Developing countries: Is secure to invest in them?
Usually we find that a developing country is a temptation to make investments, they need to grow (unemployment is not controlled, poverty exists, distribution of income is not equal, etc.). So, in a word, they try to attract capital into their countries; sometimes offering more opportunities that the ones really exist.
In some of these countries even the interest rate they offer is very high in comparison with the market one (we can talk about 2 times above regular rates).
The try to attract capital through public bonds that sounds very nice at the first look at them, but was it’s not taken into consideration is that those public debts will be paid in five, ten or even more years and that by that time these governors won’t be there any more! So, is the future government prepare – or willing – to pay investors back? Are we sure that that money that is obtained in this way is going to be used in a correct way (lets say investment in public areas that help the society, like education, health care, transport, roads, etc.), or used for “private benefits”
Are there laws that protect investments or the government is free to manage the banking system using the figure of “emergency laws” and can appropriate those funds (or part of them) to cover the emergency?
Can they issue more public bonds to pay the interests from the previous ones?
Are they just exporting primary sector products or there are industries that convert these resources into products (value added idea)?
These are some of the things that I think have to be taken into consideration in order to see if the investment is going to be a real thing or if it’ll turn into a loosing point.
Prof. Lic. Fernando Julio Silva, MSc.
September 2006
Sunday, October 01, 2006
Inflation is a lot lower in Japan than first thought
Inflation is a lot lower in Japan than first thought
Japan's economy
Adjusting the rear-view mirror
Aug 31st 2006From The Economist print edition
ONE of the most glaring mistakes in the recent history of central banking stemmed from a sound response to unsound numbers. The Federal Reserve let inflation get out of hand in the 1970s, because it thought there was more slack in the economy than there turned out to be. A big revision of Japan's inflation figures last week suggests its central bankers may be making the opposite mistake.
The Bank of Japan (BoJ), along with everyone else, had been under the impression that the country escaped deflation late last year, and that consumer prices, excluding fresh food, were now rising at the heady annual rate of 0.6%. Having raised interest rates from the floor in July, the BoJ was expected to do so again this year.
Not any more. Last week, the islands' number-crunchers carried out their five-yearly overhaul of the inflation figures. The new numbers use a more recent “base year” (2005, not 2000), and track the cost of a more up-do-date basket of 584 goods. Hijiki, an edible brown seaweed, is in; “standard” rice is out; doughnuts are included, norimaki sushi tossed aside; fees for dancing school will be counted, those for dressmaking school will not.
This reshuffling of the statistician's shopping basket has rewritten recent history (see chart). Japan, it now seems, did not escape deflation definitively until July, when the core annual inflation rate reached 0.2% for only the second month in a row. As Richard Jerram, of Macquarie Research in Tokyo, puts it “price pressures today are where the BoJ thought they were six months ago.” With hindsight, July's rate hike looks premature and there may not be another one this year. The currency markets, at least, do not seem to expect one: this week traders demanded more than 150 yen for a euro, the worst rate since the single currency was created.
Still, Mr Jerram finds a silver lining in this statistical cloud of confusion. The disturbing lack of inflationary pressure suggests that the economy is more productive than its doubters suggest. And the economy seems to be coping surprisingly well with real interest rates that are, thanks to lower inflation, 0.5 percentage points higher than the BoJ intended. Such optimism drew strength from unemployment's fall to 4.1% in July, resuming a downward drift. There are now 1.09 jobs for every applicant at Japan's government-run employment agencies, the highest ratio since 1992.
America's statisticians have also been unsettling its central bankers. According to revised figures released this week, the economy grew a little more quickly in the second quarter than first thought, expanding at an annual pace of 2.9%, not 2.5%.
A day earlier the Federal Reserve released the minutes of its most recent rate-setting meeting, held on August 8th. At that meeting, the central bankers decided to sit on their hands, leaving interest rates at 5.25%. But not, the minutes reveal, before wringing those hands thoroughly over some more statistical revisionism.
The Fed's committee members are confident the economy will continue to grow in line with its sustainable long-run rate, more or less (probably less). But after the statisticians' yearly overhaul of the country's accounts in July, they are no longer sure what that sustainable rate is. The new figures suggest that America's workers are less productive and better compensated, than first thought. As a result, unit labour costs are higher and the economy will have to lose more steam than the Fed had hoped before price pressures subside.
These second takes on old numbers have left central bankers in Washington and Tokyo in an awkward limbo. What to do? Wait for fresh numbers of course! The Fed's pause will give it a chance to “accumulate more information”, the minutes said. The BoJ, on the other hand, seems to be waiting for October's Tankan survey of businesses before deciding what steps to take next. When the facts change, central bankers do not necessarily change their minds. They just wait for the facts to change again.
http://www.economist.com/finance/displaystory.cfm?story_id=7855585
Japan's economy
Adjusting the rear-view mirror
Aug 31st 2006From The Economist print edition
ONE of the most glaring mistakes in the recent history of central banking stemmed from a sound response to unsound numbers. The Federal Reserve let inflation get out of hand in the 1970s, because it thought there was more slack in the economy than there turned out to be. A big revision of Japan's inflation figures last week suggests its central bankers may be making the opposite mistake.
The Bank of Japan (BoJ), along with everyone else, had been under the impression that the country escaped deflation late last year, and that consumer prices, excluding fresh food, were now rising at the heady annual rate of 0.6%. Having raised interest rates from the floor in July, the BoJ was expected to do so again this year.
Not any more. Last week, the islands' number-crunchers carried out their five-yearly overhaul of the inflation figures. The new numbers use a more recent “base year” (2005, not 2000), and track the cost of a more up-do-date basket of 584 goods. Hijiki, an edible brown seaweed, is in; “standard” rice is out; doughnuts are included, norimaki sushi tossed aside; fees for dancing school will be counted, those for dressmaking school will not.
This reshuffling of the statistician's shopping basket has rewritten recent history (see chart). Japan, it now seems, did not escape deflation definitively until July, when the core annual inflation rate reached 0.2% for only the second month in a row. As Richard Jerram, of Macquarie Research in Tokyo, puts it “price pressures today are where the BoJ thought they were six months ago.” With hindsight, July's rate hike looks premature and there may not be another one this year. The currency markets, at least, do not seem to expect one: this week traders demanded more than 150 yen for a euro, the worst rate since the single currency was created.
Still, Mr Jerram finds a silver lining in this statistical cloud of confusion. The disturbing lack of inflationary pressure suggests that the economy is more productive than its doubters suggest. And the economy seems to be coping surprisingly well with real interest rates that are, thanks to lower inflation, 0.5 percentage points higher than the BoJ intended. Such optimism drew strength from unemployment's fall to 4.1% in July, resuming a downward drift. There are now 1.09 jobs for every applicant at Japan's government-run employment agencies, the highest ratio since 1992.
America's statisticians have also been unsettling its central bankers. According to revised figures released this week, the economy grew a little more quickly in the second quarter than first thought, expanding at an annual pace of 2.9%, not 2.5%.
