Global Inflation

Businessworld
Bill Emmott

In what feels like the blink of an eye, the emerging markets have been transformed from global suppressors of prices to sources of a new wave of inflation. The vehicle for this transformation is the price of oil and, to a lesser extent, food, both driven higher by strong demand in China and elsewhere. In reality, though, the ultimate means by which inflationary pressure is being transmitted is a more fundamental commodity: money.


Excess liquidity in countries ranging from China to India to Saudi Arabia has pushed inflation rates higher all over the world. Yet when the developed countries’ credit crunch began in August last year, deflation looked a greater danger: the abundant savings in emerging markets offered hope that a deflationary spiral could be avoided.

From a global point of view, one country’s central bank is more important than the others: China. The reason is two-fold. One is that China is the developing world’s biggest economy, the world’s fourth largest, and one of the most open to trade. So its economic performance affects others. The other reason, though, is that China’s liquidity and its rapid, resource-intensive growth in the past five years has been a big force behind the rise in price of oil and other commodities.

If Chinese demand continues to grow, then the oil price is likely to carry on rising, intensifying the inflationary pressure worldwide. But if the People’s Bank of China (PBOC), the country’s central bank, were to raise interest rates sharply (which are now well below the rate of inflation), bank lending growth would be cut and the economy would slow, cutting also China’s demand for oil. The only way to achieve this would be for the PBOC to allow the Renminbi to appreciate much more rapidly against the dollar and the euro, ceasing its purchases of foreign currencies.


For that reason, some analysts suspect the announcement in June of a slowing of the annual inflation rate from 8.5 per cent to 7.7 per cent may have reflected political manipulation of the data to buy time. If so, the pressure on oil prices and on global inflation may remain uncomfortably strong at least until after the Chinese summer, and the Olympics, have passed. In the autumn, however, the government’s nerve might well return. Inflation needs to be defeated.