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The Return of Global Inflation

How is global inflation affecting world economic development?

August 1, 2008

How is global inflation affecting world economic development?

In emerging markets, inflation has generally risen. This is not because emerging markets have sloppier monetary management than developed countries.

Rather, it is because emerging markets are more exposed to commodity and energy price rises, given that more of their citizens are impoverished and spend a high proportion of their incomes on commodity-related items.

Looking at the four BRIC countries, we find one monetary failure, two countries struggling with the problem — and one surprising success.

The failure is Russia, a country blessed in this decade with every advantage — and even so managing to forge an economic trajectory leading directly back into poverty. Russia’s inflation is currently 14%, while its benchmark interest rate is only 11%.

In addition, that inflation rate is heavily understated. Furthermore, Russia pursues policies of property confiscation and arbitrary state action increasingly worthy of the worst be-medaled Latin American caudillo.

Once oil prices fall back, it is quite likely that Russia will fall into a combination of high inflation and deep recession that will enrage even the battered Russian populace.

The two countries struggling with inflation are India and China. Neither of them is tackling inflation effectively. In India, inflation is running at 12%, compared with a benchmark interest rate of only 9%.

Furthermore, India is attacking the problem with price controls and government subsidies, which are having their usual effect of distorting the economy (making Indian oil refining an economically ever more suicidal business). The government is also running a huge budget deficit, even at a time of massive economic boom.

In 2009, the Indian electorate will be given the chance to go to the polls — and possibly undo their mistake of 2004, when they threw out the BJP government of Atal Bihari Vajpayee.

That government was the only truly free-market government India has ever had. Unfortunately, Mr. Vajpayee has retired — and it remains to be seen whether the new BJP leaders are as committed to the free market and as economically competent.

Irrespective of that, a re-election of the Congress Party coalition would almost certainly prove troublesome in economic terms, particularly as the reformist Prime Minister Manmohan Singh is already 76 years old.

In the case of China, inflation is nominally 7.1%, but that figure is distorted by subsidies — and almost certainly artificially suppressed due to the upcoming Olympics. In any case, interest rates at 7.47% are far too low to have any beneficial effect, particularly as returns for savers are only around half this level.

In both India and China, while property rights are safer than they are in Russia, savers are losing ground all the time even before tax — not a recipe for a healthy economy.

Before turning to the last — and surprisingly well-governed — BRIC, consider two other countries’ examples which may be illuminating.

First, Vietnam has inflation of 27%, but that is almost entirely imported. Its benchmark interest rate is only 14% — and its economy is highly unstable. It runs a trade deficit of 30% of GDP, balanced by a foreign direct investment inflow of 65% of GDP.

While theoretically Vietnam is not doing enough to stem inflation, in practice its economic position is so singular it may find inflation an inevitable price of improving rapidly the living standards of its people.

The country has a real estate boom, as one would expect given its negative real interest rates. But overall, its problems are mostly those of success. It seems likely that an end to the world commodities bubble will also cool inflation in Vietnam.

Second, take a close look at Dubai. It has enjoyed a construction and tourism boom on the back of record revenues to the Gulf region and the oil-rich United Arab Emirates, of which it is a part.

It has used the money to build ever more extravagant prestige construction projects, including the world’s only seven-star hotel, the world’s tallest building, an $82 billion aerospace project to include the world’s largest airport — and a recreation of a world map in the harbor.

With only 0.02% of the world’s population, and expatriates representing 80% of its workforce, Dubai employs 10% of the world’s tower construction cranes. Its inflation rate is 22%, while long-term mortgages are available there for 7%.

Needless to say, the construction boom is proceeding without hope of restraint. After all, the country has combined the monetary policy of Ben Bernanke on steroids with the building frenzy of the 2006 Florida condo market.

Provided oil prices drop back to any kind of long-term equilibrium, Dubai has to worry about becoming the mother of all construction crashes. There is reason to worry that, by 2010, one can expect it to be a forest of half-completed concrete, with 10% residential and commercial occupancy rates.

Finally, for the surprise performer, let us examine Brazil. In the past, the country has indulged in the typical Latin American follies of excessive government spending, wild borrowing sprees, hopelessly sloppy monetary policy leading to hyperinflation — and inadequate protection of property rights, particularly foreign property rights.

Now, things are remarkably different. Foreign debt has been cut in half as a percentage of GDP since 2002, while the government’s finances are in only modest deficit. Foreign investment is encouraged and its rights protected.

Most impressively, while inflation is around 6%, because of high commodity prices, the benchmark Selic interest rate has just been raised to 13%. At that level, inflation will be squeezed out of the system and excessive borrowing will be discouraged.

Thus, when the commodities boom — from which Brazil has benefited — deflates, the country will be able to lower interest rates and continue domestic expansion without fear of running out of money.

The Nobel Committee really ought to consider giving a prize for monetary policy. From the above survey of mild to extreme inflation-producing sloppiness, there can be no question that Brazil would win it — and deservedly so.

Editor’s note: This feature has been adapted from an article that first appeared on “The Bear’s Lair,” published on the website


Of the four BRIC countries we find one monetary failure, two countries struggling — and one surprising success.

In the past, Brazil has indulged in the typical Latin American follies of excessive government spending and hopelessly sloppy monetary policy.

The Nobel Committee really ought to consider giving a prize for monetary policy.

Russia's performance is a failure, even though it has been blessed in this decade with every advantage.