The Global Dissemination of U.S. Inflation

The U.S. central bank has pumped a lot of liquidity into the world economy over the last four years, as a result triggering a synchronized world-economic recovery, in which all of the countries of the world have participated, except three. This excess liquidity from the epicenter ultimately found parking spaces at the periphery:

(1) As foreign-exchange reserves of emerging market countries [EM] – BRIC, Middle-East and LatAm.

(2) In numerous asset classes such as gold, commodities, oil and the euro,

In a fixed-exchange rate regime, the currency is prohibited from rising, which compels central banks abiding by this rule to intervene on their respective forex markets by providing domestic currency in exchange for their exporters’ dollars. The by-side product of this fixed-parity regime resulted in an extraordinary creation of the yuan, dinar, peso, dirham, rubble, etc. As a consequence, inflation - a monetary-driven phenomenon - has been exported from the epicenter (the U.S.A) to the countries at the periphery (emerging markets), which are now experiencing an uncontrolled acceleration of their domestic inflation rates (6.25%).

Will this emerging market inflation feed back into the heart of the world's largest economies (G7) and especially into the U.S., as the November data seem to suggest (+4.3%), via a lower dollar, higher oil and commodity prices, the un-pegging of several EM currencies and export-price inflation from China/India? Most investors would rush into concluding yes. Not so!

But for EM’s inflation to crawl back into the U.S. economy, three conditions need to be met:

(1) The recovery in commodity and oil prices needs feeding through producer prices. It does.

(2) The recovery in wages needs exceeding productivity growth. Unlikely.

(3) After the inflation disaster of the 1970s, the Fed is not likely to move back to a former “growth management” policy. A sure thing.

Conclusions

The United States has successfully exported abroad their subprime and inflation risk.

The U.S. will now come out first with the winning macro-combination - low inflation and soft growth, i.e., goldilocks.

Europe has somewhat shielded itself from radiation thanks to Fortress Euro.

But emerging markets and asset classes at the periphery will all be devalued by excessive inflation.

My take? Short the periphery, long the epicenter.

Comments

[Georealist]

Let's start with the foundartion assumption..the US "exported" inflation. My take is no country can export anything unless there is a willing buyer. Other countries (ie, China) buy into the system because the benefits far outweigh the deficits.
Subprime is a disaster....and is going to have a great many political repurcussions politically (it could well be the most influential factor in the 2008 Presidential election)...BUT..no one can "export" it..foreign banks and financial institutions bought into it because there was a profit to be made.

[LG]

georealist,

the exportation of inflation comes from the injection of liquidity in the excesive dolarized economies. The rate cuts of the fed also has consecuences in the developing countries, where politicians applies policies which atracts the liquidity excess trough local currency devaluations, for example.