No hunger at the Fed
By Hossein Askari and Noureddine Krichene
Food and energy prices are raging upwards once again, forcing governments in
China, India, Brazil, Russia, and others to ring the alarm bells. The United
Nations Food and Agricultural Organization (FAO) has announced that in December
2010 food price inflation broke records, with the world food price index
exceeding its peak level of 2008.
With gold prices racing beyond $1,400/ounce, rising by 30% in 2010, oil prices
about to cross the $100/barrel, rising by 25% in 2010, and the US dollar
crumbling, it is hardly surprising to see food prices also explode at alarming
rates.
In contrast to their counterparts in many leading countries, US
policymakers do not appear alarmed by energy and food price inflation; in fact,
it has hardly made it onto their agenda. Even though prices of sugar, wheat,
corn, coffee, soybeans, and many other basic food, such as onions and cooking
oil, rose at rates ranging between 60%-80% in 2010, this inflation seems to
have been of little concern to the Federal Reserve.
In his testimony on January 7 before the Committee on the Budget of the US
Senate, Fed chairman Ben Bernanke remained committed to fighting low inflation:
"FOMC [the rate-setting Federal Open Market Committee] participants also
projected inflation to be at historically low levels for some time. Very low
rates of inflation raise several concerns."
Bernanke was concerned about impact of low inflation on borrowers: "With
short-term nominal interest rates already close to zero, declines in actual and
expected inflation increase, respectively, both the real cost of servicing
existing debt and the expected real cost of new borrowing."
Most interestingly, Bernanke argued that high inflation increases wages and
incomes and translates into rising living standards and that low inflation
would cause a loss in real incomes: "It is important to recognize that periods
of very low inflation generally involve very slow growth in nominal wages and
incomes as well as in prices. Thus, in circumstances like those we face now,
very low inflation or deflation does not necessarily imply any increase in
household purchasing power. Rather, because of the associated deterioration in
economic performance, very low inflation or deflation arising from economic
slack is generally linked with reductions rather than gains in living
standards."
The contrast between US perceptions and policies and that of much of the world
is startling. While a number of major countries are battling inflation and are
alarmed by food and fuel price inflation, Bernanke is battling low inflation,
or imaginary deflation, and is determined to inject US$600 billion to prevent
low inflation and achieve higher inflation, as per the Fed's mandate to achieve
full-employment.
Bernanke's theory could imply that 10% inflation per year is better than 3%,
50% is better than 10%, and 100% is better than 50%. Even though a large number
of US consumers are suffering from higher fuel and food prices, with about 50
million on food stamps, there seems to be little sympathy from the Fed.
Believing Bernanke's testimony that food and energy price inflation raises real
incomes and that by itself brings prosperity would be hardly sensible. If a
politician were to tell consumers in India that they should be happy to see
onion prices double from what they were just a few months ago as this was a
sure sign of pending prosperity, he would be ridiculed. Similarly, if a
politician tells Chinese consumers that they should be happy with cooking oil
prices three times the level of a few months ago they would think him
insensitive to the plight of the average Chinese.
Nonetheless, supporters of inflationism regard higher inflation as the best
strategy for promoting growth and full-employment. How high inflation should
be? Inflationists portray money printing as conducive to real economic growth.
It costs nothing to print paper money. So why deprive the state, consumers, and
firms from free wealth and from lavish spending? It would be preposterous to
deny government and consumers money when money is costless to print!
But seriously, with record fiscal deficits, there could be a need for inflation
to finance these deficits, by keeping interest rates near zero, and practicing
a Ponzi scheme consisting of eroding real debt through rapid inflation. High
inflation would erode real value of debt owed to China and other foreign
creditors; it would reduce real debt and real borrowing cost for the US
government and for domestic borrowers, including mortgage borrowers.
At a time that the US Treasury is calling for an increase in the debt ceiling
to finance higher fiscal deficits, there is every good reason for the Fed to
ignore food and energy price inflation to combat low inflation and to keep
interest rates near zero level.
If Bernanke were to admit that there is rampant food and energy price inflation
in the US and that it could accelerate and spread to other sectors, he could no
longer defend his policy to fight low inflation.
Irrespective of criticisms from a number of quarters, the Fed has for years
remained insensitive to speculative housing prices and food and energy price
inflation until such inflation ravaged the banking sector, the housing sector,
and sent the US economy into the worst recession in post-war period with
unemployment approaching 10% in 2010 from 4% in 2007 and unprecedented
peacetime fiscal deficits.
In a recent interview with Wall Street Journal, Bernanke's predecessor at the
Fed, Alan Greenspan, challenged his critics to prove that he had been wrong in
his policies. Even though housing prices were doubling, tripling, and
quadrupling, speculation was rampant when he was Fed chairman, and credit
exploding at 12% a year, he was convinced that he was fighting deflation, and,
therefore, his policies were appropriate!
Hence, as in the past, Fed policy remains unchanged; it fights low inflation
with unlimited injection of liquidity and near-zero interest rates, which
unfortunately also promote speculation.
Support for such a policy has been clearly re-iterated by Bernanke: "In a
situation in which unemployment is high and expected to remain so and inflation
is unusually low, the FOMC would normally respond by reducing its target for
the federal funds rate. However, the Federal Reserve's target for the federal
funds rate has been close to zero since December 2008, leaving essentially no
scope for further reductions. Consequently, for the past two years the FOMC has
been using alternative tools to provide additional monetary accommodation.