A day earlier the Federal Reserve released the minutes of its most recent rate-setting meeting, held on August 8th. At that meeting, the central bankers decided to sit on their hands, leaving interest rates at 5.25%. But not, the minutes reveal, before wringing those hands thoroughly over some more statistical revisionism.
The Fed's committee members are confident the economy will continue to grow in line with its sustainable long-run rate, more or less (probably less). But after the statisticians' yearly overhaul of the country's accounts in July, they are no longer sure what that sustainable rate is. The new figures suggest that America's workers are less productive and better compensated, than first thought. As a result, unit labour costs are higher and the economy will have to lose more steam than the Fed had hoped before price pressures subside.
These second takes on old numbers have left central bankers in Washington and Tokyo in an awkward limbo. What to do? Wait for fresh numbers of course! The Fed's pause will give it a chance to “accumulate more information”, the minutes said. The BoJ, on the other hand, seems to be waiting for October's Tankan survey of businesses before deciding what steps to take next. When the facts change, central bankers do not necessarily change their minds. They just wait for the facts to change again.
http://www.economist.com/finance/displaystory.cfm?story_id=7855585
China lets currency rise at a rapid pace
China lets currency rise at a rapid pace
By Keith Bradsher The New York Times
Published: September 28, 2006 – International Herald Tribune
HONG KONG China's government allowed the country's currency to rise through 7.9 to the dollar for the first time on Thursday, the latest in a series of daily highs as its pace of appreciation has mysteriously accelerated.
The currency, known as the yuan or renminbi, has now been rising most days for the past month, climbing 0.8 percent since the start of the month, which works out to an annualized pace of 10 percent. That compares with an annual pace of 2 percent to 2.5 percent during most of the months after China's 2.1 percent revaluation on July 21, 2005.
"The reality is they're moving at a faster pace," said Jonathan Anderson, the chief Asia economist at UBS.
Top Chinese officials, almost always reticent about the value of the country's currency, have been especially quiet over the past two weeks.
Even before the World Bank and International Monetary Fund annual meetings in Singapore at the start of last week, Chinese officials had contented themselves with repeating their longstanding promises to let the market start playing a greater role in the currency's value, without giving any indication of a timetable.
Beijing's leaders have long bridled at foreign criticism, prompting some China watchers to suggest that quiet diplomacy may be more productive in bringing about an appreciation of the yuan than confrontation. Treasury Secretary Henry Paulson Jr., with decades of experience in dealing with China while at Goldman Sachs, has pursued a much more low-key approach to the currency issue this summer than his predecessors or U.S. lawmakers, preferring to raise the issue in private with Chinese leaders.
That has prompted some experts to speculate that the change of tactics may have influenced the Chinese decision to allow faster appreciation now, possibly as a way to reward such behavior on the part of the United States.
"The Chinese are doing this as a gesture of good will," said Tao Dong, chief Asia economist at Credit Suisse.
But the yuan's acceleration also comes at a time when the Chinese economy seems to have settled down to sustained but controlled growth, which may make Chinese officials more prepared to experiment a little more with the value of the yuan.
After signs emerged last spring of possible overheating in investment, China's central bank raised interest rates and tightened bank reserve requirements while other regulators cracked down on provincial officials who proceeded with projects without receiving the central government's permission first. The result has been a slight tempering of growth, from industrial production, to retail sales to the money supply.
The exception among Chinese economic statistics these days is the trade surplus, which is soaring and has set records for four months in a row through August.
"The one big problem sticking out in China like a thumb, like a five-ton thumb, is the trade surplus," said Anderson, the UBS economist.
A stronger yuan makes Chinese exports more expensive in foreign markets, while making imported goods more competitive in China, two effects that could tend to shrink the trade surplus in the long run.
The People's Bank of China, the country's central bank, said when it revalued the currency in July 2005 that it would start setting the value of the yuan based on a basket of foreign currencies, and would no longer peg it just to the dollar. But in practice, the central bank has allowed the yuan to appreciate at a fairly steady but very gradual pace against the dollar; statistical analyses of changes in the yuan's value have shown almost no correlation to currencies other than the dollar.
Through capital controls and other measures, the People's Bank of China has made sure that spot trading of the yuan is conducted only in Shanghai, where the central bank is heavily involved in trading and sets the benchmark exchange rate between the yuan and the dollar each morning.
To prevent the currency from appreciating more rapidly, the central bank has bought dollars and sold yuan on a massive scale, accumulating the world's largest foreign exchange reserves, which are on track to reach $1 trillion in the coming weeks.
The yuan rose 0.07 percent in Shanghai trading on Thursday to trade at 7.8965 at 5:30 p.m., and has climbed at an annual rate of 17 percent in the last two weeks.
The yuan's latest rise above 7.9 to the dollar could create problems for the Hong Kong dollar, which is pegged in a narrow band of 7.75 to 7.85 to the dollar. The Hong Kong Monetary Authority has said repeatedly that it has no plans to abandon this trading range and start pegging the currency to the yuan.
But speculation that the Hong Kong Monetary Authority may shift the Hong Kong dollar to a yuan peg when the two currencies reach parity have periodically shaken currency markets. As the yuan approaches the same value as the Hong Kong dollar, " that might invite a lot of speculation for the Hong Kong dollar peg," said Liang Hong, a China economist at Goldman Sachs.
http://www.iht.com/articles/2006/09/28/business/yuan.php
By Keith Bradsher The New York Times
Published: September 28, 2006 – International Herald Tribune
HONG KONG China's government allowed the country's currency to rise through 7.9 to the dollar for the first time on Thursday, the latest in a series of daily highs as its pace of appreciation has mysteriously accelerated.
The currency, known as the yuan or renminbi, has now been rising most days for the past month, climbing 0.8 percent since the start of the month, which works out to an annualized pace of 10 percent. That compares with an annual pace of 2 percent to 2.5 percent during most of the months after China's 2.1 percent revaluation on July 21, 2005.
"The reality is they're moving at a faster pace," said Jonathan Anderson, the chief Asia economist at UBS.
Top Chinese officials, almost always reticent about the value of the country's currency, have been especially quiet over the past two weeks.
Even before the World Bank and International Monetary Fund annual meetings in Singapore at the start of last week, Chinese officials had contented themselves with repeating their longstanding promises to let the market start playing a greater role in the currency's value, without giving any indication of a timetable.
Beijing's leaders have long bridled at foreign criticism, prompting some China watchers to suggest that quiet diplomacy may be more productive in bringing about an appreciation of the yuan than confrontation. Treasury Secretary Henry Paulson Jr., with decades of experience in dealing with China while at Goldman Sachs, has pursued a much more low-key approach to the currency issue this summer than his predecessors or U.S. lawmakers, preferring to raise the issue in private with Chinese leaders.
That has prompted some experts to speculate that the change of tactics may have influenced the Chinese decision to allow faster appreciation now, possibly as a way to reward such behavior on the part of the United States.
