For those who are in the QE-creates-inflation camp, this chart from Morgan Stanley’s Spyros Andreopoulos is useful.
It shows that via the US, China, and the other countries that peg their currencies to the dollar, Bernanke directly and indirectly controls 40% of the world’s economy on a purchasing power parity basis.
Photo: Morgan Stanley
Meanwhile, MS sees a prisoner’s dilemma:
How to break out of the loop. Preventing the global inflation loop from spiralling upwards requires a circuit breaker. This would mean normalisation of global monetary conditions through either hikes in DM or EM regaining some of their monetary independence through allowing substantial currency appreciation against the dollar. (Note that the latter would mean a one-off increase in DM inflation; the loop, however, would be broken.) Neither of these seems on the cards. On our forecasts, the Fed (and the ECB) won’t tighten until 1Q2012. And EM currency appreciation sufficient to choke off the global inflation loop seems difficult – many EM economies will want to wean themselves off their export-led development strategy only gradually.
Are global monetary conditions becoming a prisoner’s dilemma? We are therefore concerned that global monetary conditions might end up becoming a hostage to a prisoner’s dilemma-style game between DM and EM policymakers. In a prisoner’s dilemma (PD) game, two parties acting in isolation in the pursuit of their own self-interest will achieve an outcome that is undesirable for both. In this case, neither side chooses to tighten. That means tightening is delayed, and the inflation genie will be out of the bottle.