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Catch-22: Inflation and Sizzling Growth Equals more Inflation

January 24, 2011

I have been tracking this for a over a year, well before I started this blog. Global food prices and shortages have caused unrest in various countries. Today, the WSJ’s front page story focuses on global food prices once again, but more importantly, inflation. Commodities have been steadily rising for months and pressures are building in many countries. I have some comments after the excerpt from the WSJ.

Inflation fears—fueled by spiraling food, oil and raw material prices—are mounting around the globe, prompting the head of the European Central Bank to signal that it could raise interest rates in the future even though some countries have been weakened by the Continent’s debt crisis.

In an interview with The Wall Street Journal ahead of this week’s annual meeting of the World Economic Forum in Davos, Switzerland, Jean-Claude Trichet warned that inflation pressures in the euro zone must be watched closely, and urged central bankers everywhere to ensure that higher energy and food prices don’t gain a foothold in the global economy.

Mr. Trichet’s warning comes at a time when inflation concerns are mounting among investors around the world. Fast-growing emerging markets such as China and Brazil are seeing rising inflation at home, and their demand for globally traded commodities is pushing prices higher elsewhere.

While high unemployment and spare capacity are restraining underlying inflation pressures in the U.S. and elsewhere in the developed world, annual inflation in China is almost 5%—and a sizzling 9.8% economic growth rate in the fourth quarter triggered fears of more price pressures ahead. Inflation in Brazil is even higher.

Global inflation isn’t just coming from volatile commodities that track the ups and downs of the world economy. Fast-growing emerging nations are taking increasingly aggressive actions to beat back rising food prices as they grow more worried about threats to stability.

Changes in food and energy prices are largely determined on world markets, and thus aren’t directly influenced by interest rates in any one economy. For that reason, central banks in many major economies, including the U.S., put greater weight on core inflation than on headline measures. For now, Fed officials don’t see much evidence that commodity prices are feeding broader inflation in the U.S.

With the global recovery still in its early stages, those moves could accelerate. Higher raw material prices, especially coal and iron ore, are pushing up steel prices across the globe. Steelmakers including AK Steel and Nucor in the U.S., and China’s Baosteel and South Korea’s Posco—the world’s second and third largest—have been steadily increasing prices in recent weeks. The world average carbon-steel price is forecast to exceed $1,000 per metric ton by the second half of 2011, up from an average $733 last year, according to U.K.-based consultancy MEPS.

It is in our interest, the United States, that Europe remains stable. What with the EU austerity plans kicking in, inflation may be the last straw for millions of Europeans. Already Parisians and Londoners have marched in the streets of their capitals. France has had several serious labor strikes. I am concerned that President Obama is paying too much attention to India and China while our closest allies are experiencing great difficulties. While inflation is not a threat here (yet), global upheaval due to high inflation around the globe would have severe consequences for the U.S. and risk President Obama’s agenda to crank up the economy through ramped up trade with India and China which he will outline tomorrow night in his State of the Union Address. It is precisely these two countries that are the manufacturing engines of the world and they use high amounts of iron ore and coal which if put into overdrive will further drive up the costs through demand. It is a Catch-22 scenario: growth oriented global economies like the U.S., India and China, may hit a stumbling block as increased manufacturing will fuel further inflation costs of minerals and key resources which will ironically hamper economic recovery as costs rise and as costs rise the downstream effect will be higher prices for goods… which will drive inflation where… to United States consumers… for this is a three-legged stool by design. As Trichet stated…. “high unemployment and spare capacity are restraining underlying inflation pressures in the U.S. ” Once we unleash the engine of commerce here we will set into motion the very thing Trichet is so very concerned about — inflation.

Related story: Emerging Markets Face Inflow Threat as Davos Meets, IIF Says

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