"The Chinese are doing this as a gesture of good will," said Tao Dong, chief Asia economist at Credit Suisse.
But the yuan's acceleration also comes at a time when the Chinese economy seems to have settled down to sustained but controlled growth, which may make Chinese officials more prepared to experiment a little more with the value of the yuan.
After signs emerged last spring of possible overheating in investment, China's central bank raised interest rates and tightened bank reserve requirements while other regulators cracked down on provincial officials who proceeded with projects without receiving the central government's permission first. The result has been a slight tempering of growth, from industrial production, to retail sales to the money supply.
The exception among Chinese economic statistics these days is the trade surplus, which is soaring and has set records for four months in a row through August.
"The one big problem sticking out in China like a thumb, like a five-ton thumb, is the trade surplus," said Anderson, the UBS economist.
A stronger yuan makes Chinese exports more expensive in foreign markets, while making imported goods more competitive in China, two effects that could tend to shrink the trade surplus in the long run.
The People's Bank of China, the country's central bank, said when it revalued the currency in July 2005 that it would start setting the value of the yuan based on a basket of foreign currencies, and would no longer peg it just to the dollar. But in practice, the central bank has allowed the yuan to appreciate at a fairly steady but very gradual pace against the dollar; statistical analyses of changes in the yuan's value have shown almost no correlation to currencies other than the dollar.
Through capital controls and other measures, the People's Bank of China has made sure that spot trading of the yuan is conducted only in Shanghai, where the central bank is heavily involved in trading and sets the benchmark exchange rate between the yuan and the dollar each morning.
To prevent the currency from appreciating more rapidly, the central bank has bought dollars and sold yuan on a massive scale, accumulating the world's largest foreign exchange reserves, which are on track to reach $1 trillion in the coming weeks.
The yuan rose 0.07 percent in Shanghai trading on Thursday to trade at 7.8965 at 5:30 p.m., and has climbed at an annual rate of 17 percent in the last two weeks.
The yuan's latest rise above 7.9 to the dollar could create problems for the Hong Kong dollar, which is pegged in a narrow band of 7.75 to 7.85 to the dollar. The Hong Kong Monetary Authority has said repeatedly that it has no plans to abandon this trading range and start pegging the currency to the yuan.
But speculation that the Hong Kong Monetary Authority may shift the Hong Kong dollar to a yuan peg when the two currencies reach parity have periodically shaken currency markets. As the yuan approaches the same value as the Hong Kong dollar, " that might invite a lot of speculation for the Hong Kong dollar peg," said Liang Hong, a China economist at Goldman Sachs.
http://www.iht.com/articles/2006/09/28/business/yuan.php
Dear Fernando,
I'm not too sure if this is going to be of any help, or even related toyour idea of contributing to the Blog, but I will talk about it anyway.I find this method quite helpful while doing revision with my studentsespecially when exams are just a few weeks away.What I do is that I photostat a few very good scripts on a particularquestion (a past year A-Level exam question) of my students (formerstudents or students from other classes). I then hand over a script toeach group comprising of 3-4 at most, and then get them to mark thescript as per suggested answers, with their respective mark allocation,handed to them as a guide. The scripts are then inter-changed with theother groups, until all the scripts have been read by all the groups.Marks are then compared/ commented upon.By so doing, the weaker students get some ideas to go about answering thatquestion. At the same time, while reading different essays on the sametopic, it helps the students to remember and understand a topic better.
Regards,
Sunthary
I'm not too sure if this is going to be of any help, or even related toyour idea of contributing to the Blog, but I will talk about it anyway.I find this method quite helpful while doing revision with my studentsespecially when exams are just a few weeks away.What I do is that I photostat a few very good scripts on a particularquestion (a past year A-Level exam question) of my students (formerstudents or students from other classes). I then hand over a script toeach group comprising of 3-4 at most, and then get them to mark thescript as per suggested answers, with their respective mark allocation,handed to them as a guide. The scripts are then inter-changed with theother groups, until all the scripts have been read by all the groups.Marks are then compared/ commented upon.By so doing, the weaker students get some ideas to go about answering thatquestion. At the same time, while reading different essays on the sametopic, it helps the students to remember and understand a topic better.
Regards,
Sunthary
Thursday, September 21, 2006
Oil that glisters
Oil that glisters
Commodities
Jul 20th 2006From The Economist print edition
How high can they go? Speculators love commodities right now. But what do the fundamentals say?
WHEN commodity prices slipped from their giddy highs in May, many observers hailed the beginning of an inevitable correction after four years of rapid ascent. But the markets, it turns out, were simply pausing for breath. On July 14th the price of a barrel of West Texas Intermediate oil reached a new record in nominal terms of $78.40, although it has since fallen a little. Nickel followed, topping $26,000 a tonne for the first time. Even some agricultural commodities are starting to get caught up in the boom. Rapeseed oil, for example, is fetching unprecedented sums. The price of food crops has risen by 40% since the beginning of 2002, although that increase is dwarfed by huge run-ups in the prices of oil and metals, as the left-hand chart, below, shows.
Some analysts believe that investors have inflated a speculative bubble in commodities. Hedge funds' investments in energy markets rose from $3 billion in 2000 to about $90 billion last year, according to the International Energy Agency, a think-tank. Trading of commodities at exchanges doubled between 2001 and 2005, according to International Financial Services London, an industry group. Over-the-counter trade has risen faster still.
Other pundits think piling into commodities is justified, because the world has embarked on a “super-cycle”, in which commodity prices rise far higher and for much longer than is normal in a business blighted by frequent busts. The boom is certainly exceptionally long and lucrative. A recent report by Société Générale, a French bank, analysed five others since 1975. They lasted 28 months, on average, during which prices rose 35%. The present run, by contrast, has lasted 56 months, during which prices have doubled.
The super-cyclists put all this down to a simple mismatch between supply and demand. During the 1980s and 1990s, when commodity prices were low, mining and oil firms invested too little in new mines and wells, leaving them with little or no spare capacity. Although they are now rushing to increase their output, it takes years to find and develop new seams and fields. In fact, it takes longer now than it used to, because environmental regulations have become more onerous and activists more obstreperous around the world. With everyone trying to dig and drill at the same time, costs are rising and shortages of such things as huge tyres for mining trucks are hampering progress.
Meanwhile, on the demand side, the world as a whole, and China in particular, has been growing much faster than expected and consuming lots of raw materials as it does so. In the past 15 years China's imports of commodities have risen more than tenfold (see right-hand chart, above). One recent forecast, by Deutsche Bank, says that they will continue to grow by more than 10% a year for the next decade. At any rate, China's economy shows little sign of slowing. GDP grew at an annual rate of 11% in the first half of the year, according to official figures published on July 18th—the fastest pace in over a decade. This combination of feeble production and feverish consumption, the argument runs, means that demand for commodities will outpace supply for years to come.
