It is the du jour worry in the back of the minds of every investor and regular person on the street. But do people actually know what it means or how it works?
Prices are rising, that’s a fact. The U.S. Consumer Price Index and the CPI of any countries around the world indicate that prices are increasing on a variety of goods.
But that’s not necessarily a bad thing. Price increases suggest growth. And right now, the U.S. economy is growing, as are economies like China, India, and Germany. But that’s only one of the reasons prices are increasing across the U.S. and the world.
Another reason is the weather. The weather has slammed the global economy, reduced crop output, and increased prices for food around the world. All at a time where supplies were already low, and demand was rebounding.
But there’s another lingering concern; that all of the money the Federal Reserve and other central banks have added to the international finance system to combat the economic downturn is now moving from bank balance sheets to the market.
That stimulus is fueling the economic growth that driving the global recovery. It has been particularly effective in Asia, where now policy markers are pulling back those measures as inflation rises.
Where do we stand in the current conflict with inflation? And how did we get here in the first place?
Asia's biggest economies, all concerned about the extent of the international downturn, put in place stimulus packages in 2009 and 2010 to pull their economies from the brink. This stimulus was both fiscal and monetary in nature, meaning it included the easing of interest rates and spending on infrastructure projects.
China's program included extensive loans, which eventually increased the country's loan to GDP ratio to 117.4% in 2009. China's fiscal program was worth $586 billion.
Source: Morgan Stanley, Wikipedia
What happened is, while Asia had been busy stimulating domestic demand through loans and other stimulus, the west turned it around too, with the U.S. and Europe both engaging in massive stimulus programs.
This coordinated world stimulus made the recession rebound take just as much time as those from the two previous Asian downturns, while it was much deeper.
That means the turnaround was way bigger, and inflation rose with it.
Source: Morgan Stanley
But putting this in perspective: This spike is now weakening, and recent inflation, at its peak, is only back to 2008 levels.
You can see the rebound in food price inflation occurred just as Asia's economies turned around. That suggests the price spike was associated with the return of rampant Asian growth, as well as a push through impact of regional monetary stimulus.
The price spikes are a lot like those in 2008, but as of yet are not as high.
This reduces the supply side of the food equation. So while the region is rebounding, more people are employed, and spending is up, the supply of food is down.
Citi say that even before the weather effects were in place, there was a low supply of food stocks in Asia.
The increase in energy prices is adding to the increase in food prices, through and rise in the cost of transporting goods. But the rise is oil prices is also increasing demand for biofuels, made from soya and corn.
Demand for oil has rebounded with the global recovery.
But it's important to note: WTI crude prices are actually down 40% from 2008.
The rising costs in China will eventually be passed on to U.S. consumers. As wages and commodity prices increase the cost of producing goods in China, so to will they increase the costs U.S. consumers pay when they shop.
Source: Societe Generale
Inflation expectations in the United States have increased as the recovery has taken hold. That's only natural: the economy does better, people expect prices to rise.
Source: Societe Generale
The emerging world is in line for a significant round of monetary tightening. China, India, and Brazil have already started. Latin America is expected to tighten big this year. It's only Russia that is not.
Tightening outlook for the rest of 2011, according to Citi:
- Brazil will raise rates by 1.5%
- China will raise rates by 0.75%
- India will raise rates by 0.5%
Farmers are going to plant more as result of this past year's high prices. And weather should, theoretically, improve over the course of 2011, and the La Nina effect dims.
Business Insider Emails & Alerts
Site highlights each day to your inbox.