# Threat of inflation



## evoke (14 Jun 2006)

i do not understand if the fed raises interest rates why does it have a effect on the whole world. i know when america does bad, europe does  bad .but the whole world. they must have a  huge grasp on the world.

 why is that.

inflation seems to be the biggest threat now. in ireland now it is 3.9%. maybe this inflation will cause a market down turn


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## walk2dewater (14 Jun 2006)

evoke said:
			
		

> i do not understand if the fed raises interest rates why does it have a effect on the whole world. i know when america does bad, europe does bad .but the whole world. they must have a huge grasp on the world.
> 
> why is that.
> 
> inflation seems to be the biggest threat now. in ireland now it is 3.9%. maybe this inflation will cause a market down turn


 
I forget the exact % but the US consumer is a major component of world aggregate demand (all of the things that everyone demands).  Heavy debtors don't make good consumers when rates are rising.

Inflation IS out of control.  Have you noticed the changes in property prices in Ireland recently, say since 1997?  "Oh but that's not inflation that's returns on my property investment".....


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## room305 (14 Jun 2006)

House price inflation rarely is because it generates massive consumer spending as people feel "richer" and begin to borrow against the equity in their homes. This is a comment from Bank of England governor Mervyn King (excerpted from http://business.scotsman.com/economy.cfm?id=866992006):

"During the fastest three-year period of world economic growth for a generation, monetary policy around the world may simply have been too accommodative."

He added: "So far, we have seen little more than a modest correction to the prices of a wide range of assets that had risen sharply over the previous two years. The realisation that such levels of asset prices were unlikely to be sustainable, coupled with a tightening of monetary policy in many countries, has injected uncertainty into financial markets. And it is hardly surprising that, as investors realised that they might have underestimated the uncertainties, the price of risk moved up." 

I don't have any quotations to hand but I'll wager he wasn't quite so hawkish when the price of houses in the UK was growing at phenomenal rates a while back.


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## darex (14 Jun 2006)

Basically what happened is this. China came into the world market in a big way with effectively free labour. Take one of the main cost components out of many world traded products and naturally prices will fall. Central banks had to pump in liquidity to keep prices up and prevent deflation in western economies. Some of this liquidity went into keeping headline inflation on target but most went into asset price inflation (not a primary concern of the central banks).

Now that the China effect has disappeared due to commodity prices rapidly rising, the central banks are having to mount a major mopping up operation of excess liquidity. As the liquidity that went into assets is sucked out of the system, asset prices will naturally fall. The interesting queston is how far and how fast and can the banks avoid a resession. My guess is recessions in America and Ireland - but not on the European mainland.


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## soma (14 Jun 2006)

darex said:
			
		

> Now that the China effect has disappeared due to commodity prices rapidly rising


Actually I think the larger reason is the fact that the wages being demanded (and achieved) in chinese factories are rising dramatically (tho still incredibly low).


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## room305 (14 Jun 2006)

Now that the Bank of Japan has successfully fought deflation, they are likely to increase their overnight interest rate from 0%. Again, this will take an awful lot of liquidity out of the world markets.


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## bearishbull (14 Jun 2006)

inflation is rampant in china and the fact their currency is pegged to the dollar etc has prevented inflation hitting us for a long time but with oil/commodities rising and pushing up the costs for chinese factories they cant keep theur prices low enough to be profitable,if their currency was freely floating then inflation would be an even bigger problem in short term.


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## CGorman (14 Jun 2006)

evoke said:
			
		

> inflation seems to be the biggest threat now. in ireland now it is 3.9%. maybe this inflation will cause a market down turn



I think the down turn - whilst inevitable - will not materialise for another few years, possibly 2008 or 2009. The SSIA money should plug the gap left for the next 2 years when people can't borrow at ridiculous rates to buy Plasma TV'S and Spanish Villas.

Unfortunately inflation is beyond our control. 

Group 4, in the CPI is made up of Housing, Water, Electricity, Gas and Other Fuels. It makes up 12% of the weighting and it surged 14% in the past 12 months. Of this group over half is energy products... and unfortunately we can't even make a cent of difference to global oil and gas prices.

No other group exceeds annual inflation of 4.8% (transport being at that figure). Interestingly inflation for goods is just 2.6% whilst service inflation exceeds 5%. Clothing and Footwear, Household Equipment, Furniture, and Communications have all fallen in Price in the past year.

So what does all that mean? Inflation is being caused by two things:

1) Energy - we can't change Irelands reliance on imported energy overnight - it will take decades to adapt - and I personally believe oil prices will hit over $100 within three years... infact I HOPE they hit $200 soon! (sorry, but I have a green streak in me)
2) Services - health and education both jumped by over 4% and services in gerneral by 5%. This is demand-pull inflation; too much money (often borrowed) is chaseing too few service providers like cosmetic surgeons, grind schools, landscape gardeners, concerts, etc.