But it is hard to apply this logic to all commodities. The supply of agricultural ones, for example, increases much more readily when prices rise, because farmers can plant more of them. Take maize (corn, to Americans) which is used both to make ethanol and to feed livestock. China's exports of maize are shrinking, as its herds multiply to cater to its citizens' growing appetite for meat. At the same time, the high price of oil is fuelling demand for ethanol, which is used as both a substitute for and an additive to petrol. Ethanol is expected to consume about a fifth of America's maize harvest next year. Both trends have helped to propel the crop's price to dizzy heights, with the prices of other commodities from which fuel can be made, such as sugar and rapeseed oil. But not for long: American and Chinese farmers are already planting more maize.
Gold is another exception. It is dearer than it has been for decades, yet jewellers and industrialists would need years to use up all the world's stocks. Gold is valued not for its scarcity, but as a hedge against inflation. Its price has duly risen, as worries about inflation have grown (thanks partly to the expense of oil) and central banks have raised interest rates. Higher interest rates, however, should eventually slow global growth, and so crimp demand for other commodities. The prices of gold and more mundane metals may therefore start to move in opposite directions.
Not even oil, the archetypal industrial commodity, quite conforms to the super-cycle theory. Granted, consumption continues to rise, especially in China, where imports have grown by about 10% so far this year. Furthermore, the industry can muster only about 1.5m barrels a day of spare pumping capacity—a tiny fraction of the 84m-odd barrels the world consumes daily. That makes the price sensitive even to relatively minor interruptions in supply. Iran, which exports 3.4m barrels a day, has threatened to use oil as a weapon in its disputes with America and the European Union. So oil traders twitch every time the two sides exchange barbs.
Nonetheless, during the past year spare capacity has actually increased marginally, as have stocks. This cushion should expand further over the next couple of years, as production starts from oilfields now being developed. Meanwhile, there are signs that demand, although not falling, is growing more slowly in the face of high prices. Supply and demand will certainly remain finely balanced for several more years, but the outlook is improving for consumers—even if this is not yet detectable in the price of oil.
It is hard, concedes Frédéric Lasserre, the author of Société Générale's report, to translate nebulous fears about future supply into prices. In the long run, the price of any given commodity should revert to the cost of producing an incremental unit of supply. By that measure, Mr Lasserre calculates, oil is overvalued by 50%, and zinc and copper by almost 40%. In the short term, the level of stocks plays an important part. But again, relative to the historical relationship between stocks and prices, Mr Lasserre reckons copper is 148% too dear; zinc, 122%; nickel, 70%; and oil, 49%.
Other analysts see parallels with the dotcom bubble of the late 1990s. After all, plenty of people are opining that “things are different this time”. Pension funds and individual investors are keen to get in on the action. CalPERS, America's biggest pension fund, is due to decide soon whether to put money into commodities. If such a conservative operator is eyeing commodities, cynics say, then a correction must be close at hand.
http://www.economist.com/finance/displaystory.cfm?story_id=7198908
Commodities
Jul 20th 2006From The Economist print edition
How high can they go? Speculators love commodities right now. But what do the fundamentals say?
WHEN commodity prices slipped from their giddy highs in May, many observers hailed the beginning of an inevitable correction after four years of rapid ascent. But the markets, it turns out, were simply pausing for breath. On July 14th the price of a barrel of West Texas Intermediate oil reached a new record in nominal terms of $78.40, although it has since fallen a little. Nickel followed, topping $26,000 a tonne for the first time. Even some agricultural commodities are starting to get caught up in the boom. Rapeseed oil, for example, is fetching unprecedented sums. The price of food crops has risen by 40% since the beginning of 2002, although that increase is dwarfed by huge run-ups in the prices of oil and metals, as the left-hand chart, below, shows.
Some analysts believe that investors have inflated a speculative bubble in commodities. Hedge funds' investments in energy markets rose from $3 billion in 2000 to about $90 billion last year, according to the International Energy Agency, a think-tank. Trading of commodities at exchanges doubled between 2001 and 2005, according to International Financial Services London, an industry group. Over-the-counter trade has risen faster still.
Other pundits think piling into commodities is justified, because the world has embarked on a “super-cycle”, in which commodity prices rise far higher and for much longer than is normal in a business blighted by frequent busts. The boom is certainly exceptionally long and lucrative. A recent report by Société Générale, a French bank, analysed five others since 1975. They lasted 28 months, on average, during which prices rose 35%. The present run, by contrast, has lasted 56 months, during which prices have doubled.
The super-cyclists put all this down to a simple mismatch between supply and demand. During the 1980s and 1990s, when commodity prices were low, mining and oil firms invested too little in new mines and wells, leaving them with little or no spare capacity. Although they are now rushing to increase their output, it takes years to find and develop new seams and fields. In fact, it takes longer now than it used to, because environmental regulations have become more onerous and activists more obstreperous around the world. With everyone trying to dig and drill at the same time, costs are rising and shortages of such things as huge tyres for mining trucks are hampering progress.
Meanwhile, on the demand side, the world as a whole, and China in particular, has been growing much faster than expected and consuming lots of raw materials as it does so. In the past 15 years China's imports of commodities have risen more than tenfold (see right-hand chart, above). One recent forecast, by Deutsche Bank, says that they will continue to grow by more than 10% a year for the next decade. At any rate, China's economy shows little sign of slowing. GDP grew at an annual rate of 11% in the first half of the year, according to official figures published on July 18th—the fastest pace in over a decade. This combination of feeble production and feverish consumption, the argument runs, means that demand for commodities will outpace supply for years to come.
But it is hard to apply this logic to all commodities. The supply of agricultural ones, for example, increases much more readily when prices rise, because farmers can plant more of them. Take maize (corn, to Americans) which is used both to make ethanol and to feed livestock. China's exports of maize are shrinking, as its herds multiply to cater to its citizens' growing appetite for meat. At the same time, the high price of oil is fuelling demand for ethanol, which is used as both a substitute for and an additive to petrol. Ethanol is expected to consume about a fifth of America's maize harvest next year. Both trends have helped to propel the crop's price to dizzy heights, with the prices of other commodities from which fuel can be made, such as sugar and rapeseed oil. But not for long: American and Chinese farmers are already planting more maize.
Gold is another exception. It is dearer than it has been for decades, yet jewellers and industrialists would need years to use up all the world's stocks. Gold is valued not for its scarcity, but as a hedge against inflation. Its price has duly risen, as worries about inflation have grown (thanks partly to the expense of oil) and central banks have raised interest rates. Higher interest rates, however, should eventually slow global growth, and so crimp demand for other commodities. The prices of gold and more mundane metals may therefore start to move in opposite directions.
Not even oil, the archetypal industrial commodity, quite conforms to the super-cycle theory. Granted, consumption continues to rise, especially in China, where imports have grown by about 10% so far this year. Furthermore, the industry can muster only about 1.5m barrels a day of spare pumping capacity—a tiny fraction of the 84m-odd barrels the world consumes daily. That makes the price sensitive even to relatively minor interruptions in supply. Iran, which exports 3.4m barrels a day, has threatened to use oil as a weapon in its disputes with America and the European Union. So oil traders twitch every time the two sides exchange barbs.
