Hyper-inflation in the commodities markets is rivaling the US housing collapse and the global banking crisis, as the biggest threat to the world economy. Finance ministers from the United States, Canada, Japan, France, Germany, Italy, Britain, and Russia, have expressed their alarm over the doubling of agricultural, energy, and key raw material prices from a year ago, which is pushing inflation rates around the world, to their highest in three decades.
Crude oil briefly touched $140 a barrel, and the price of corn, used to make ethanol, hit $8 /bushel. Chinese steelmakers agreed to pay 96% more for Iron ore from Australian miner Rio Tinto, a five-fold increase since 2003. Steel prices have soared almost 50%, this year, as coal and iron ore prices continue to climb and global demand shows little sign of abating. Dow Chemical is raising prices on a wide range of its products by 25%, due to sharply higher energy and raw material costs.
Sharply higher shipping costs, driven by rising oil prices, have increased the cost of transporting a standard 40-foot container from Shanghai to the east coast of the US from $3,000 when oil was priced at $20 per barrel, to $8,000 today, with crude oil around $135 /barrel, according to CIBC World Markets analysts Jeff Rubin and Benjamin Tal. The Baltic Dry Index, which monitors merchant shipping costs on forty major export routes for dry commodities, is 50% higher from a year ago.
South Korea’s President Lee Myung-bak noted on June 16th, that inflation was the biggest challenge the global economy has faced in 30-years. “It’s no overstatement to say that the world is faced with the gravest crisis since the oil shock of the 1970’s, with oil, food and raw materials prices skyrocketing,” he said. A week later, Myung-bak switched his government’s top policy goal to fighting inflation, and within hours, the Bank of Korea (BoK) sold US$1 billion from its foreign currency stash to bolster the Korean won against the dollar, to help keep import costs down.
Smaller tier central banks are moving to combat inflation pressures, with tougher monetary policies. The Reserve Bank of India (RBI) raised its key lending rate by a half-point to 8.50%, it’s highest in six years, and increased the ratio of deposits banks keep with it by 50 basis points to 8.75%, to fight inflation, now raging at 11 percent. The Bombay Sensex index fell below 14,000 points for the first time in 10-months, after the RBI tightened it monetary policy. The Indian stock market has lost more than 30% in 2008, one of the worst performing Asian indices this year.
Beijing lifted retail gasoline and diesel prices by 18% last week, the first hike in eight-months and biggest ever one-off rise, which could push the overall inflation rate to 9% next month. A week earlier, the People’s Bank of China (PBoC) hiked the bank reserve ratio by a full-percent to 17.5%, soaking up 422 billion yuan, and knocked the Shanghai stock market 14% lower over the next four-days. “Surely higher energy prices will put some pressure on the CPI, so we may need a stronger policy against inflation,” warned PBoC chief Zhou Xiaochuan on June 20th.
Brazil’s central bank hiked its overnight Selic rate by a half-point rate to 12.25% on June 5th, to bring inflation down from a two-year high in Latin America’s commodity powerhouse. The latest half-point rate hike pushes the real interest rate, adjusted for inflation, to 7.25%, the highest among the world’s 52-leading economies. On June 19th, Brazil’s central bank chief Henrique Meirelles signaled a third rate hike, to bring inflation down from a two-year high in Latin America’s largest economy.
Futures contracts in Sao Paulo project a 1% Selic rate hike to 13.25% by year’s end. “It’s necessary to slow domestic demand in order to balance the whole equation and to avoid the pass-through of the wholesale price increases as a result of the raw materials component to retail prices,” Meirelles warned. Inflation in Brazil climbed from an eight-year low of 3% in March 2007 to 5.9% in the 12 months to mid-June, and above the bank’s 4.5% upper target for a sixth month.
Brazil’s central bank expects the inflation rate will accelerate further to 6.3% in the third quarter of 2008. The Brazilian real strengthened to 1.591 to the US$, a nine-year high, and is +9% higher this year, the biggest advance among the 16 most-traded currencies against the dollar. The central bank is utilizing a stronger currency to hold down import price inflation, and appears to be adjusting its overnight loan rate in reaction to trends in global commodity markets.
South Africa’s central bank hiked its overnight repo rate by 50-basis point to 12%, to counter surging inflation, extending a tightening cycle that has lifted the lending rate 500-basis points higher since June 2006, to a 5-year high. South Africa’s CPIX inflation hit 10.4% year-on-year in April, and producer prices are 12% higher. Eskom, the electric utility, is raising electricity rates by 27% due to a doubling of coal prices from a year ago. RBSA chief Tito Mboweni is warning the markets of higher interest rates ahead, and “Yes, it will be painful,” he said on June 23rd.
ECB and Fed in Game of high Stakes Poker
Central bankers of fast-growing emerging economies are navigating through the stormy seas of commodity inflation by tightening monetary policies. But the “Group of Seven” central bankers have acted in a different fashion. The British, Canadian, and US central banks are focused on the global banking crisis, and the slide in US home prices, and have lowered their interest rates, while the Bank of Japan has stood motionless. But the European Central Bank was moving in the opposite direction, and guided Euro-zone money market rates to their highest in 7-years.
And when powerful central bankers clash, - moving in opposite directions, - nasty accidents can happen in the global stock markets. Tighter monetary policies in the emerging economies is an interesting side-show, but what is really rattling the global stock markets these days, is the looming battle of wits between the two most powerful central banks, the Fed and the ECB, which hold diametrically different views over how to cope with the twin-evils of the “Stagflation” trap.
“The world has been staging a run on the greenback, with damaging results if it continues,” warned former Fed chief Paul Volcker on April 9th. “Concerns about recession are rife, and the Fed will be tempted to subordinate the fundamental need to maintain a reliable currency, to the impulse to shore up a flagging economy. The danger is that you lose both battles, as in the 1970’s, and wind up with “Stagflation,” - the twin-evil of a stagnating economy plagued by high and rising inflation.
Since the sub-prime mortgage debt crisis erupted into full bloom last summer, the Fed has chosen to counter the “Stag” part of the equation, by slashing the fed funds rate 325-basis points to 2%, and far below the inflation rate.
