Steinbock: Exporting an Inflation Tsunami
“We do not want higher inflation and we’re not tolerating higher inflation,” Fed chairman Ben Bernanke told Congress yesterday.
In a way, that’s true. Washington is exporting higher inflation, which it does not want, to the emerging world, which must tolerate it.
And Brussels has joined in.
Yesterday, the Fed’s chairman, Ben S. Bernanke, was sharply questioned by members of the House Budget Committee for not having a stronger focus on inflation.
“This policy runs the great risk of fueling asset bubbles, destabilizing prices and eventually eroding the value of the dollar,” said Representative Paul Ryan, the Wisconsin Republican who is chairman of the House Budget Committee.
“The prospect of all three,” Ryan said, “is adding to uncertainty and holding our economy back.”
What was conveniently ignored is the fact that the prospect of asset bubbles, destabilizing prices and the eroding value of the dollar has swept over the emerging world since fall 2010.
As Brussels is now joining in, the potential for a financial tsunami is increasing.
QE in the West, QT in the East
Yesterday, the Fed chair Bernanke defended the central bank’s newly established price goal and rejected suggestions he was prepared to allow higher inflation to create jobs.
In reality, the liquidity trap was set by the exhaustion of traditional instruments of monetary policy, which prompted the Fed to initiate quantitative easing (QE) in fall 2010.
With investors seeking higher returns, more QE has driven “hot money” (short-term portfolio flows) into high-yield emerging-market economies, inflating potentially dangerous asset bubbles in Asia, Latin America and elsewhere.
Naturally, emerging and developing countries have sought to move in the opposite direction; toward quantitative tightening (QT). In China, interest rates were increased to 6.6 percent. In India, the central bank raised rates dozen times to 8.5 percent since March 2010 to bring down inflation. Brazil’s central bank reduced rate only recently to 10.5 percent.
The World Bank has already warned developing countries to prepare for the risk of the world going into a slump like the global downturn in 2008-09 owing to an escalation in the Eurozone debt crisis.
Ironically, the worst threat stems not from what could go wrong, but from the way the Eurozone, along with the Fed, seeks to resolve the debt crisis.
How ECB discovered the printing press
Since the global crisis and the onset of the Eurozone turmoil in May 2010, European leaders have struggled to contain the debt crisis, but with few results.
One option remains. Officially, it is rejected as unthinkable; unofficially, debt monetization is already occurring.
In the course of the global financial crisis, national central banks in the Eurozone embraced the debt, which thereby became the responsibility of the European Central Bank.
During the past few years, financial institutions from debt-stricken Greece, Portugal and Ireland have borrowed extensively from the ECB .
Since May 2010, the ECB has purchased sovereign bonds from crisis-stricken Eurozone members worth EUR 213 billion ($280 bn). In December, ECB also injected European banks with EUR 500 billion ($650 bn), with generous loan periods of three years. The assumption is that the debt and the collaterals are sustainable.
Unfortunately, banks have not been passing the ECB money in loans to companies for employment and to stimulate the economy. Rather, they have re-parked the money with the ECB.
In early January, Italy and Spain had few problems raising new funds in sovereign bond auctions. To many, this was a relief because it seemed to signal reduction of tension in markets. Yet, some banks were using its liquidity in the auctions to buy the bonds.
By injecting the banks with cheap money, the ECB is creating hollow demand for sovereign bonds; that, in turn, allows it to cut back on its own bond purchases, while pumping up artificial demand.
When the money-printing machine eventually sputters, it may harm the banks, bankrupt countries and undermine the ECB’s legitimacy.
Domestic decisions, global consequences
Hoping to avoid Japan’s two lost decades, the Fed and the ECB seek to realize significant real exchange rate depreciation by printing money. It can be seen as the advanced world’s effort to force the emerging world to accommodate drastic inflation and thus nominal rate appreciation.
With the Fed’s QE1 in fall 2010, China’s minister of commerce Chen Deming lamented that the U.S. issuance of dollars was “out of control” and China was attacked by “imported inflation.”
Then, the critical chorus extended from the BRICs to Germany. Tomorrow, it will be more extensive because any slowdown in the BRICs is bound to have an adverse impact on smaller emerging and developing economies whose growth depends on these giants.
In emerging Asia and Latin America, this debt monetization is comparable to successive waves of QE, which amount to debasing the value of the dollar and the euro alike.
The advanced economies seek to inflate away their massive debt by exporting inflation to the emerging world. The net effect is a massive financial tsunami that has potential to sweep over the emerging economies – and, ultimately, the developed economies as well.
In a global economy, the Fed and the ECB may want to spend more time to think about the global implications of their monetary policy decisions. Pursued too single-mindedly, the ultimate result of price stability in major advanced economies can be economic instability globally.
Dan Steinbock is research director of International Business at India China and America Institute (USA), visiting fellow at Shanghai Institutes for International Studies (China) and in the EU-Center (Singapore).