Nonetheless, during the past year spare capacity has actually increased marginally, as have stocks. This cushion should expand further over the next couple of years, as production starts from oilfields now being developed. Meanwhile, there are signs that demand, although not falling, is growing more slowly in the face of high prices. Supply and demand will certainly remain finely balanced for several more years, but the outlook is improving for consumers—even if this is not yet detectable in the price of oil.
It is hard, concedes Frédéric Lasserre, the author of Société Générale's report, to translate nebulous fears about future supply into prices. In the long run, the price of any given commodity should revert to the cost of producing an incremental unit of supply. By that measure, Mr Lasserre calculates, oil is overvalued by 50%, and zinc and copper by almost 40%. In the short term, the level of stocks plays an important part. But again, relative to the historical relationship between stocks and prices, Mr Lasserre reckons copper is 148% too dear; zinc, 122%; nickel, 70%; and oil, 49%.
Other analysts see parallels with the dotcom bubble of the late 1990s. After all, plenty of people are opining that “things are different this time”. Pension funds and individual investors are keen to get in on the action. CalPERS, America's biggest pension fund, is due to decide soon whether to put money into commodities. If such a conservative operator is eyeing commodities, cynics say, then a correction must be close at hand.
http://www.economist.com/finance/displaystory.cfm?story_id=7198908
Interest rates Inflation scare
Interest rates Inflation scare
Aug 10th 2006From The Economist print edition
Why rates will rise again
THE Bank of England surprised financial markets on August 3rd when it raised the base rate from 4.5% to 4.75%. Its next step should prove less unsettling to the City. This week the bank indicated that a further increase is in the offing.
The bank signalled the rise in its quarterly Inflation Report, published on August 9th. This set out, as usual, both a central projection for inflation and the risks around it (see chart). The bank's main view is that if the base rate were to stay at 4.75%, the annual rate of consumer-price inflation would exceed 2.0%—the government's target—over the next two years. Since it takes that time for changes in monetary policy to have their maximum effect on inflation, the projection suggests the need for another rate rise.
The bank has become gloomier about inflation, especially over the next few months. According to the latest figures, consumer prices rose by 2.5% in the year to June, the fastest rate of increase (along with last September's) since the series began in 1997. The bank now thinks that further rises in household energy bills and still higher oil prices will push inflation up more over the next few months. And, towards the end of 2006, it expects higher university fees to add a quarter of a percentage point to inflation, something that was not included in previous forecasts.
As a result, there is now a big risk that inflation could rise above 3.0% around the turn of the year. If that were to happen, Mervyn King, the bank's governor, would have to write an explanatory letter to Gordon Brown. The chancellor of the exchequer requires this if inflation diverges from the 2.0% target in either direction by more than a percentage point. Since the bank was given independence to set interest rates in May 1997, this has never been necessary. But Mr King now thinks there is a 50% chance that he will have to write such a letter in the next six months.
A bigger worry still for Mr King is that the longer-term prospects for inflation have deteriorated. There are two main reasons for this. First, the bank now thinks there is less spare capacity than it did before. This follows the revisions to the national accounts made by official statisticians on June 30th, which raised the level of GDP at the start of the year by 0.7%. The bank accepts that there is a bit more slack in the labour market, which will temper pay pressures. However, it worries about surveys showing that companies face tighter capacity constraints.
Second, the bank does not draw much comfort from a likely moderation in energy-cost inflation. It fears that this will be accompanied by a recovery in profit margins and pay growth. A survey of companies by the bank's regional agents showed that profit margins had been squeezed in the 12 months to May and that this was contributing to a clampdown on wages. The bank's concern is that an easing in energy costs may cause a revival in pay pressures. It has unearthed evidence that over the past 15 or so years domestically-generated inflation has tended to move in the opposite direction to changes in import and energy prices.
The bank's hawkish line means that interest rates seem sure to rise by another quarter-point to 5%, probably in November. Whether they will rise beyond that is uncertain. Much will depend upon how strongly the economy continues to recover from its slowdown in 2005. The bank may be gloomy about inflation but it is upbeat in its forecast for GDP growth, expected to be close to its average rate in the past decade. That prediction relies, however, on optimistic assumptions about a pick-up in consumer spending, which grew in 2005 by only 1.3%, the slowest since 1992.
This week's stern report sends a clear message designed to reinforce the rate increase on August 3rd. Inflation may be rising but Mr King and his fellow rate-setters are determined to keep it under control.
http://www.economist.com/research/backgrounders/displaystory.cfm?story_id=7279210
Aug 10th 2006From The Economist print edition
Why rates will rise again
THE Bank of England surprised financial markets on August 3rd when it raised the base rate from 4.5% to 4.75%. Its next step should prove less unsettling to the City. This week the bank indicated that a further increase is in the offing.
The bank signalled the rise in its quarterly Inflation Report, published on August 9th. This set out, as usual, both a central projection for inflation and the risks around it (see chart). The bank's main view is that if the base rate were to stay at 4.75%, the annual rate of consumer-price inflation would exceed 2.0%—the government's target—over the next two years. Since it takes that time for changes in monetary policy to have their maximum effect on inflation, the projection suggests the need for another rate rise.
The bank has become gloomier about inflation, especially over the next few months. According to the latest figures, consumer prices rose by 2.5% in the year to June, the fastest rate of increase (along with last September's) since the series began in 1997. The bank now thinks that further rises in household energy bills and still higher oil prices will push inflation up more over the next few months. And, towards the end of 2006, it expects higher university fees to add a quarter of a percentage point to inflation, something that was not included in previous forecasts.
As a result, there is now a big risk that inflation could rise above 3.0% around the turn of the year. If that were to happen, Mervyn King, the bank's governor, would have to write an explanatory letter to Gordon Brown. The chancellor of the exchequer requires this if inflation diverges from the 2.0% target in either direction by more than a percentage point. Since the bank was given independence to set interest rates in May 1997, this has never been necessary. But Mr King now thinks there is a 50% chance that he will have to write such a letter in the next six months.
A bigger worry still for Mr King is that the longer-term prospects for inflation have deteriorated. There are two main reasons for this. First, the bank now thinks there is less spare capacity than it did before. This follows the revisions to the national accounts made by official statisticians on June 30th, which raised the level of GDP at the start of the year by 0.7%. The bank accepts that there is a bit more slack in the labour market, which will temper pay pressures. However, it worries about surveys showing that companies face tighter capacity constraints.
Second, the bank does not draw much comfort from a likely moderation in energy-cost inflation. It fears that this will be accompanied by a recovery in profit margins and pay growth. A survey of companies by the bank's regional agents showed that profit margins had been squeezed in the 12 months to May and that this was contributing to a clampdown on wages. The bank's concern is that an easing in energy costs may cause a revival in pay pressures. It has unearthed evidence that over the past 15 or so years domestically-generated inflation has tended to move in the opposite direction to changes in import and energy prices.
