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INFLATED BRIC!!!
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CONTENTS
Introduction
Inflated BRIC
Inflation and Policy Stance
Brazil
Russia
India
China
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Introduction
Chairman Bernanke's experiment with quantitative easing continues to have unintended
consequences for the global economy, due to the impact of the equation highlighted below:
QE2 = inflation [globally] = monetary policy tightening [globally] = slower growth [globally]
While prices for food and energy have been rising, inflation in the United States has remained
relatively subdued. One common explanation for that phenomenon is that U.S. inflation has
been "exported" to China and elsewhere through the U.S. Federal Reserve's monetary policy.
And given the perennial U.S. balance of payments deficit, it's good to know the country has
found something it can successfully export!
U.S. monetary policy has involved excessive money creation since 1995, fueling asset bubble
after asset bubble. However, it has not produced inflation in the United States because the
dollar is a reserve currency, so excess dollars flow to countries whose economies are more
vulnerable to inflationary pressures. However, the bad news here is that inflation does not stay
exported - and in 2011 it may boomerang back to make life on Main Street miserable.
In the 1990s, the excess dollars flowed to Argentina, whose currency was pegged to the dollar.
The imported inflation wrecked Argentina's sound policies of that decade and contributed to a
debt-fueled collapse in 2001.
Since 2008, the excess money has gone to China, India, Brazil and other fast-growing emerging
markets. It also has fueled a massive growth in foreign exchange reserves among the world's
central banks. Central bank holdings of forex reserve have grown more than 16% per annum
since 1998.
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Inflated BRIC
China, India, and Brazil all currently have massive inflation problems. China, which has
increased its inflation by holding down its currency against the dollar, has been very proactive
in tackling inflation as of late. The People's Bank of China (PBOC) surprised the markets on
Christmas Day by raising its one-year refinancing rate by 52 basis points to 3.85% and increasing
the benchmark deposit rate by 25 basis points to 2.75%.
The PBOC has increased bank reserve requirements five times in the past year and raised
interest rates twice - albeit by a scant 0.25% each time. China's official inflation rate currently is
5.1%, up from 1.5% at the beginning of 2010, but its figures are suspect. The PBOC probably will
have to raise its benchmark rate several more times from its current level of 5.81% before it's
able to bring inflation under control.
India's inflation is about 8.4%, but is expected to rise further since food prices are surging at
double-digit rates. Prices for onions, for instance, are up 33% from last year. The Reserve Bank
of India (RBI) is again raising interest rates, now at 6.25%. But, as in China, sloppiness in official
inflation statistics means Indian interest rates are negative in real terms and the RBI will have to
continue raising rates if it wants to control inflation.
Brazilian inflation was 5.91% in December and is rising fast. Newly elected President Dilma
Rousseff fired the central bank chief and is trying to bring interest rates down from their
current level of 10.75%. Again, inflation seems likely to surge in the near term.
To complete the BRIC (Brazil, Russia, India, and China) picture, Russian inflation is currently
running at 8.8%. That's down from a year ago, but still much higher than the Russian
government would like it to be. With inflation rising in all four BRIC countries and many other
emerging markets, the U.S. holiday from inflation cannot last much longer.
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The Fed's second round of quantitative easing (QE2), which included purchases of $600 billion
in Treasury bonds before July, and the December package of tax cuts are also fueling
inflationary forces. Money growth, which had been low in 2009 after the burst in late 2008, has
once again risen to worrying levels. Over the last four months, the average growth rates of
broad money on the Federal Reserve Bank of St. Louis' Money of Zero Maturity and M2 Money
Stock measures were up 10% and 7%, respectively. That's comparable to their growth in the
1970s.
Furthermore, oil prices are approaching $100 per barrel, and other commodity prices are
strong, as well. So however successful the Fed has been in exporting inflation since 2008, its
success won't last for much longer. At some point in 2011, inflation will be re-imported - and
probably with a roar rather than a whisper. When that happens, the Fed will have to raise
interest rates to fight rising prices. Of course, Federal Reserve Chairman Ben Bernanke will
almost certainly resist this inevitability, fudging figures and producing spurious arguments to
avoid making the right decision. When the Fed does eventually raise rates, it will do so
grudgingly - as it did during the period from 2004 to 2007. That means higher short-term
interest rates probably won't arrive until 2012, and higher long-term rates could potentially be
delayed by more quantitative easing. The result will be an unholy mess that takes the form of
surging inflation in 2011 and a second recessionary "dip" in 2012.
Gold and other commodities will continue to offer protection against the surge in inflation in
2011, as they have in the last few years. At some point, though, the market will start to
anticipate tighter Fed policy and gold and other commodities prices will collapse. If the gold and
commodities markets didn't believe the obviously serious Volcker would stop inflation until
several months after he took decisive action, they certainly won't have confidence in the
actions taken by a reticent Ben Bernanke. So your gold and commodities investments will
probably be pretty safe even if the Fed does eventually start raising rates.
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Inflation and Policy Stance
A brief review of global economic data points highlights struggles with inflation in three very
key countries: China, India and Brazil. While the divergence between each country's responses
reminds us that both inflation and monetary policy are local, analyzing them collectively allows
us to derive the equation laid out on first page.
Country: BRAZIL Policy Stance: Reactive Last fall, Brazil's monetary policy graded out less than favorably due to its relatively late
reaction (compared to China) in fighting inflation. But it appears Brazil is
finally ready to shift the fight into high gear in January,
after raising reserve requirements early last month.
