Monday, 26 July 2010

Two different worlds

Two different countries. Two newspapers. And two quite different economic problems. In India the Economic Times is warning its readers that the country's central bank is expected to put up interest rates by a quarter of a percent this week to cool double digit inflation. 26-07-2010 indianeconomictimesinflation
In the United States the Los Angeles Times has brought fears, not of rising prices but of deflation striking the economy, from up the back of the book on the finance pages to become the front page lead.26-07-2010 latimesdeflationFor Australia, comfortably caught at what was thought to be the end of the global financial crisis between a still rapidly growing Asia and a stagnant or slowly growing United States and Europe, there are clear dangers from the quite different problems of both regions.
The Indians are not the only Asians confronting the problem of the inflationary pressures that come from rapid growth. China is experiencing problems of its own as the authorities try to confront the dangerous social tensions created by a housing price boom that is making basic shelter unaffordable by the workers whose toil is generating the export led development. Dearer housing has not yet been matched by price rises in other areas and in June China's consumer price index rose 2.9% from a year earlier, down from May's 3.1% rise. Yet the People's Bank of China clearly is concerned about future possibilities. On Monday it laid out how a more flexible exchange rate will help alleviate inflationary pressures in the Chinese economy and generally improve the effectiveness of its monetary policy. The central bank Vice Gov. Hu Xiaolian explained in a statement reported by the Asian Wall Street Journal that especially since China joined the World Trade Organization in 2001, foreign capital has flowed into the country via its massive payments surpluses with the outside world.
To preserve the relative stability of the currency, the central bank has been forced to buy up the incoming foreign currency with yuan, thus increasing domestic money supply, she said. To prevent that new money from causing inflation, the central bank has in turn been compelled to "sterilize" that new money creation through various measures that soak up liquidity such as issuing bonds and raising the reserve requirement ratio for banks. Ms. Hu said that in recent years, those sterilization measures "have had some effect," but the central bank hasn't been able to fully counteract the capital inflows, and "excess liquidity pressure has been difficult to fundamentally resolve." In addition, the costs to the central bank of undertaking sterilization operations have been rising, she said.
A more flexible exchange rate can therefore help the central bank curb inflation and asset price bubbles, help alleviate imported inflationary pressures, and help deal with external economic shocks, she said.
It would be prudent for Australians to interpret those remarks as indicating that the recent 10% plus Chinese growth rate will slacken at least a little in coming months taking away some of the boom in prices for our commodity exports.
While the emergence of a rapidly growing China and other parts of Asia has taken away the simplistic truth of the old saying that when America sneezes Australia catches a cold, it is wrong to think that we would escape unscathed from an America in a deflationary spiral if for no other reason than exports from those Asian economies would be seriously affected. Hence the reason to be at least disturbed by the LA Timesdiscovery of a deflationary problem. As the paper explained in its page one story:
The White House prediction Friday that the deficit would hit a record $1.47 trillion this year poured new fuel on the fiery argument over whether the government should begin cutting back to avoid future inflation or instead keep stimulating the economy to help the still-sputtering recovery.
But increasingly, economists and other analysts are expressing concern that the United States could be edging closer to a different problem — the kind of deflationary trap that cost Japan more than a decade of growth and economic progress.
And as Tokyo's experience suggests, deflation can be at least as tough a problem as the soaring prices of inflation or the financial pain of a traditional recession.
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