Exporting Inflation: Oil versus Equities
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In semi-annual testimony before both houses of Congress, Fed Chairman Ben Bernanke expressed concern about “significant increases in some highly visible prices, including those of gasoline and other commodities,” but then quickly downplayed their significance for monetary policy. The price increases, in Bernanke’s telling, reflected rising demand for raw materials and have been reflected in all major currencies, not just the dollar. Moreover, the phrase “highly visible” suggests Bernanke’s concern is less with the commodity price inflation itself as it is with the public’s overreaction to it.
At the same time that Bernanke argued that Fed policy has nothing to do with price increases in food and commodities, he was very eager to take credit for increases in the prices of stocks, corporate bonds, and other assets:
“… market indicators support[s] the view that the Federal Reserve's recent actions have been effective. For example, since August, when we announced our policy of reinvesting principal payments on agency debt and agency MBS and indicated that we were considering more securities purchases, equity prices have risen significantly, volatility in the equity market has fallen, corporate bond spreads have narrowed, and inflation compensation as measured in the market for inflation-indexed securities has risen to historically more normal levels.”
When the globally traded commodity is oil, the price run up is a result of supply and demand and political unrest. When the globally traded commodity is a common stock, the price increase is the handiwork of the Fed. Price increases that reduce Americans’ terms of trade by increasing the number of hours of work required to fill the gas tank are global phenomena with no linkage to the Fed. Conversely, price increases that work through similar channels but instead boost Americans’ net worth through increases in the value of their mutual fund holdings are most definitely attributable to the Fed. As argued in a recent Barron’s article, this line of argument is both intellectually incoherent and unseemly.
While the effects of the global commodity inflation is only beginning to lead to increases in U.S. price levels, many of the world’s emerging economies are already dealing with rapid inflation in price levels. Global food prices are at all-time records, with an index of basic staples 2.2% above 2008 averages when “soaring prices sparked rioting and food-export bans in some developing nations.” Bernanke argues that this is not his problem to solve. Developing countries can use “exchange rate adjustment, monetary and fiscal policies, and macroprudential measures” to slow price increases in their domestic economies. Here, Bernanke is trying to separate economic activity in developing countries from that of developed countries. The prices of various commodities, in his reckoning, are purely set in emerging countries as a result of the policies they adopt.
This ignores the fact that the Fed has a great deal of influence over global monetary policy. The reserve status of the dollar, as well as the fact that several countries around the world operate official or unofficial currency pegs to the collar, mean that Bernanke’s actions have global effects. Academic researchers are increasingly blaming the Fed’s monetary policy during the last ten years for a global boom that led to greater capital flows into America. The Fed’s quantitative easing policy may be similarly exporting loose American monetary policy across the world today, explaining the global rises in commodity prices that Bernanke feels are not his responsibility.
Making matters worse, developing countries are increasingly relying on wage subsidies to allow consumers to deal with the price increases. South Africa, Thailand, and much of Asia are providing wage subsidies so workers can avoid reductions in real incomes. In some nations, the wage subsidies are being coupled with price controls, which further distort market outcomes by making the globally traded commodities less expensive on a relative basis. The result is increased demand for commodities and further overheating, which may culminate in a 1970s-like wage price spiral.
While the inflation situation in America remains complex, it is certainly clear that large categories of commodities have seen large price spikes. These have already contributed to conditions of stagflation or rapidly rising inflation throughout the world – and have been associated with rising political uncertainty throughout the world. At the very least, this is a situation worth watching as QE2 is scheduled to slow down, and the Fed considers whether to raise rates or initiate new easing actions.