The inflation story is old news here, but in emerging markets, where easy money policies have spurred both an economic boom and accelerating inflation (now 8%-10% in many countries), it’s a new concept. The Economist argues that inflation is set to cripple emerging markets for 4 key reasons, which we outline below.
Before we do, however, recall that many US investors are banking on international growth to save them from a US slowdown–with internationally diversified companies thought to be nearly immune from troubles here. Europe, however, is slowing dramatically, and if the Economist is right, emerging markets will soon follow suit.
Here are the recent inflation rates in several key markets, per the Economist:
Venezuela 29%… thanks Hugo
And here’s why the Economist thinks you should be shaking in your boots:
- Policy-makers see the spike as a short-term phenomenon related to a supply shock, and don’t take it seriously.
- Money supplies are growing faster in emerging markets than they ever have in the developed world.
- Many central banks are not yet independent, and when monetary policy is subject to political meddling, there’s a recipe for disaster.
- Inflation expectations are too low.
Also, because emerging economies are operating at full capacity and food comprises a larger chunk of household budgets that it does in developed economies, emerging markets are even more vulnerable to a wage-price spiral:
Prices are rising much faster partly because food accounts for a bigger chunk of their consumer-price indices. But wages (rising at nearly 30% a year in Russia) and core-inflation rates are also accelerating. Many of these economies are operating close to full capacity, where inflation is more likely to take hold.
There are alarming similarities between emerging economies today and the rich world in the 1970s when the Great Inflation lifted off. Many policymakers in emerging markets view the rise in inflation as a short-term supply shock and so see little need to raise interest rates. Instead they are using price controls and subsidies to cap prices. Money supplies are growing almost three times as fast as in the developed world. Many central banks are still not fully independent. And inflationary expectations are not properly anchored, increasing the risk of a wage-price spiral. Emerging markets may as well be inviting the muggers into their own homes.
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