The bank's hawkish line means that interest rates seem sure to rise by another quarter-point to 5%, probably in November. Whether they will rise beyond that is uncertain. Much will depend upon how strongly the economy continues to recover from its slowdown in 2005. The bank may be gloomy about inflation but it is upbeat in its forecast for GDP growth, expected to be close to its average rate in the past decade. That prediction relies, however, on optimistic assumptions about a pick-up in consumer spending, which grew in 2005 by only 1.3%, the slowest since 1992.
This week's stern report sends a clear message designed to reinforce the rate increase on August 3rd. Inflation may be rising but Mr King and his fellow rate-setters are determined to keep it under control.
http://www.economist.com/research/backgrounders/displaystory.cfm?story_id=7279210
Emerging markets and interest rates Developing countries have their own monetary headaches
Emerging markets and interest rates Developing countries have their own monetary headaches
Bernanke has it easy
Aug 3rd 2006
From The Economist print edition
SPUTTERING platinum smelters and dwindling diamond deposits do not rank highly on the list of concerns of the world's “big three” central bankers—Ben Bernanke, chairman of the Federal Reserve, Jean-Claude Trichet, president of the European Central Bank and Toshihiko Fukui, governor of the Bank of Japan. Both, however, feature in the latest inflation report of the South African Reserve Bank, which, as The Economist went to press, was expected to raise its benchmark interest rate by as much as half a percentage point, to 8%, having already raised it by the same amount in June.
The connection between tight monetary policy and troubled quarries and furnaces may seem a bit murky. But such is the lot of a central banker in an emerging economy, where troubles brew in remote places then break with unpredictable force. Platinum, palladium, gold and diamonds account for almost a quarter of South Africa's exports. But mining output struggled last year and shrank by about 6% in the first five months of this year. South Africa's lacklustre exports are one reason why its merchandise trade deficit was the worst on record in the first quarter and not much better in the second. The trade gap put downward pressure on the rand, which has, in turn, put upward pressure on prices. Hence the increase in interest rates.
South Africa's central bank is not alone in spreading its wings and sharpening its talons. The Czechs, Indians, Slovaks, Israelis, Hungarians and Turks all raised rates last month. Like their counterparts in Pretoria, central bankers in these countries face their own idiosyncratic challenges to price stability. In Israel, for example, the central bank wants to know how much slack remains in the job market. But how to calculate that, when the Israeli army might any day call up its reserves, which represent about 18% of the labour force?
These peculiarities aside, the central bankers share some common complaints. Their lives have all been complicated by Mr Fukui's recent triumph over deflation and Mr Bernanke's rearguard action against inflation. Thanks in part to their efforts, money is now harder to come by. Investors thus became less willing to throw it at emerging-market assets. As a result, currencies fell in May and June, stoking inflationary pressures.
Turkey's central bank has waged the fiercest fight. It has raised rates by as much in two months as the Fed has in two years. In December 2005, it set itself the target of reducing annual inflation steadily from 7.7% to 5% by the end of this year. By June, however, annual inflation was running at over 10%. Has Turkey been overheating? The economy grew by 6.4% in the year to the first quarter, the stockmarket boomed and the current-account deficit widened. Perhaps most telling, Harvey Nichols plans to open a luxury store in Istanbul.
But the central bank lays the blame elsewhere. In an open letter, explaining the breach of its target, it bemoans higher oil, food and gold prices. Most of all it blames the lira, which fell by 23% against the dollar between May 5th and June 23rd. Were it not for this currency mischief, the bank calculates, annual inflation would have been a pardonable 8.6% in June.
The central banks of both Turkey and South Africa have promised not to allow faster inflation to persist. But so far, it seems, only South Africa's commitment is much believed. Despite the fall in the rand, South Africans expect their central bank to keep inflation within its target range of 3-6% this year and next—after all, it has done so successfully since September 2003. The weaker lira has, however, “disrupted inflation expectations” in Turkey, the central bank admitted in the minutes of its July meeting, released this week. According to its latest survey, Turks now think inflation will exceed 8% in a year, and be over 6% two years hence.
Forint or against it
As investors become pickier, keen to distinguish one emerging market from another, they may begin to see Hungary in the same light as Turkey and South Africa. It too runs a big current-account deficit, which the IMF thinks will exceed 9% of GDP this year. Indeed, on fiscal matters, the comparison is rather to Hungary's disadvantage. Turkey may labour under heavy public debts, but it is at least running a heroic budget surplus, before interest payments, estimated at 6.4% of GDP. South Africa now runs a modest fiscal deficit, but its stock of debt is quite manageable. Hungary, on the other hand, has both high debts (almost 60% of GDP in 2005) and a wide budget deficit. Nouriel Roubini, of Roubini Global Economics, calls it an “accident waiting to happen”.
Curious then, that the Hungarian forint has so far escaped the traumas visited on the rand and the lira, falling by 10.7% from peak to trough this year. Inflation remains at just 2.8% but Hungary's central bank is not taking any chances: it raised interest rates by half a percentage point on July 24th, after a quarter-point increase in June.
Mr Roubini offers three possible explanations. Perhaps the markets are complacent—but surely the turmoil of May and June woke them up? Maybe Hungary is shielded by its prospective membership of the euro—but a tie to the D-mark did not save the Italian lira or the pound sterling in the early 1990s. Or the markets may be giving the benefit of the doubt to a new government, which has unveiled plans to put public finances in order.
If so, the government impressed the markets more than the IMF, which publicly cast doubt on the wisdom and credibility of Hungary's strategy. Temporary expedients would temporarily appease the markets, the fund said, but the country would remain vulnerable.
No amount of monetary rectitude can save a country from fiscal recklessness. Indeed, hard money, which preserves the real value of domestic debts, may only serve to hasten the day of reckoning. Central bankers in emerging economies must hazard faltering exports, vengeful currency markets and political tensions. But nothing troubles a central banker more than a profligate finance minister.
http://www.economist.com/finance/displaystory.cfm?story_id=7253174
Bernanke has it easy
Aug 3rd 2006
From The Economist print edition
SPUTTERING platinum smelters and dwindling diamond deposits do not rank highly on the list of concerns of the world's “big three” central bankers—Ben Bernanke, chairman of the Federal Reserve, Jean-Claude Trichet, president of the European Central Bank and Toshihiko Fukui, governor of the Bank of Japan. Both, however, feature in the latest inflation report of the South African Reserve Bank, which, as The Economist went to press, was expected to raise its benchmark interest rate by as much as half a percentage point, to 8%, having already raised it by the same amount in June.
The connection between tight monetary policy and troubled quarries and furnaces may seem a bit murky. But such is the lot of a central banker in an emerging economy, where troubles brew in remote places then break with unpredictable force. Platinum, palladium, gold and diamonds account for almost a quarter of South Africa's exports. But mining output struggled last year and shrank by about 6% in the first five months of this year. South Africa's lacklustre exports are one reason why its merchandise trade deficit was the worst on record in the first quarter and not much better in the second. The trade gap put downward pressure on the rand, which has, in turn, put upward pressure on prices. Hence the increase in interest rates.