This is all tempered by the continual fall in the price of footwear, clothing and basic goods which has occured in recent years. This will soon come to an end as Chinese labour costs rise and the costs of getting stuff here from there surges... so it is entirely feasible that inflation could soon hit 4%, 5%, 6% even more.

Of course if prices suddenly surge, demand will fall and the demand pull inflation will subside (the increased cost of borrowing will also slow spending). In addition, whilst I expect oil to hit $100 soon, it should then  settle between $60 and $80 as current investment in production capacity and refinery expansion in the US come on stream.... So now what? Well inflation will proably continue to rise to 5%+ before falling back as the economic downturn begins.

Check out [broken link removed] for more detail.

Well, theres the museings of an amateur economist. 

(P.S.  I wrote an essay on inflation in todays Leaving Cert Business exam... it was a lovely paper... just wish I had far more time! I was enjoying it!)


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## room305 (15 Jun 2006)

Some interesting points there CGorman and I imagine you'll score highly in your essay!

A few points however:

- If the US economy heads into a recession then the Irish economy (and probably the rest of the world) will be sucked in too, no matter how much SSIA money is sloshing around. I think this could happen as early as the end of this year but probably into the first or second quarter of 2007 (well a major slowdown at least, if not exactly a recession - either way, it'll be painful).

- I think in the short term the price of oil will fall dramatically, at least as low as $50 a barrel maybe as low as $40. There has been a fall off in demand that is not reflected in the current trading prices. However, this will be a mere correction before the resumption of an upward trend. I think the government should fix the price at the pumps and in other areas higher than current levels and force people to change their habits sooner rather than later. I can't imagine it would be popular move though.

There seems to be a general agreement that inflation is spiralling out of control worldwide for a number of reasons. I wonder, does anyone have confidence in the world's central bankers (particularly Bernanke) to get it under control?


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## yygaurav (15 Jun 2006)

According to BP Oil will falll to $40

http://business.guardian.co.uk/story/0,,1795824,00.html


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## CGorman (15 Jun 2006)

BP excels at saying one thing and doing the other. Their slogon "Beyond Petrolem" is as ironic as it is inaccurate. Lord Brown is telling the media that oil will fall, so that investment in renewables slows. If he said oil would hit $150, then firstly investment in alternatives to oil would increase and secondly there would be renewed calls for a windfall tax. Of all the oil majors, I think BP has the slickest (pardon the pun) PR policy.

As regards fixing oil prices... whilst it is a very desirable idea from a global warming and sustainable energy point of view it is impractical. As you pointed out, governments could never implement it without political backlash. Besides my mantra in life is "I believe in God, capitalism, and the free market; tempered by fairness and the state!" So basically I think in normal times commodity prices should always reflect supply and demand in the form of price.

On the topic of oil, I would like to add that I think aviation fuel should be taxed internationally and heavy taxs should be placed on inefficent cars and SUV's. I read in last weeks _"The Economist"_ of a fella in the states who has modified his Toyota Prius so that he can plug it in at night for a recharge - it now achieves 200 miles to the gallon! That compares to the typical 10-20 mpg achieved by many SUV's and big cars.Of course it still uses electricty  which we must create somehow, but at least it is practical to generate electricity from alternatives, unlike powering cars by hydrogen (something that _will_ not happen commercially for at least another decade).

In my opinion the only way to stop inflation is to jack up interest rates (to stop borrowing) and for governments worldwide to cut budget deficits and curb spending increases. This should cut demand pull inflation somewhat; but of course the later point is political suicide and impossible to co-ordinate globally - the Chinese and Irish governments would prefer for example to increase spending (particularly capital on infastructure) whilst the Germans and Japanese may wish to reduce spending to cut inflation. Oh, and of course the central banks in Europe and Britian are independent from governments... so thats an even tricker matter. Inflation is unstoppable!... without a serious downturn or even complete economic stagnation for the next few years! Time to jump out of the skyscrapers again!


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## PMU (15 Jun 2006)

CGorman: A very insightful post, but you must remember that  “_*Inflation is Always and Everywhere a Monetary Phenomenon*_*”*. So said economist Milton Friedman and he won a Nobel Prize for that. The ECB says it as well. Once you increase the supply of money faster than the economy can create value you get inflation. It’s nothing to do with cost push, e.g. from energy and services. That just reflects inflation, it doesn’t create it. Inflation is never beyond our control. That’s what monetry policy is about, and you can read up on monetary policy on the ECB’s web site www.ecb.int.