Analysis of Brazilian interest rate swaps suggests
traders are betting bhike in benchmark Selic rate by
50bps to 11.25% in January.
New President Dilma Rousseff, has also joined thefight against inflation by taking action to cut
government spending by $15 billion. However, we see
that the Brazilian Congress just approved an increase
in the minimum salary – a metric that determines
both the nation's minimum wage and transfer
payments.
Given that a broad-based wage hike would augment already-robust
Brazilian consumer demand, we would expect to see more monetary policy tightening and
offsetting fiscal restraint elsewhere in the government's budget over the intermediate trend.
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Brazil's Manufacturing PMI came in at 52.4 for December, a 2.5
increase over November's 49.9 reading. Brazil is in a setup very similar to China: while we have
conviction that growth will continue to slow throughout the first half of 2011, it is robust
enough to continue providing demand-side inflationary pressures.
Country: RUSSIA Policy Stance: Active Russia may need to let its currency rise to curb inflation and that the government should begin
withdrawing its huge fiscal stimulus. A return to a policy of resisting nominal ruble appreciation
could send inflation back to double-digit levels. Monetary policy should focus firmly on inflation
control in the context of a more flexible exchange rate.
Russia’s central bank, which has sharply reduced the
extent to which it steers the ruble to lessen the
effects of currency moves on producers, still
prioritizes exchange-rate stability over inflation.
Also, inflation in the world’s largest energy
supplier shouldn’t exceed 5 percent to 7
percent in the coming three years. Russia
doesn’t have a strategy for the removal of
stimulus and doing so will not be possible
without reinvigorating long- delayed public-
sector reforms. International comparisons
suggest the nation can make significant savings
in health and social protection adding that the
pension system isn’t financially viable without a
comprehensive overhaul, including a gradual increase
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in the retirement age. Russia’s authorities previously expected to start withdrawing stimulus
this year, and to gradually lower the non- oil budget deficit to 9.5 percent of gross domestic
product by 2012, from 13.75 percent of GDP in 2009. However, with the recent supplementary
budget, there is instead a small further expansion in 2010, and the authorities also appear to be
revisiting the planned pace of consolidation over the medium term. Russia’s GDP is projected to
increase 4.25 percent in 2010 and inflation to remain relatively subdued, reaching 6 percent at
the end of the year. Still, with limited prospects for further increases in oil prices over the
medium term, the nexus of strong growth in investment, productivity, real wages, and
consumption that powered the pre-crisis growth is unlikely to materialize any time soon.
Country: INDIA
Policy Stance: Inactive
India continues to lag in its bout with taming inflation, opting instead for the "wait and see"
approach with regard to implementing another rounds of tightening. Having shifted from his
hawkish stance (six rate hikes in 2010 and 1 in Jan 2011) to a more relaxed position. That would
be fine if India had inflation under control.
Unfortunately, the latest wholesale price index (WPI) reading of +8.4% year-over-year suggests
India is far from achieving its target of +4-4.5% inflation. It is, however, a marginal improvement
nonetheless, though expecting an additional +300bps drop from here absent any further
tightening would be reckless at best. Moreover, food inflation continues to plague the 828
million Indians who live on less than $2 per day, with the PPP accelerating to +14.44% year-
over-year in the second week of December.
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Compounding this blatant lack of vigilance is the RBI's decision to add fuel to the fire by buying
back government bonds from Indian lenders with the intention of increasing liquidity in a cash-
strapped banking system that has been struggling to meet demand for loans. In December, the
RBI pumped nearly 414 billion rupees ($9.3B) into India's financial system via sovereign bond
purchases (a.k.a. Quantitative Easing).
Fueling speculation when inflation is running at nearly twice the target rate is not our idea of
prudent monetary policy. We expect further tightening ahead. This is one of the reason, we
expect Indian equities bearish over the intermediate-term trend. we can be bullish on many
commodities like corn, sugar, oil, etc. as countries like China and India look to accelerate
food and energy imports to ease any supply shortages. India's food
price index had risen for the fifth straight
month to 18.3% in late December, its
highest in more than a year, while fuel
prices climbed 11.63%, government data
last week showed. Food makes up a little
over 14% of the wholesale price index,
while fuel contributes about 15%, and a
quickening or softening in these
components will put pressure on the
headline figure in either direction.
Industrial output in November rose a
slower-than-expected 2.7% from a year
earlier, sharply lower than the previous month's
revised annual growth of 11.3%, government data.
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The central bank is expected to raise its key rates by 25 basis points at its policy review on
January 25, in its efforts to squeeze inflation back to its projected level of 5.5% by end-March.
The RBI had raised its key rates six times last year and by another 25 basis points in Jan 2011.
Country: CHINA
Policy Stance: Proactive
On a relative basis, China has been particularly proactive in its fight with inflation of late, hiking
interest rates twice in the last 2.5 months, raising banks' reserve requirements, and announcing
potential price controls and supply rationing in its food market. China has
proactively fought speculation and its latest Purchasing
Managers' Index (PMI) report shows early signs
of success.
Manufacturing PMI, a proxy for demand,
slowed in December to 53.9 vs. 55.2 prior withthe Input Prices component backing off a 29-
month high, coming in at 66.7 vs. 73.5 in
November. Dampening some of the positive
headway made in the report was acceleration
in Non-Manufacturing PMI to 56.5 vs. 53.2
prior, which suggests Chinese monetary policy
has more, tightening to do before growth has
slowed enough to rein in both inflation and
inflation expectations.
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