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Tilting at inflation windmills

Tilting at inflation windmills
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First Published: Mon, Jun 23 2008. 10 03 PM IST
Updated: Mon, Jun 23 2008. 10 03 PM IST
Singapore Airlines said on Friday that it has not seen any impact of the global credit crisis on air travel in Europe and Asia-Pacific. On Thursday, the UK government reported that retail sales rose in volume terms by 3.5% — a record bettered only in the early days of former prime minister Margaret Thatcher. China’s automotive agency reported that sale of sport utility vehicles, or SUV, rose by 40% in the first four months of this year, compared with the same period last year. Separately, the US government reported that producer prices for crude goods (raw materials) rose more than 40% year-on-year, and excluding food and energy, prices rose 33% in May. The last time they rose together by such magnitude or higher was in, er.., 1973-74. Pursuit of growth objectives at this stage only fans the flames of inflation without delivering growth.
Recently, central bankers are waking up to the dangers of the toxic policy they and their predecessors had brewed. Earlier this month, US Fed chairman Ben Bernanke warned more than once of the dangers of a falling dollar for inflation expectations. Traders bought dollars. Two days later, Jean-Claude Trichet of the European Central Bank (ECB) said he remained strongly vigilant, sending the signal that he was ready to raise interest rates in July. Traders bought the euro. In the case of ECB, the rhetoric matched its policy goals. It is not obvious that Bernanke is serious about inflation.
There are several explanations for Bernanke’s inflation warning, but the one that Bare Talk leans towards is this. The US continues to need a lot of money to put its financial house in order. Without that, the US’ superpower status is under threat. The money comes from sovereign wealth funds and, in particular, from those in the oil exporting world, for they are the least accountable to their public among countries that put public money into private investment. They were displeased that falling share prices have made their earlier investments look less sagacious and the falling dollar judged their investment wisdom more harshly. Hence, their ultimatum that the US had to do something about the currency if it wished to attract more money. US treasury secretary Henry Paulson and Bernanke got down to work.
Paulson went to Arab countries and told them that oil prices were driven by fundamentals. It is true, of course. He told them that they should not abandon their dollar pegs. In any case, they do not intend to do so and incur losses on the investments in the US. He then dropped the insistence that China must allow its currency to appreciate. Economist Brad Setser dryly notes that Paulson’s first China speech had a much stronger focus on getting market access for US banks, investment banks and private equity funds rather than on the renminbi (“Why is the US taking the currency issue off the table in talks with China?” http://blogs.cfr.org/setser/ 17 June).
In other words, the US had to appear to act on the currency so that the money taps, let alone the oil tap, from the Gulf did not run dry. Would they act to stem inflation? Rather doubtful, for it not only runs counter to their multiple policy objectives and their conduct in the last two decades, but also to Bernanke’s strong belief that credit-intensive economies cannot afford to run the risk of zero inflation or even mild deflation. Unfortunately for them, their “fool some people all the time; all people for some time” routine was rudely interrupted by Trichet, with his own rate hike comment. If he follows through on 3 July, the fireworks begin. The Fed would be under pressure to demonstrate its sincerity by hiking rates in August. If it does, then the financial sector would be buried and the stock market would take it on its chin. If it does not, its credibility would be damaged. Traders would sell dollars. Inflation would remain an issue.
Whichever way one slices the problem, the summer months are going to be hot in many ways. By now, investors must be suitably disabused of the notion that Asia is a hiding place. Asia has shown itself up to be a region that usually gets a better billing than it deserves. It is a balloon that is inflated by global economic tailwinds. When that turns into a headwind, the balloon deflates. As for Latin America, Morgan Stanley’s Gray Thomson says that had external conditions not been favourable, growth rates in the last five years “would have averaged 3.7% per annum rather than the observed 8.8% —a difference of just more than five percentage points. In the case of Brazil, the gap would have been 1.6 percentage points, largely eliminating the recent growth spurt” (Macro and Micro Radars—1st Half 2008, 10 June).
Well, 2008 or, for that matter, 2009-10, is about not losing money and not losing jobs, and not about making money.
V. Anantha Nageswaran is head, investment research, Bank Julius Baer & Co. Ltd in Singapore.These are his personal views and do not represent those of his employer. Your comments are welcome at baretalk@livemint.com
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First Published: Mon, Jun 23 2008. 10 03 PM IST