measures that affect this growth should take into consideration both the factors. Logically it follows that the countries need to de-peg its currencies to US dollars to have more independence regarding its own interest rate policies.
To elaborate with example - If we take look at the investment in infrastructure , India is expected to invest 500 billion$ through its five year plan (data from Economist) and China along with other oil producing countries are expected to invest in fixed asset majorly .Investments in infrastructure translates into prosperity and lays path for the sustained economic development and the growth does not seem to be slowing down in the EE.While in US there is no major contribution to the infrastructure any time soon in other words it is expected to be flat .Hence, in India the RBI should start tightening the monetary policy regardless of how long US takes to tighten its own and India should smoothen the path of its own economic development.
It will take more than traditional method of pegging currencies to US dollar ,to combat the inflation, by the emerging economies as they have much more to loose by following the US dollar this time.
2 comments:
hey... useful insight.... keep writing such articles....
Ben Bernanke is bluffing!
WHEN the Federal Reserve Chairman speaks, the financial world goes ballistic. So it proved with the bloodbath in the US Treasury bond market after Dr. Bernanke said that the American central bank "will strongly resist an erosion of long term inflation expectations." The bond vigilantes reawoke with a vengeance and priced in two Fed rate hikes, with the two year T-note yield rising 65 basis point, the most in a quarter century.
This is total, utter nonsense. Ben Bernanke has as much probability of raising interest rates at the June and August FOMC conclaves as I have of becoming the next Queen of England. Yes, amigos, Ben Bernanke is bluffing. Why? Here are seventeen reasons why. I trade interest rates, global equities, FX and derivatives from sunrise in Singapore to sunset in Manhattan 24/5. Fed watching is my obsession as every twists and turn in mass perceptions of monetary policy impacts my trading book P&L, net worth and, alas, self worth.
One, US house prices are falling at the worst rate since the 1991 real estate crash. US housing starts in May were the worst in seventeen years.
Two, the unemployment rate is 5.5 per cent and the Fed never raises interest rates until the jobless rate stops rising.
Three, US capex and commercial property market prices have now gone sluggish.
Four, business and consumer confidence has slumped to a recession SOS. The Dow Jones is below 12000and Silicon Valley tech shares have lost their post Bear Stearns sizzle.
Five, US state and municipal governments now face fiscal black holes, as does Uncle Sam.
Six, the US auto business in Michigan just died. Look at the zombie GM and Ford shares.
Seven, bank credit is falling. The first wave of regional bank failures will begin this summer. In investment banking, the fate of Bear Stearns and Lehman Brothers could be shared by thousands of broker/dealers.
Eight, economic slack in the US is rising, not falling.
Nine, there is not an iota of an evidence for systemic wage hikes despite the CPI spike and $4 gasoline.
Ten, the Democratic candidate for 2008 is an economic populist. A rate hike will send Obamanomics into orbit.
Eleven, the trade weighted dollar has now stabilized, reducing the necessity of a tight money bias.
Twelve, a cosmetic rate hike would be useless against the current CPI surge. The monetarist purists of The Chicago School proved that monetary policy operates with a time lag.
Thirteen, unlike the ECB's Trichet, the Fed has a dual mandate. The US economy is hurting big time and Helicopter Ben is on the hook and unable to be a hawkish Apache.
Fourteen, Congressional politics make rate hikes unthinkable. Congress will scream bloody murder that Bernanke bailed out the oligarchs at Bear Stearns and raises interest rates when the average Joe Habibi has lost his house, cannot pump gasoline in his SUV and could well lose his house.
Fifteen, when banking systems go kaput, as the US just did, the Fed has to recapitalise the banks with negative real interest rates. Remember Citigroup and 3 per cent Fed Funds in 1991-93? The banking system needs an easy money Mommy (Fed). It will get it.
Sixteen, the Wall Street broker/dealer index has been killed since May. The Fed discount window is now open to investment banks and the last thing Bernanke needs is a run on American securities firms in the global money markets, which are already in Trauma City.
Seventeen, the Fed cannot raise rates just once to reassure the bond vigilantes.
It has to engage in a multi - session FOMC tightening. This will only trigger a global financial panic, bank failures, the Black Death in property, Any investor long shares real estate or a bank account should hope and pray that Bernanke is bluffing. The history of world finance teaches me that nasty endgames are the norm in credit crises, that global markets go schizo when central banks lose their credibility, that the money game is no fairy tale, that the ugly stepsisters and not Cinderella invariably attend Prince Charming's palace ball. As we say in my dealing room, hit happens.
The spectacle of bankrupt airlines, food riots by enraged peasants in the Third World (Wall Street's polite term is, of course, emerging markets), truckers blocking the urban arteries of Paris and Brussels, gasoline at petrol stations and a monumental wealth transfer from the West and Japan to the planet's petrocurrency kingdoms naturally awakens visions of a 1970's style inflation spiral. But history rhymes, not repeats, in the financial markets. The US economic GDP is ten times its GDP during the first Arab oil embargo in 1974 but its energy consumption has risen only by a third in the last thirty five years. This is the reason even $139 crude oil has not triggered an economic collapse. Moreover, the US economy is now a services colossus, the manufacturing Rust Belt is in terminal decline, President Reagan destroyed the trade unions whose wage demands created the second round spirals in 1978, Chinese factory workers and Indian IT services offshoring have made the Western economies flexible, competitive and energy efficient. Airlines have been almost wiped out by the exponential rise in jet fuel but do not have pricing power to hike prices, as they did in the 1970's, due to the Darwinian competition and airline deregulation.
The world's auto giants, from Detroit's Big Three to Volvo in Sweden, Renault in France, the South Koreans and the Japanese, have perfected the art of just in time inventory and high tech robot assembly lines. Above all, the Fed has learnt the lessons of the 1970's all too well. It took Paul Volcker a decade and 20 percent interest rates to choke the money supply and combat inflation, triggering the worst global recession since the 1930's Great Depression. This meant an international banking crisis, the sovereign debt crisis in Mexico and Brazil, the collapse of world trade, $250 gold and $8 crude oil. There is no way the Bernanke Fed will sacrifice Paul Volcker's low inflation crusade by allowing a promiscuous expansion of the money supply, the modus operandi of the Arthur Burns Fed after the first oil shock during the October 1973 war in the Sinai and Golan Heights.
At some point in 2009, if commodities prices continue to rise, Asian central banks lose their last shred of credibility and US economic growth surges, the Federal Reserve will be forced to initiate a tight money bias. But with forward CPI at 4 per cent and Fed funds at 2 per cent, a credible monetary policy will necessitate a 5 per cent Fed Funds rate and possibly 6 per cent in three month dollar LIBOR. But that is then (summer 2009) and this is now. At this precise point in time, Ben Bernanke is bluffing. That much, at least, is certain and a billion dollars in range accrual LIBOR notes strategies back my convictions.
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