Thursday, May 15, 2008

Global Inflation

It started two years ago with the sharp jump in the oil price which was passed on to the economy. The second round effect is to transmit the higher costs to all retail prices, including food.

In theory, the first expected response is the curtailment of consumption, either of food or other retail stuff so that in the end the demand for oil will fall and the price of oil softens. The fear is recession.

If overall demand is strong - because of easy money policy to sustain demand growth and prop up the economic growth - then the oil price will stay high. Ideally, the easy money policy will put money into people's hands and they use the extra money to buy food. In this way, the easy money policy helps to put the extra cash in the pockets of whoever is keeping up the price of oil - and that is usually the traders - not producers.

The higher oil price will encourage of marginal fields but that will take ages.

If the extra cash from easy money policy is used to increase food production, the assumption is that the rise in the price of food comes from supply shortages due to climatic change or non-food use such as biofuel, then it will cure supply problem. But the high cost of food production from high oil price remains.

I think it is due to the sustained and rapid growth of China. I think China should slow down to 5% growth - rather than the 10% today. With demand doubling every 7-8 by the world's largest population, and a large part of the world not getting hungry everyday anymore, there is a supply problem for all commodities including oil and food.

To ration demand in the next few years until new supply comes onstream, a higher interest rate policy will be the right stance - not easy money. To ration means some people will have to tighten their belt. Income assistance can be provided to the low income groups, but not control of prices.

No comments: