Monday, November 29, 2010

Is the United States Making the Emerging Nations Stronger?

Why is the rate of inflation so low in the United States when the government has pumped huge amounts of debt into the country and the Federal Reserve has loaded the financial system with large amounts of liquidity?

The same question was asked in the 1990s. Where was the United States inflation?
The answer for the 1990s…and for the present time period…is that the United States has exported inflation to the rest of the world…more specifically…Asia. As the accompanying chart shows, inflation seems to be heading up in Asia…as it is also heading up in many other emerging nations.
As reported in the LEX column of the Financial Times yesterday, global inflation has seemingly bifurcated. In the developed countries the current inflation rate is below 2 percent (Australia and the UK are exceptions). Morgan Stanley expects a 1.5 percent rate of growth for the wealthier countries in 2010. “By contrast, the emerging market inflation rate is about three times higher—expected at 5.4 percent in 2010…” (

The post-financial crisis stimulus is now feeding the inflation in the emerging countries. “A significant portion of the river of cheap money flowed into commodity markets. The initial price recovery caused no problems, but the trend now threatens to create a vicious circle.”

There is also the “carry trade” which takes United States dollars throughout the world seeking higher interest rates. This flow is certainly not insignificant.
In these days, it seems like it is very difficult to contain the international flows of capital. Maybe policy makers need to give this a little more weight in their policy discussions.
There is an argument that central banks, in some Asian countries, kept their interest rates “appropriately low” over the past year or so because of “concerns about the strength in their developed-market trading partners” especially the United States. Now, with inflation threatening to get out-of-hand in the emerging nations, these same central banks are faced with the need to raise their domestic interest rates higher and higher. (See “Emerging Wild Card: Inflation”:

The article continues: “One conundrum for investors is how more aggressive tightening would play out in the currency markets. Most investors have been operating on the assumption that with the Fed keeping interest rates at zero for the foreseeable future, any moves by emerging-market countries to raise interest rates would attract even more money from yield-hungry investors.”
This seems to reflect a cumulative problem. By keeping interest rates low in the United States, dollars are flowing out into the rest of the world. This out-flow is threatening to bring about greater amounts of inflation in the emerging nations of the world. In order to combat this rising level of inflation, the central banks in emerging nations are raising interest rates. But, in raising interest rates, more United States dollars flow to these emerging nations.

And the flow of money into dollars from Europe as a “safe haven” has kept the value of the dollar stronger than it otherwise would be in such a situation which just enhances the return to investors from moving into the interest rates in the emerging countries.
So, the Federal Reserve continues to inject large amounts of reserves into the banking system, hoping to get the United States economy going again. But, individuals, families, and small businesses do not seem to want to be borrowing. Only large, healthy companies seem to be borrowing and piling up cash reserves. The money the Fed is printing seems to be going off-shore.

Therefore, instead of stimulating the United States economy, the Federal Reserve seems to be stimulating the emerging countries of the world. The two results of this seem to be that the United States is not getting stronger, but it is helping the rest of the world to get relatively stronger. The rest of the world needs to keep inflation under control, but the emerging nations feel the relative shift in power within the world and are taking more and more advantage of this increased power. See reports on the recent G-20 meeting. (
Only strong, self-disciplined countries come out on top. Right now, the United States is anything but self-disciplined and it is finding that its relative strength is slipping away. The unfortunate thing is that in its lack of self-discipline, the United States is feeding the rising relative strength of the emerging nations in the world. This is our fault, not the fault of other nations within the world.

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