Central Bank Woes: Inflation Risk and Economic Lows

On any given day, central banks of the industrialized world face numerous challenges, the latest being skyrocketing food and energy prices caused by global imbalances between supply and demand. It is great that global demand is pushing world economies forward. However, as the supply also lags, prices surge, as does the risk of inflationary ripples adversely impacting economies in both developed and developing countries.

Commodity prices are the main culprit, particularly food and energy, as the emerging markets pump up the demand, while the rest of the world struggles to keep up the pace. In China, for example, the country’s newfound prosperity is sending its citizens to grocery stores, car dealerships, homebuilding sites, etc. Unfortunately, monetary policy makers both in the demand and the supply hotspots appear sadly unprepared for dealing with global inflationary threats.

Granted, the financial markets turmoil has thrown economies all over the world out of whack. The worst was experiencing a major shift in the global economic balance, with the U.S. economy slowing down more than anyone could have expected (although somebody should have!). Add to that the unrelentingly steep growth curve of the emerging markets and we could end up with an inflationary disaster of global proportions. It’s no wonder that central bankers are losing more and more sleep as of late.

Talking about what is already happening is an exercise in futility, unless we can estimate when, how and if things are to settle down. One plausible scenario is that the slowdown in the U.S. is likely to cause slowdowns in many other economies. In turn, those secondary and externally caused slowdowns are likely to ease the demand for commodities, thus somewhat easing the grip of surging prices.

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Yet, the International Monetary Fund (IMF) begs to differ, stating that the demand for commodities is not even close to tapering off. To illustrate, in China, inflation is at 7.1% or at an 11-year high, while in India, inflation is dancing around the five-percent level. Furthermore, the emerging markets are not the only ones dealing with the effects of surging food and energy prices. In the U.S., for example, inflation has hit four percent, while in the European Union it averages about 3.2%.

There is another worrisome effect of rising prices and inflation. Central banks are becoming increasingly worried about the negative public sentiment with respect to the job they have been doing, or rather the lack of it. Meaning, if prices and inflation are surging and central banks are merely playing catch-up without effecting any real change, what is their purpose then?

According to Jean-Claude Trichet of the European Union’s central bank, “The difficulty in the present juncture is disentangling what is structural and what is conjectural.” In other words, Trichet wonders how much of the global trend has been caused by structural imbalance between demand and supply, and how much of it has been the consequence of jittery traders, spooked investors and the existence of the overall state of fear. I’m afraid no disentangling will be necessary this time around because what has been going on lately in global markets is the result of both structural and conjectural shifts, neither of which is likely to resolve itself easily and without serious uphill battles.