The
global recession is still very much with us, despite
the recent attempts by media and some policy makers
especially in the North to dismiss it as almost over,
and to find some indications of the ''green shoots'' of
recovery in almost each item of economic and financial
news. But even as the downturn continues to cause trade
flows to decline, and jobs to be lost, some analysts
are already talking about the fears of a major inflationary
spiral once the global economy recovers.
Most of those who are raising this concern are those
who were opposed to countercyclical economic policy
measures in the first place. When governments in the
developed world, and especially in the US, came up relatively
rapidly with measures to provide huge bailouts to ease
bank lending in the face of the severe credit crunch
and lower interest rates, such critics argued that this
would release too much liquidity into the system and
therefore eventually create inflation.
They were even more opposed to fiscal expansion and
running large deficits to combat the liquidity trap
conditions that seemed to have emerged in core capitalist
economies. They insisted (and some like the German Chancellor
Angela Merkel continue to insist) that such a strategy
would simply generate more inflation. There was an implicit,
usually unstated, concern that the positive effects
of fiscal expansion would leak out through imports so
that other economies would benefit rather than those
in which the fiscal expansion occurs.
There are some obvious flaws to such an argument, which
fundamentally indicates a monetarist approach to economic
policy. In situations of unemployment and excess capacity,
government spending creates new effective demand that
then generates more output through a multiplier process.
Therefore new demand is met by new supply, and this
creates an output response rather than the price response
that is expected by monetarists. It is only in conditions
of full employment, or where there is some supply bottleneck
that prevents the multiplier process from running its
course, that any inflation would result. In any case,
the spectre facing the world a few months ago was one
of generalised deflation, or falling prices, and this
still seems to be happening in most major economies.
So this argument was misplaced.
However, while the basic premises of the monetarist
argument are wrong, this does not mean that the threat
of future inflation can be completely discounted. In
fact, it can be argued that even without a complete
revival of the global economy, and even as wage incomes
throughout the world continue to fall, there may be
upward pressure on certain prices in the near future.
In particular, global commodity prices - especially
those of oil and food - may well increase again in the
next couple of year.
The reasons for this possibility are very different
from those offered by monetarists. They are not even
related to possible imbalances between global demand
and supply. Instead, they reflect the continuing possibility
that financial speculation can cause sharp changes in
the prices of commodities in the world market.
Financial deregulation in the early part of the current
decade, especially in the US, gave a major boost to
the entry of new financial players into the commodity
exchanges, and allowed unregulated activity in commodity
futures markets, which became a new avenue for speculative
activity. The result was excessive volatility displayed
by important commodities like oil, minerals, food and
other cash crops over 2007 and 2008. As more purely
financial players entered these markets in search of
quick capital gains, prices in the futures markets soared
and drove up spot prices, in a process completely the
opposite of the risk-hedging role that futures markets
are supposed to play. The subsequent sharp declines
in prices were also related to changes in financial
markets, in particular the need of financial agents
for liquidity to cover losses elsewhere. These price
changes did not reflect real demand and supply at all,
since both scarcely changed over the year.
In food items, such volatility had very adverse effects
on both cultivators and consumers. It sent out confusing,
misleading and often completely wrong price signals
to farmers that caused over-sowing in some phases and
under-cultivation in others. Also, while the pass-through
of global prices was extremely high in developing countries
in the phase of rising prices, the reverse tendency
has not occurred as global prices have fallen. Both
cultivators and food consumers lost out because of extreme
price instability, and the only gainers were the financial
speculators who were able to profit from rapidly changing
prices.
The problem is that, despite the unfortunate lessons
delivered by the functioning of financial and commodity
markets in the past two years, the moves towards more
effective regulation are still hesitant and inadequate.
Even the recent document released by the Obama administration
in the US on financial sector reform does not adequately
come to grips with the need to control commodity futures
markets and prevent the kind of speculative activity
that has caused so much damage.
Meanwhile, it is also the case that banks and other
financial players are once again awash with liquidity
and looking for profitable avenues to invest in. Commodity
markets are once again ripe to be invaded by such players.
And prices in such markets can be talked up not only
by such investment but also by pliant international
financial media. If there are any short term supply
reductions in any major grain market, some poor harvests
because of adverse weather conditions and so on, the
chances are that prices in such markets will rise much
more and faster than is warranted by any supply shortfall.
This will be because of speculation, but once again
it will have very detrimental effects on the real economy,
especially in the developing world. And such price rises
will then force governments to focus on inflation control
rather than real economy revival.
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