INFLATION RETURNS
The possibility a rise in inflationary problems is now being acknowledged in many parts of the world. Oil prices have risen to US$ 95-96, a previously unheard of level, that is quickly being felt in the US and in countries with currencies tied to the US dollar.The rise in the oil price has been less significant in other parts of the world, where a fall in the value of the US dollar against their currencies is softening the impact of rising fuel prices. Big oil exporters such as the Middle Eastern countries and Russia are keen for the oil price to rise, in US dollar terms, to compensate for the falling purchasing power of the dollar itself.
The banking and credit crisis has lead to large injections of liquidity from the central banks to "unfreeze" the banking system, which is contributing to inflationary pressures. Before the credit crisis broke in August, there was concern about rising consumer prices but the lowering of American interest rates which has occurred in response to the sub prime mortgage problems, will exacerbate the amount of inflation across the world.
The rise of both the oil and gold prices are indicators that the risk of global monetary inflation, is rising the way that it did in the 1970's. The changes are occurring across the world with the cost of living rising by 9% in Russia, at least 10% in China and 11% in the United Arab Emirates. The inflation estimate for the US itself is approximately 7-8%, if the rate was being calculated in the same way as it was years ago. In Australia the price of fresh food has risen about 10% in 12 months, making the likelihood of rising official interest rates, in the immediate future a high probability. Conversely, the price of food has increased by 18% in the US in the past year, but interest rates are on their way down.
Even the Australian government has admitted that the CPI is rising by 3% and the interest rate futures market is pricing in at least two 0.25% rate hikes. The European Central Bank is also hinting at interest rate rises with the inflation rate, in the Euro zone sitting at the top of the target range.
The rise of affluent populations in China, India and elsewhere has increased the demand and the price pressure on a large range of foodstuffs. These are the same factors that have lead to a rise in oil prices. For example, China is importing 12% more oil than a year ago, and this newfound wealth is also affecting wheat, soybeans and a host of other foodstuffs. The factory workers and newly urbanised populations are eating more protein, meat and vegetables and proportionally less rice. The price of wheat and a range of other grains are at all time highs. In China itself, the industrial production, pollution and industrial usage of water has cut the amount of land available for agriculture.
Globalization has meant, among other things, that there are extra billions of people now competing for a range of the same products and resources. This is being combined with the reckless spending in the US, on the war in Iraq and other things, is resulting in a lot of money printing by the world's central banks. As the Americans print more US dollars to pay for their deficits and the Iraq war, other central banks also print more of their currencies to avoid a marked rise in their currency's value against the US dollar. This is only partly effective since most major currencies, except the Japanese yen, have been rising in value against the greenback anyway.
As populations realise that the value of their money is being debased, they will try to convert it into assets that they hope will hold value better. The traditional favourites such as gold, silver and platinum are already rising in value with gold soaring to US$ 800 after the Halloween interest rate cut by the Federal Reserve. All the world's commodities have been in an uptrend as have natural resource companies. There has been heavy gold buying in Arab countries and in India.
The rise in oil has also translated into a rise in the price of a number of alternatives being used such as natural gas and uranium. Heating costs, power costs and transportation costs are all on the increase as a result. Whereas the previous rises in prices were primarily in asset values such as real estate and stocks, the new rises are in general cost of living items and in costs to businesses.
Why many people are finding it harder to make ends meet, is that the inflation rate is a lot higher than most government statistics, in different countries are indicating. Trust your own gut reactions rather than official figures. Most women are well aware of the level of inflation, because they tend to do most of a family's shopping. This official dishonesty is seen by the professional money managers, who are bidding up the price of oil and precious metal as inflation hedges.
The only major economy pretending not to have any inflationary problems is Japan. However, the price of crude oil, measured in yen, has risen by 44% in the last twelve months. Japan is also a large food importer and the large price rise in grains and other foodstuffs has to affecting ordinary Japanese.
In organising your affairs, it is important to realise that this is the case and to appreciate that in most countries, apart from the United States, interest rates will have to rise (eventually). The prevailing conditions have altered and the next few years are likely to be quite different from the last 10 to 15 years. The days of low inflation and low interest rates are over. Even Mr Bernanke is admitting that "recent increase in energy and commodity prices, among other factors, may renew upward pressure on inflation."
The psychology of inflation will begin to permeate the actions of ordinary people as well as the professionals. The usual assault on inflation by the authorities is by higher official interest rates. High debt levels are not going to be as desirable as they have been in the recent past. Being well informed, and taking proactive measures, is going to avoid a lot of heartache. The low interest rates which have prevailed until recently, have favoured asset inflation. If rates rise in many countries, as is now possible, strategies favouring high debt levels are going to be less attractive.
Wage pressures are going to rise. It was reported than in booming Dubai, thousands of building workers were on strike on October 28th. The unrest stemmed from the fact that most of them were on fixed wage contracts, while inflation was at 9-10% officially, but many believe that the real rate is higher. The local currency is pegged to the US dollar, which has been falling rapidly, and forcing Dubai authorities to print more currency to maintain the peg. Similar inflationary pressures are being experienced in Hong Kong, which also has a currency tied to the US dollar.
No matter where you live, world wide inflationary pressures are back!
This is a situation which many younger people have not encountered before, and it requires different approaches to everything to do with money - including wage contracts, borrowing for whatever purpose and any form of investment.
November 4, 2007
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