Think Inflation in the U.S. Is Bad? Listen Up

Includes: EEM, GMM, PXH, VWO
by: The Sovereign Society

By Jack Crooks

Think your gas and grocery bills are bad? They're just a drop in the bucket compared to some other places around the world.

For example, year-over-year consumer prices in Vietnam just surged by a whopping 26.8%. The month-over-month numbers jumped a cool 2.1%. To put that in perspective, 2.1% inflation is what the Federal Reserve considers a comfortable pace for inflation for the entire year.

The biggest problem facing the Vietnamese government is figuring out how to keep rising food and energy prices from derailing their roaring economy. Sound familiar? If so, then you know Vietnam isn't the only country facing this problem - not by a long shot.

In fact, according to my research, there are over 50 different countries around the world battling double-digit rates of inflation. Like Vietnam, most of these countries are emerging markets. And all of them are at risk of transforming from an appealing growth story to an economic disappointment.

In sharp contrast to the Federal Reserve here in the U.S., central banks in key emerging markets around the world are proactively working to counter inflation. You may be surprised to learn how their currencies have responded. Let me explain...

Learning from the Fed's Ignorance

After witnessing how the Fed shredded the dollar's value and slammed stocks by ignoring inflation, emerging market central banks are stepping up to the plate:

  • We know that China is already making strides with its currency. Interest rate increases highlight their efforts.
  • India's central bank raised its benchmark rate by 50 basis points, to 8.5% with immediate effect. That's its highest rate since March 2002 and the second increase this month. It also signaled that it would act again if needed.
  • The State Bank of Vietnam sharply raised its benchmark interest rate to 12% from 8.75%. That's an aggressive effort to curb surging inflation and tighten lending. Commercial banks are now allowed to offer depositors rates of up to 18%.

Interest Rates: The Quicker Currency Picker Upper

Will this bias toward tightening monetary policy spark a new emerging market Forex rally? Adjusting monetary policy to fight off inflation should normally support a country's currency. The logic here is that interest rates are going up and the investment appeal rises with it.

Mexico's peso strengthened to a five-year high after the central bank unexpectedly raised its benchmark interest rate a quarter percentage point to 7.75%. The same thing happened in Brazil. Bonds also rose because investors gained confidence that the proactive monetary policy would curb inflation and help preserve the value of debt's fixed payments.

Bottom Line: Monetary policy has been too accommodative and must respond to the growing inflationary environment. The rising prices will require that most emerging market central banks take action. By working to strengthen the currency's value they can hope to ease the strain of crude and food costs.

The line in the sand is quite fine. That's going to make it easy to scrutinize the efforts, or lack thereof, central banks take to counter inflation.


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