South Africa's central bank is not alone in spreading its wings and sharpening its talons. The Czechs, Indians, Slovaks, Israelis, Hungarians and Turks all raised rates last month. Like their counterparts in Pretoria, central bankers in these countries face their own idiosyncratic challenges to price stability. In Israel, for example, the central bank wants to know how much slack remains in the job market. But how to calculate that, when the Israeli army might any day call up its reserves, which represent about 18% of the labour force?
These peculiarities aside, the central bankers share some common complaints. Their lives have all been complicated by Mr Fukui's recent triumph over deflation and Mr Bernanke's rearguard action against inflation. Thanks in part to their efforts, money is now harder to come by. Investors thus became less willing to throw it at emerging-market assets. As a result, currencies fell in May and June, stoking inflationary pressures.
Turkey's central bank has waged the fiercest fight. It has raised rates by as much in two months as the Fed has in two years. In December 2005, it set itself the target of reducing annual inflation steadily from 7.7% to 5% by the end of this year. By June, however, annual inflation was running at over 10%. Has Turkey been overheating? The economy grew by 6.4% in the year to the first quarter, the stockmarket boomed and the current-account deficit widened. Perhaps most telling, Harvey Nichols plans to open a luxury store in Istanbul.
But the central bank lays the blame elsewhere. In an open letter, explaining the breach of its target, it bemoans higher oil, food and gold prices. Most of all it blames the lira, which fell by 23% against the dollar between May 5th and June 23rd. Were it not for this currency mischief, the bank calculates, annual inflation would have been a pardonable 8.6% in June.
The central banks of both Turkey and South Africa have promised not to allow faster inflation to persist. But so far, it seems, only South Africa's commitment is much believed. Despite the fall in the rand, South Africans expect their central bank to keep inflation within its target range of 3-6% this year and next—after all, it has done so successfully since September 2003. The weaker lira has, however, “disrupted inflation expectations” in Turkey, the central bank admitted in the minutes of its July meeting, released this week. According to its latest survey, Turks now think inflation will exceed 8% in a year, and be over 6% two years hence.
Forint or against it
As investors become pickier, keen to distinguish one emerging market from another, they may begin to see Hungary in the same light as Turkey and South Africa. It too runs a big current-account deficit, which the IMF thinks will exceed 9% of GDP this year. Indeed, on fiscal matters, the comparison is rather to Hungary's disadvantage. Turkey may labour under heavy public debts, but it is at least running a heroic budget surplus, before interest payments, estimated at 6.4% of GDP. South Africa now runs a modest fiscal deficit, but its stock of debt is quite manageable. Hungary, on the other hand, has both high debts (almost 60% of GDP in 2005) and a wide budget deficit. Nouriel Roubini, of Roubini Global Economics, calls it an “accident waiting to happen”.
Curious then, that the Hungarian forint has so far escaped the traumas visited on the rand and the lira, falling by 10.7% from peak to trough this year. Inflation remains at just 2.8% but Hungary's central bank is not taking any chances: it raised interest rates by half a percentage point on July 24th, after a quarter-point increase in June.
Mr Roubini offers three possible explanations. Perhaps the markets are complacent—but surely the turmoil of May and June woke them up? Maybe Hungary is shielded by its prospective membership of the euro—but a tie to the D-mark did not save the Italian lira or the pound sterling in the early 1990s. Or the markets may be giving the benefit of the doubt to a new government, which has unveiled plans to put public finances in order.
If so, the government impressed the markets more than the IMF, which publicly cast doubt on the wisdom and credibility of Hungary's strategy. Temporary expedients would temporarily appease the markets, the fund said, but the country would remain vulnerable.
No amount of monetary rectitude can save a country from fiscal recklessness. Indeed, hard money, which preserves the real value of domestic debts, may only serve to hasten the day of reckoning. Central bankers in emerging economies must hazard faltering exports, vengeful currency markets and political tensions. But nothing troubles a central banker more than a profligate finance minister.
http://www.economist.com/finance/displaystory.cfm?story_id=7253174
Inflation is increasingly determined by global rather than local economic forces
Inflation is increasingly determined by global rather than local economic forces
Economics focus. A foreign affair
Oct 20th 2005From The Economist print edition
THE average inflation rate in the G7 economies rose to an estimated 3.2% in September, its highest for 13 years. The main reason for the return of inflation is that oil has become a lot more expensive; “core” inflation rates, which exclude oil and food, remain much lower in all countries. But fears are mounting that higher oil prices will feed into other prices throughout the economy, pushing inflation higher still.
This is particularly worrying for America. On top of soaring oil prices, companies' unit labour costs rose by 4.2% in the year to the second quarter, mainly thanks to slower productivity growth. The rate of growth of these costs increased by more over the year than at any time for two decades. With energy and labour becoming conspicuously dearer, any inflation model based on a mark-up of prices over costs should be flashing red. Yet in the past year core inflation has not budged. How come?
Stephen Roach, chief economist of Morgan Stanley, suggests that thanks to globalisation, the inflation process has changed over the past three decades in a way that has significantly weakened the link between domestic cost pressures and inflation. He draws on an analysis in the latest annual report of the Bank for International Settlements (BIS), which suggests that global forces have become more important relative to domestic factors in determining inflation in individual countries.
According to the BIS, the correlation between core inflation and the growth in unit labour costs in America fell to only 0.3 in 1991-2004, from nearly 0.8 in 1965-79. The link between inflation and labour costs also faded in other developed economies (see chart). This probably reflects two things. First, the integration into the world economy of China and other emerging economies with vast supplies of cheap labour has curbed the bargaining power of workers in developed economies. These workers therefore find it harder to secure higher wages when inflation picks up. And second, fiercer global competition has made it more difficult for firms to pass increases in wages through to prices. Instead they must absorb them in their profit margins.
As further evidence that firms are less able than they were to hand cost increases on to their customers, the BIS found that fluctuations in import prices also have much less impact on core inflation than they once did. Similarly, the link between movements in exchange rates and import prices has sharply diminished. Standard economic theory has it that a fall in the dollar against the euro should push up the dollar prices of European exports to America, raising America's inflation rate. But the proportion of exchange-rate changes passed through to import prices has fallen everywhere; in America, it has been 60% lower since 1990 than it was in the previous 20 years. Today, exporters set their prices for a local market and then either hedge their currency risk or absorb currency changes in their margins.
Increased global competition has thus limited the room for firms to pass on higher costs. This makes a nonsense of traditional economic models of inflation, which virtually ignore globalisation and assume that companies set prices by adding a mark-up over unit costs, with the size of the margin depending largely on the amount of slack in the economy. In reality, when setting prices firms are increasingly likely to be constrained by global competition. Given the price the market will bear, they design and make their products as profitably as they can. As a result, domestic cost pressures, whether in labour or energy, no longer lead automatically to higher inflation, but are more likely to show up as swings in profit margins.