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## Duplex (15 Jun 2006)

PMU said:
			
		

> CGorman: It’s a pity, but you probably failed your Leaving Cert if your essay on inflation reflected what you said in your post. “_*Inflation is Always and Everywhere a Monetary Phenomenon*_*”*. So said economist Milton Friedman and he won a Nobel Prize for that. The ECB says it as well. Once you increase the supply of money faster than the economy can create value you get inflation. It’s nothing to do with cost push, e.g. from energy and services. That just reflects inflation, it doesn’t create it. Inflation is never beyond our control. That’s what monetry policy is about, and you can read up on monetary policy on the ECB’s web site www.ecb.int.


 
This post will be deleted if not edited immediately give the kid a break he/she's half way through their exams and you have them failing.   C.Gorman you made a number of very interesting points, kick ass.


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## ivuernis (15 Jun 2006)

Duplex said:
			
		

> This post will be deleted if not edited immediately give the kid a break he/she's half way through their exams and you have them failing. C.Gorman you made a number of very interesting points, kick ass.


 
Seconded! 

CGorman, your analysis of economics is impressive for someone of your age.


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## Sherman (15 Jun 2006)

> i do not understand if the fed raises interest rates why does it have a effect on the whole world.


 
Oil, and most other commodities, are traded in dollars. Interest rates in US rise = dollar increases in value versus other currencies = dollar-priced commodities become more expensive for non-dollar economies.


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## Remix (15 Jun 2006)

Good posts CGorman. But please don't forget to read the small print in the back of your Irish Economics text book regarding inflation and 
higher interest rates.

It should say there that the normal rules apply to the rest of the world and not Ireland. Here, high inflation is a healthy sign of our growth. We need surging growth figures coupled with inflation, tons of personal borrowing, giveaway budgets and runaway house prices. And at the same time hope interest rates don't rise.

This is the successful approach that we keep telling the rest of europe to follow but for some reason they don't appear to listen.


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## darex (15 Jun 2006)

PMU said:
			
		

> CGorman: A very insightful post, but you must remember that  “_*Inflation is Always and Everywhere a Monetary Phenomenon*_*”*. So said economist Milton Friedman and he won a Nobel Prize for that. The ECB says it as well. Once you increase the supply of money faster than the economy can create value you get inflation. It’s nothing to do with cost push, e.g. from energy and services. That just reflects inflation, it doesn’t create it. Inflation is never beyond our control. That’s what monetry policy is about, and you can read up on monetary policy on the ECB’s web site www.ecb.int.



I think this mis-represents the case somewhat. The presence or abscence of inflation is due to changes in the ratio of money to available goods. Hence you can create inflation either by holding the quantity of available goods constant and increasing the amount of money in the system or by reducing the amount of goods and keeping amount of money constant. So if you limit the amount of oil coming into the system and keep the supply of money constant you get inflation - hence rising oil prices are causing inflation (I.e Limited supply is causing inflation). 
The ECB will consequently have to reduce (or slow down the increase of) the money supply to prevent inflation.


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## CGorman (15 Jun 2006)

Remix said:
			
		

> And at the same time hope interest rates don't rise.



Hopeing does'nt sound like a very solid econmic policy! I know people who spend their lives hopeing to win the lotto - but no amount of hopeing will do it for them!  



			
				Remix said:
			
		

> This is the successful approach that we keep telling the rest of europe to follow but for some reason they don't appear to listen.



If the rest of Europe copied us then tax competition would wreck havoc on government budgets; aggregate borrowing would be frightening and there is simply a limit to the success of our economic model - Ireland has boomed in recent years by taking in as much as 25% of US FDI in the EU but we only having 2% population; for all of Europe to experience this level of FDI, US investment in Europe would have to be 5000% (50 times) more than it is currently! The absurdities of the Irish economy only exist because of our relative insignificance to the EU as a whole... Put another way - the GDP of Gort, County Galway could average €500,000 per capita (it does'nt) yet national GDP would remain at about $48,000 as it is presently.  But I do agree with your point in general - i.e. "I know what you mean". Europe needs to cut red tape, foster business, and basically open the econmoy more.



			
				PMU said:
			
		

> Inflation is never beyond our control.


What a ridiculous thing to say! Have you never heard of hyperinflation? Anyways inflation is only a theoretical thing - as is the entire subject of economics. You are right in the sense that inflation can be up'd or down'd by monetary policy; but this is at the expense of other economic aims. Did you ever hear of the Phillips Curve?



			
				PMU said:
			
		

> but you probably failed your Leaving Cert


PMU, this is a discussion fourm for debating ideas - you obviously disagree with my opinions; but there is no need to cut me like that. I may not have a degree yet, or a masters in the subject; but I am an entirely self thaught student of economics and it was my best result in the mocks (83%); in addition I do Business and Accounting. I also run a business and have been an avid reader of _Fortune, Business Plus_ and especially _The Economist_ since as young as age eleven. I have read countless books on the subject and related areas rangeing from _Wealth of Nations_ to _Freakonomics_. Yes I am an amateur and my opinions may not be aligned with yours - but please do not react so poorly. What qualifies you above me to theorise about this subject? Are you an economics teacher, have a degree in it? Or are you just like myself, a person with an interest in the topic.