Notably, between December 2008 and March 2010, the FOMC purchased about $1.7
trillion in longer-term Treasury and agency-backed securities in the open
market ... At its meeting in early November, the FOMC formally announced its
intention to purchase an additional $600 billion in Treasury securities by the
end of the second quarter of 2011, about one-third of the value of securities
purchased in its earlier programs."
The resurgence of record food and energy prices could bring economies back to
the nightmare experienced in 2008. At that time, agriculture, airlines,
transportation, the auto industry, and many other sectors were also paralyzed.
The number of food stamp recipients surged. At the same time, the number of
poor people suffering malnutrition in Mauritania and other vulnerable countries
rose by the millions. Governments were in disarray and held world food and
energy summits, with a view to "permanently" solving food and energy crises.
Food and energy price inflation will again play havoc with many economies as it
did in 2008 and could in turn bring economic growth again to a standstill in a
number of countries. This time again, food and energy price inflation will
remain unchecked, speculation will intensify, and the adverse effects will keep
on compounding; it will hurt food and energy importing countries and slow
economic growth worldwide.
Central bankers have not articulated the disruptive role of energy, food, and
housing price inflation for growth and triggering economic crises. Chairman
Bernanke, renowned academics, and much of the media blamed fuel and food price
inflation during 2002-2008 on high demand in China and India. Looked at as an
Indo-Chinese problem, food and fuel price inflations were thus a non-issue;
left to burn out themselves, ravaging economies and precipitating long
recessions.
In the recent past, periods of economic stagflation have been associated with
high food price inflation. On the one hand, during the stagflation of the
1970s, food price inflation averaged 12.5% per year during 1970-80. On the
other hand, periods of steady economic growth were associated with stable or
declining food prices. The period 1982-2000 was marked by steady economic
growth with food prices dropping by 2% per year. During the period 2005-2007
leading up to the financial crisis, food prices were rising at 16% per year.
Food prices accelerated from August 2007 to July 2008 at an annual rate of 41%,
leading to a standstill in economic activity and negative real GDP growth of 2%
in the US.
Food and energy price inflation jolted many economies in 2008. Food price
inflation and energy price inflation are likely to get worse. They may even
accelerate at a faster rate than observed in 2010.
The Fed will have injected $600 billion on the top of the already injection of
$1.7 trillion; this would make about $2.3 trillion in money created out of thin
air. The US Fed has put no food or oil on the markets; it cannot put one gram
of onion or one drop of cooking oil on the market. It has only printed more and
more money.
Significant money creation amounts to a tax and a redistribution of wealth and
real resources in favor of recipients of the created money at the expense of
workers. The recipients of this money will be beneficiaries of money creation
at the expense of those who loose through high inflation. The new money will
translate into higher demand for food, energy, and other commodities, and
progressively into higher prices. Such money creation, in turn, destroys
savings and real investment.
Food and fuel prices are determined in speculative markets that are swamped
with liquidity at near-zero interest rates. The determinants of food and fuel
price inflation will only worsen; these determinants are the continuous
depreciation of the US dollar, the currency of denomination for commodity
prices; near-zero interest rates in the US, Europe, Japan, and in many other
countries; dangerous levels of fiscal deficits in the US and in many Europeans
countries; money printing by the Fed, the European Central Bank, and a number
of other central banks; and a developing currency war, with most countries
inflating at the same rate as the US to prevent an appreciation of their
currencies vis-a-vis the US dollar.
All these factors could compound to make food price inflation even worse and
more durable than observed during 2002-2008.
Major central banks, including the Fed, are unlikely to be moved by food price
inflation. Speculators know that US policy will remain most propitious to
speculation in commodities and asset markets.
A country that wants to insulate itself from food price inflation has to
appreciate its currency significantly; this would mean a significant loss of
competitiveness; or, it has to subsidize food prices. Absent these two drastic
measures, countries have to live with the implication of unorthodox US monetary
and fiscal policies.
Food and energy price inflation will tax fixed pension incomes and workers'
wages, which lag considerably behind inflation. It will force real cuts in food
consumption. Food and fuel price inflation, as any other inflation, will
certainly benefit producers and sellers, as inflation always increases
substantially profits and redistributes wealth at the expense of the workers.
Inflation (the outcome of excessive money creation), large fiscal deficit
financing that finance wars and political spending, and unsound government
policies have been rarely conducive to increasing real supply or to sustainable
economic growth. It is more a symptom of highly distorted and politically
imposed policies than a sign of prosperity.
As producers notice that inflationary expectations have become embedded and
that money is depreciating at faster rate, they would be inclined to bid for
constantly higher prices and would tend to hoard and reduce real supplies. The
more their expectations of higher prices are validated, the less they will
produce, and the faster inflation becomes. The dynamics of inflation are such
that inflation could turn into hyperinflation, disrupting production and trade.
Examples of hyperinflation are numerous both in distant and recent past.
The US is trapped in the vortex of inflationary policies: a combination of the
largest peacetime fiscal deficits in its history, rising public debt, near-zero
interest rates, and excessive injection of liquidity. The Fed has regarded
money printing and near-zero interest rates as the best policies to secure
economic prosperity and full-employment, even though these policies have
already ruined banks in the US and in Europe and have rewarded speculators.
A combination of overwhelming fiscal deficits and most unorthodox monetary
policies in the US offers little hope for quick relief from fuel and food price
inflation, which has plagued many countries and millions of consumers in the
past eight years.
Hossein Askari is Professor of International Business and International
Affairs at the George Washington University. Noureddine Krichene is an
economist with a PhD from UCLA.
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