Loose-money policies in the United States have combined with robust growth in China and other emerging nations in recent months to set off a price spiral in food, energy and other basic goods needed to run the economy.
The trend threatens to pick up speed and become an obstacle for the global economy this year as growth in the United States accelerates to as high as 4 percent and contributes to burgeoning demand for basic goods obtained in global markets.
The chain reaction behind the phenomenon is reminiscent of the commodity-price spiral that occurred in 2008, which led to record-high prices for oil, corn, wheat, copper, iron and other necessities. China, in particular, is playing a key role in translating the Federal Reserve’s loose-money policies — aimed at reviving the U.S. economy — into global commodity inflation through its policy of linking its currency to the U.S. dollar. That makes for one more reason the currency issue is sure to be raised as a bone of contention when Chinese President Hu Jintao visits Washington next week.
Michael Drury, chief economist at McVean Trading & Investments, said China really is more to blame for the inflation uptick than the Fed, although the U.S. central bank can be faulted for largely ignoring evidence of growing inflation in raw materials. Since such commodity prices often fluctuate widely, Fed officials adamantly contend that what matters is the “core” rate of inflation — which excludes food and energy and which currently remains tame.
A report released Thursday that showed a flare-up in food and energy costs pushed up wholesale inflation in the U.S. by 1.1 percent last month — the most in a year. But while the Fed concedes that prolonged inflation in such commodities eventually can push up the overall inflation rate paid by consumers, it typically focuses on the rate excluding them — which was up modestly by 0.2 percent in December and rose by only 1.3 percent during the full year 2010.
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“The Fed’s preferred measure is not a very good measure of inflation” because it not only ignores vital necessities that consumers use each day, but it excludes fast-rising investment prices like home prices — another blind spot at the Fed that resulted in the housing market bubble and collapse, Mr. Drury said.
Still, despite the Fed’s shortcomings, “Today, the inflation that is most on the radar screen is food inflation in China,” he said, and that is mostly the result of China’s policy of translating the Fed’s loose-money policies into loose-money policies in China via its exchange-rate mechanism. Food prices are rising so fast in China that people are starting to stockpile food as a hedge against rising prices, he said.
“A series of global weather events have tightened food supplies back to inflationary levels not seen since the 1970s,” he said, citing the fires that destroyed wheat crops in Russia last year and this year’s floods in Australia’s grain-growing region.
With much of U.S. farmland now being used to raise corn for the production of ethanol, “the world is faced with tight stocks of all edible grains and oil seeds, and little available acreage around the world,” he said.
Even as supplies tighten, the incomes of consumers in China and other emerging countries are growing rapidly, and people are clamoring for more expensive and resource-intensive foods like meat. That means “the risk remains decidedly on the high side for agricultural prices,” Mr. Drury said.
The transmission mechanism by which the Fed’s loose-money policies result in higher commodity inflation starts with the fact that all major commodities traded in global markets are priced in U.S. dollars. The rest of the world obtains dollars to purchase those commodities primarily through trade with the U.S. Over several decades, the U.S. has run lopsided trade deficits that have flooded the rest of the world with dollars.
The deficit with China has been particularly large, ranging to more than $200 billion a year and enabling China to amass a giant war chest of $2.8 trillion in foreign exchange reserves. But nearly every U.S. trading partner has accumulated surplus reserves of dollars.
China, India and other fast-growing countries use their reserves and the dollars they earn through trade with the U.S. to bid up the price of wheat, corn and oil to fuel their rapidly growing economies. Thus, for example, the price of premium crude oil spiked to two-year highs of more than $90 a barrel recently despite lackluster demand in the U.S., the biggest consuming country.
The result is what Mr. Drury calls a “commodities trap.” The Fed remains lax on monetary policy because U.S. unemployment remains high and core consumer inflation remains low, while China and other countries translate this lax policy into high commodities inflation. But ironically, the higher prices force American consumers to spend more on food and energy and less on nonessential services, further driving down the core inflation rate and depressing U.S. growth. That leads the Fed to further loosen the money spigot and sets off the chain reaction all over again.
U.S. leaders from Fed Chairman Ben S. Bernanke to Treasury Secretary Timothy F. Geithner are keenly aware that China’s policies have boxed in the Fed and much of the world economy through this vicious cycle. They have registered increasingly sharp complaints against China and are promising to raise the issue during the Chinese president’s visit.