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Inflation is real risk, so forget Bear Stearns

Inflation is real risk, so forget Bear Stearns
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First Published: Mon, Apr 07 2008. 11 15 PM IST
Updated: Mon, Apr 07 2008. 11 15 PM IST
Forget Bear Stearns Cos. Ignore what Ben Bernanke and Henry Paulson are up to. Take your attention away from which hedge fund is about to blow up. Think about rice.
How Federal Reserve chairman Bernanke and US treasury secretary Paulson tend to the credit crisis may pale in comparison with surging costs of vital foods. The price increase of rice, the staple food for about three billion people, to a record last week, is the real crisis in the fastest growing region.
That’s not all. “Food is just the tip of the iceberg,” says Ifzal Ali, chief economist at the Asian Development Bank (ADB) in Manila. “We see signs of overheating emerging everywhere in Asia.”
There are two other forces behind Asia’s inflation surge, both of which have been building for years. One is asset-price gains that have their roots in low interest rate policies from Washington to Tokyo. The other is wages as Asians command higher pay and companies encounter skilled-labour shortages. It’s a kind of horror scenario. Yet what’s most noteworthy about it is how surprised many investors and economists are.
Given how the Bank of Japan and Federal Reserve have trimmed interest rates over a number of years, these price trends were predictable. Ditto for Asia’s build-up of currency reserves, which are seeping into the money supply. Also, given Asia’s rapid growth, it stands to reason that wages would be rising. The ADB says Asian inflation may reach the highest in a decade this year.
Party is over
What may surprise many is how rising food prices are less of a cyclical phenomenon than a secular one. For economists like Ali, who have been warning about this for years, it’s disheartening to see so little focus on increasing investments in agriculture techniques and technologies.
“The party with high growth and low inflation, the age of innocence, is over,” Ali says. “Governments now need to buckle down if they are to be able to fly higher again in the future. If this trend isn’t arrested and reversed, it could well lead to the end of poverty reduction in Asia.”
Strong words, indeed. And yet today’s bout with inflation could markedly set back a region that has spent 10 years recovering from the Asian crisis. Central banks will have little choice but to raise interest rates, a dynamic that would slow growth and hurt equity markets.
Rough time
Governments are in for a rougher time. The rise in commodities since the start of the decade has been largely masked by subsidies and export controls. That’s becoming too expensive now as prices soar and leaders have a grim choice to make: vastly increase debt levels or let the public bear the brunt.
Food costs alone are a clear and present danger. In many Asian countries, Ali says, food and edible oils account for 60% of the consumer price index (CPI). Even before recent increases, Asian families on average shelled out 50% of income on food. That portion is rising at this very moment.
Economists in the US and Europe often focus on “core” inflation, which excludes food and energy. That’s impossible in developing Asian economies. Looking at core CPI only masks what Ali calls a “pauperizing effect” knocking back hard-won gains in living standards.
Hence World Bank president Robert Zoellick’s call last week for a “New Deal” to end hunger and an additional $500 million (Rs1,995 crore) for a United Nations food programme. He also urged rich countries to cut agricultural subsidies and open markets for food imports.
Speed bumps
And then there are what Ali calls “speed bumps to growth” that are fuelling inflation. Big increases in prices of everything from cement to steel will complicate Asia’s need to improve roads, bridges, ports and telecommunications. It’s an odd twist of fate that in improving infrastructure to restrain inflation, all that building activity could further fuel it. All this will require quite an adjustment. Asia is the latest frontier for capitalism, and multinational companies are depending on its rapid growth, swelling populations and emerging middle-class consumer sectors to boost profits. Investors are making similar assumptions.
It’s not a completely dire situation. ADB expects Asia, excluding Japan, to expand 7.6% this year. While the decoupling myth that economists spun last year has been debunked, Asia enjoys a considerable cushion as the US and Japan slow.
In the late 1990s, turmoil sent economies such as Indonesia, South Korea and Thailand hat-in-hand to the International Monetary Fund for bailouts. Asian governments are now cumulatively sitting on trillions of dollars of currency reserves. That’s money that can be used to buy food stocks.
For most people in the world, filling a gas tank is a choice. If speculators drive oil prices higher, you find a way around it as best you can. If gold prices surge, you buy silver. When it comes to the costs of food that can’t easily be substituted, such as rice, wheat, corn, soya bean, pork and palm oil, Asia has a problem.
“This inflation issue has a direct impact on basic well-being,” Ali says. “That’s why it is so politically and socially explosive.”
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First Published: Mon, Apr 07 2008. 11 15 PM IST
More Topics: Food | Inflation | Bear Stearns | Markets | Rice |