By the way, I  refrained from expressing my opinions in the essay - I stuck to safe text book stuff! 

Thanks ivuernis, remix and Duplex for your responses.


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## bearishbull (15 Jun 2006)

so oil is rising due to too much money?? could it not be demand and speculation that is driving commodity prices higher or is it purely due to  global liquidity situation?

its alright saying inflation is purely a monetary phenomenon but here in euro zone we have no control over non ecb monetary policy and hence on imported inflation,in a globalised world with many differnt currency/monetary systems inflation can be out of policy makers hands .


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## shnaek (15 Jun 2006)

Remix's comments were tongue in cheek I am sure!


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## room305 (15 Jun 2006)

bearishbull said:
			
		

> so oil is rising due to too much money?? could it not be demand and speculation that is driving commodity prices higher or is it purely due to  global liquidity situation?



It is certainly a factor, globally people and companies shrugged and absorbed the rises with a little grumbling. There was no real change in the demand side of the equation. Compare this reaction to the oil crisis in the 1970s. As money is sucked out of the economy by interest rate rises, fewer people will be able to absorb the high energy costs and will look to reduce their demand for the goods.

That said, I agree with your comment, it is not fair to say inflation is purely a monetary phenomenon and can be dealt with solely by monetary policy. Central bank chiefs are now expected to act like politicians as much as economists.


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## PMU (16 Jun 2006)

If you are interested in inflation as a monetary phenomenon you should check out the Wikipedia entry that gives as good explanation as I could.  http://en.wikipedia.org/wiki/Inflation http://en.wikipedia.org/wiki/Monetarism

To get back to evoke’s original question: 


			
				evoke said:
			
		

> i do not understand if the fed raises interest rates why does it have a effect on the whole world. i know when america does bad, europe does bad .but the whole world. they must have a huge grasp on the world. why is that. /quote]
> One reason the Fed’s decisions on monetary policy affect the whole world is simply that about 45% of the world’s total investible assets are denominated in US dollars (i.e. US dollar denominated bonds (19%), US equities (21%) and US real estate (5%)).  Changing interest rates changes the relative returns between bonds, equities and real estate thus altering prices, which are set by the market. This also affects prices elsewhere in the world as Americans or anybody else won’t hold equities unless the market rewards them for the extra risk in doing so.  So changing interest rates affects the yield on bonds that then affects decision making on equity investment, and interest rate changes affect decision making in real estate investment by changing the price of mortgages.


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## Canonball (16 Jun 2006)

Perhaps our learned economists and wannabees out there can explain the significance of the latest weak export figures (see attached CSO release today), taken together with the recent (and probably forthcoming) increases in inflation. The figures show that the period 1996-2001 showed huge growth in exports (value terms), whereas the export performance for the period 2001-2006 has been very very weak (with 2006 looking like being another disappointing year judging by the Jan-Apr figures). How resilient can the exporting sector be now that inflation is taking off again (on top of an already high cost base)? If our export performance for the next 5 years is as bad as the last 5 years can we still stay pretty?      

[broken link removed]


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## bearishbull (16 Jun 2006)

Canonball said:
			
		

> Perhaps our learned economists and wannabees out there can explain the significance of the latest weak export figures (see attached CSO release today), taken together with the recent (and probably forthcoming) increases in inflation. The figures show that the period 1996-2001 showed huge growth in exports (value terms), whereas the export performance for the period 2001-2006 has been very very weak (with 2006 looking like being another disappointing year judging by the Jan-Apr figures). How resilient can the exporting sector be now that inflation is taking off again (on top of an already high cost base)? If our export performance for the next 5 years is as bad as the last 5 years can we still stay pretty?
> 
> [broken link removed]


As george lee pointed out in "BOOM" the last 5 years have been driven by an unsustainable property boom rather than the thing that makes countries rich -an export boom(like we had pre2001).the sucess of the economy in last 5 years is built on unsustainable growth in house prices ,building, unproductive (non export) jobs,consumer spending,and immigrant workers. 
The succesful appearance of this economy is a facade that hides the ugly true state of affairs.
As moor mcdowell said ,we cant get rich/stay rich taking in each other washing!


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## gearoidmm (19 Jun 2006)

Inflation is already here.  In America, the core inflation rate is >3%.  If you include energy and food prices (which of course you should, they affect everybody), the inflation rate is >5%.  Producer prices, import prices, everything is rising rapidly at the moment, just as the economy is starting to slow down.

In parallel, we are seeing a rapid rise in inflation here also which will only get worse as interest rates rise, increasing mortgage repayments.  The genie is out of the bottle.


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