This suggests that in forecasting inflation central banks now need to pay less attention to domestic shifts in unemployment and capacity utilisation and much more to the global balance between supply and demand. The BIS's research shows that since 1990 the core rate of inflation has become less responsive than it used to be to changes in the output gap (a measure of economic slack) in all the main developed economies except Britain. The ups and downs of inflation increasingly reflect the global balance between supply and demand.
A premature obituary
The nature of inflation has thus changed. But it has not died, although the forces of globalisation have helped to combat it. Policy blunders by central bankers could still allow it to break out again. Indeed Don Kohn, a governor of the Federal Reserve (and one of several potential successors to Alan Greenspan as chairman), reckons that the impact of China and other newly industrialising economies on inflation is often exaggerated. In a speech last week, he drew on a Fed study which concluded that the direct impact of cheaper Chinese imports on American inflation was modest. However, this study ignored the indirect effects of China on wages and the fact that cheaper Chinese goods do not just reduce the price of imports from China but, through competition, the price of all goods sold worldwide.
Mr Kohn may well have underestimated the extent to which globalisation has borne down on inflation in past years. However, more important for policymakers today is its future effect. As Mr Kohn argued, the emergence of new industrial giants has increased not only global supply but also demand, particularly for oil and other raw materials. By running large current-account surpluses these economies are currently adding more to supply than to demand, so their net effect is disinflationary. But this could change. If their exchange rates rose and their domestic demand increased, said Mr Kohn, downward pressure on prices would ease, and might one day be reversed.
Even though globalisation has helped to hold down inflation so far, capacity constraints will eventually appear in the global economy, just as they always have at the national level. Globalisation does not relieve central bankers of their responsibility for maintaining price stability. But it may require them to steer policy by a different compass: one that takes much more account of developments abroad.
Source: http://www.economist.com/finance/displayStory.cfm?story_id=5054125
INFLATION: AN INTRODUCTION
Prof. Lic. Fernando Julio Silva, MSc.
As a definition: The inflationary process deals with a persistent increase in the general price level.
Types of inflation:
· Hyperinflation: Prices raise at a phenomenal level. Other names are galloping o run away inflation. Can people “create” hyperinflation? The answer is yes, don’t forget that under this situation, an extreme case, people in general don’t trust their currency so the try go get rid of it son they continue buying products just in case their price level goes up, not seeing that those extra buys are producing more inflation. I’m going to explain this in a deeper way later.
· Suppressed inflation: It takes place whenever demand exceeds supply. Effects on prices can be minimized using policies such as price control or rationing. This situation may lead to the appearance of black markets.
· Creeping inflation: This is the most common type of inflation. Usually it moves between 1-6%
Causes of inflation:
They are classified in two main groups:
A) Demand Pull
B) Cost Push
A). Aggregate Demand (AD) exceeds Aggregate Supply (AS) in a persistent way, so prices are pulled upwards.
In order to have this type of inflation we need to be under conditions of full employment, if not an increase in AD won’t have any effect over prices level because you can increase the number of the factors of production needed in order to increase your level of output; but if demand continues increasing, at a certain point full employment conditions will be reached and then yes inflation may appear.
Situations under which this type of inflation may appear are:
I.- Wartime conditions: local resources (factors of production) are going to be used in order to produce products for war and the availability for local products is going to be reduced but on the other hand we are going to have full employment conditions that will increase people’s income. Shortage will appear. Associate this concept with P.P.C. and opportunity cost theories.
Government solutions will come by the hand of rationing and price control policies.
II.- Exports surplus will also increase country’s income, so more money is going to be available producing an increase on demand, but supply is going to be reduced because part of the production now is exported. A possible solution can be to increase the level of imports.
III.- Economic growth: whenever a country tries to increase the rate of their economy, they’ll have to reduce their production of consumer goods and increase their production
of capital goods. Producing this decision a reduction of the level of consumer goods on the short term; even thought this will benefit the country in the long term because the increase in the level of capital goods will allow the country to increase their production for consumer goods in the long term. Solutions that government can take in order to reduce the effect of this situation are related with an increase of taxes and/or saving
IV.- Government spending: an increase on government spending may lead to inflation if it’s financed by increasing borrowing (central banks will have to increase M {amount of money in circulation} or by increasing taxation {people will try to reduce their level of saving rather than reducing their stand of living in the short term}
Inflationary process under Demand Pull inflation:
Supply is increasing the demand for factors of production because they are able to sell more products in the market and if you remember that we are talking about having all he resources fully employed, an increase on the demand for them will be followed by an increase on their prices too. So suppliers will have to increase their products prices (not been worried about this situation because they know that the demand exists); on the other hand, now consumers will have more money in their pockets (don’t forget consumers are also part of the factors of production and now they get better payments for their work). This situation will lead to a new increase on the demand and the situation will continue
B). This type of inflation is produced ‘cause of an increase on the cost of the factors of production that can’t be absorbed by the producer, you have to be aware that this is not a situation produced by an excess of demand.
Examples can take the form of:
* Increase on price of imports
* Increase on indirect taxation
* Increase on wages that are higher tan the increases on productivity
Inflationary process under Cost Push:
This situation is related to what is known as the “wage price spiral” which shows that an increase on wages given in order to compensate for an increase in prices will be followed by another increase in prices that will take to another increase in wages and so on. So an increase in costs will be followed by an increase in demand.
Cost inflation and unemployment:
In the old days it was said that if unemployment was high inflation was supposed to be low because as demand was having less money the if prices were high, consumers were not going to be able to buy products; so the solution was a reduction on the price level
On the other hand, when people were fully employed (unemployment was reduced) then inflation was taking place cause now consumers were having the chance to buy an prices were increasing.
But around the 80’s it was probed that something different was taking place and countries were facing a high level of unemployment followed by an increase in prices.
How was this possible? Because wages were increasing too!
Why? Because the unemployed people were not the ones that the companies were needing, these unemployed were unskilled workers, people that had been out of the market for such a long time that the were considered – at a certain point – as a part of the “permanent unemployed” people
Differentials:
A very important feature of the “wage price spiral” s related with the wages differentials because an increase on wages of one sector of the economy will produce a reaction on other sectors because they want to maintain the existing wage differentials between different jobs. The main point appears whenever the first sector was able to receive an increase on their wages ‘cause of an increase on productivity so, as you can see, this won’t have any effect on prices; but as the differential effect to be maintained increases on wages of other sectors of the economy that are not produced ‘cause of the same reason will have a direct effect over the price level.
Bibliography:
“Introductory Economics” – Fifth edition, G.F. Stanlake. Longman Group UK Ltd, 1990
My profile
Hello. I'm Fernando Julio Silva, from Argentina.
I hold a bachellor degree in Biz Adm and a MSc in Organizational Psychology
I'm a professor of Economics at secondary school and university level.
I prepare students that take exams at Cambridge University and at University of London, both in England.
My areas of interest are:
- Macroeconomics
- Inflation
- Poverty
- History of Economics
- Distribution of income
- Behavioral Economics
Between others
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