Global Inflation, local solutions

Inflation is making headlines globally again, and going by Google trends, is almost as worrying for most people globally as it was in 2008 !

Consider the following news pieces over the past few days:

• South Korea raises rates to tackle Inflation (here): S. Korea increased rates to 2.75%, about 75 basis points more than its low during Feb 2009 period, when it had slashed rates to tackle recessionary effects. This is its 3rd attempt since, to bring inflation back to under 3% from about 3.5% currently and for Korean PM to bring the growth back on track to at least 5%.

• Australia faces food-inflation risk with Tomato prices shooting up by 20% (here): Situation might get further aggravated due to floods in Australia, which reportedly could have caused as much loss as 1% of its GDP. Besides, with petrol prices inching up further in the coming weeks, the inflation is unlikely to come down anytime soon. Moreover, flood situation is likely to result in a delay in increase in rate hikes as well, to be able to offset the lack of growth in the flood affected region.

• China increases its RRR again in a bid to control Inflation (here): China (as also Taiwan) has increased is reserve ratio requirement (RRR) by 0.5 % which mandates banks to hold more money with themselves instead of lending it, in a bid to reduce the money in circulation and tighten liquidity. China is clearly refraining from increasing the borrowing interest rates as it might not only hit the growth hard, but even fuel the Yuan carry trade (wherein, people from foreign countries with lower interest rates can take loans in their countries and invest in China at higher interest rates - something similar, but in reverse order has happened in Japan for a long time due to its long bout of near zero interest rates). If a Yuan carry trade does happen, it'll negate all measures being taken to contain inflation as a whole lot of foreign money will come in into China's financial system.

• India's WPI inflation touched 8.43% in December (here): Indian markets are caving in due to better growth prospects from US and due to upward pressures on interest rates due to high inflation. Although onion prices in India have come down from its highs of over 2$ / kg to around 1$ /kg, its still high enough to be unaffordable to over 75% of India's population. Expect some interests rate hikes soon from India. Since moving money in and out of India is not easy due to various capital flow controls, unlike some other countries, India would not trigger a massive Rupee carry trade by increasing interest rates.

Its not just the emerging market economies / Asian economies which are facing teething troubles due to inflation, even UK and US are reporting increases in inflation. Besides, Compare the response to inflation in China now (@ 5.1%) as compared to in 2008, when it was over 8.3% and its RRR was about 16% as compared to 19.5% today ! Back then, it was a real problem with excess liquidity, now its not. Thus, at this stage one question that needs to be asked is not How to control inflation, but rather, What is causing inflation despite poor growth and high unemployment in most of the developed world?

Reasons for Global Inflation:

Inflation can be caused primarily due to 2 reasons - if liquidity / amount of money in the system is high (like in China), or if Supply and Demand dynamics of inflation causing elements change. For example, food - which contributes a decent chunk to inflation figure, and is fairly inelastic in nature (just because food prices have gone high, you'll not stop consuming food...may be make a temporary dietary shift, but still eat something). Or real estate, if everyone starts buying houses tomorrow, then considering the decent amount of weight it has in inflation figure, inflation will rise along with prices of other related commodities like steel, cement, etc.

Yet another way of looking at inflation is, like Mish says, to look at the supply and demand of money itself. But this time around, I think its primarily the supply and demand of commodities, which is causing inflation globally, and not the excess supply of money / poor demand for money (which might happen if interest rates are reduced to such low levels, that people do not have any incentive to save). 

If we look at the real estate bubbles forming across different countries like India, China, Singapore, Australia, Thailand, etc., its not very difficult to see why costs of some of the basic commodities is going up, which is further stoking inflation. Food prices globally are also on the rise, from basic food items to raw materials like soybeans and palm fruits, which are used to produce soy and palm oil (to be used in cooking). High energy prices (crude oil nearing 100$ - though now it has come back to 91$ / barrel) aren't contributing to reducing inflation in any way either. Just like Australia, India too is looking at higher petrol prices due to high crude prices globally...India will rise today to an approx. 5% hike in petrol prices...and how this will affect inflation is anybody's guess.

Its a combination of liquidity control and food / commodity production investments which are a key to controlling inflation right now, rather than just using text-bookish ways of taming it through fiscal / monetary measures. The former is the playground of central bankers, while the latter, that of the governments. China has already started investing big time in food production to tackle this issue, Singapore has started implementing roof-top harvesting concepts to reduce dependency on imports of essential commodities in future as also to reduce the fluctuations in food prices, heck, even Greenland is using greenhouse effect to increase its produce of agriculture.

Though these are baby steps towards future sustainability, and is surely unlikely to yield either results or fruits (literally !) in near future, but it looks increasingly likely that another Green Revolution is required in sync with liquidity control measures to tackle inflation from here on...