Calories, Capital, Climate Spur Asian Anxiety

Higher oil prices mean lower rates from the Fed, and higher inflation rates induced by shortages mean stronger currencies abroad.

Why do I have so much trouble getting aboard this paradigm, and instead keep looking for reversals? Feels a lot like watching the NASDAQ go from 3500 to 5000 a few years ago.

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Calories, Capital, Climate Spur Asian Anxiety

2007-12-26 17:51 (New York)
by Andy Mukherjee

(Bloomberg) — The new year may be a challenging one for Asian policy makers.

Year-end U.S. closing stocks for wheat are the lowest in six decades; soybeans in Chicago touched a 34-year peak this week. Palm oil in Malaysia climbed to a record yesterday.

The steeply rising cost of calories may be more than just cyclical, notes Rob Subbaraman, Lehman Brothers Holdings Inc. economist in Hong Kong. Growing use of food crops in biofuels and increasing demand for a protein-rich diet in developing countries may have pushed up prices more permanently.

The wholesale price of pork in China has surged 53 percent in the past year.

“Consumer inflationary expectations may soon rise, feeding into wage growth and core inflation, but we expect Asian central banks to be slow to react, initially due to slowing growth and later because of strong capital inflows,” Subbaraman says.

If the U.S. Federal Reserve continues easing interest rates to combat a housing-led economic slowdown, a surge in capital inflows into Asia may indeed become a stumbling block in managing the inflationary impact of higher commodity prices.

Food and energy account for more than two-fifths of the Chinese consumer-price index, compared with 17 percent for countries such as the U.K., U.S. and Canada, and 25 percent in the euro area, according to UBS AG economist Paul Donovan in London.

As Asian central banks raise interest rates — when the Fed is cutting them — they will invite even more foreign capital into the region. That will cause Asian currencies to appreciate, leading to a loss of competitiveness for the region’s exports.

Carbon Emissions

On the other hand, paring the domestic cost of money prematurely may worsen the inflation challenge.

That isn’t all.

Higher oil prices will also boost the attractiveness of coal as an energy source, delaying any meaningful reduction in carbon emissions in fast-growing Asian nations such as China and India.

As Daniel Gros, director of the Centre for European Policy Studies in Brussels, noted in recent research, the price of coal — relative to crude oil — has been halved since the end of 1999. And per unit of energy produced, coal is a much bigger pollutant than oil or gas.

This doesn’t augur well for the environment.

“Given that China is likely to install over the next decade more new power generation capacity than already exists in all of Europe, this implies that the current level of high oil prices provides incentive to make the Chinese economy even more intensive in carbon than it would otherwise be,” Gros said.

Beijing Olympics

Climate-related issues will be in the spotlight in Asia next year. China’s eagerness to use the Beijing Olympic Games to showcase solutions to its huge environmental challenges will be one of the “big things to watch for” in Asia in 2008, Spire Research and Consulting, a Singapore-based advisory firm, said last week.

Even if China succeeds in reducing air pollution during the Olympics, the improvements may not endure after the sporting event ends on Aug. 24, especially since the underlying economics continue to favor higher coal usage.

A drop in hydrocarbon prices might help check emissions and global warming, Gros noted last week on the Web site of VoxEu.org.

In fact, lower oil prices may also make food costs more stable by lessening the craze for biofuels.

That will leave capital flows as Asia’s No. 1 challenge in 2008. And it won’t be an easy one for policy makers to tackle.

Capital Inflows

Take India’s example.

The $900 billion economy has attracted $100 billion in capital in the 12 months through October, with a third of the money entering the country as overseas borrowings, according to Morgan Stanley economist Chetan Ahya in Singapore.

This has caused the rupee to appreciate more than 12 percent against the dollar this year, knocking off more than three percentage points from India’s inflation index, says Lombard Street Research economist Maya Bhandari in London.

Naturally, exporters are complaining.

So why doesn’t India cut domestic interest rates? It can’t do that without the risk of stoking inflation.

Money supply is growing at an annual pace of more than 21 percent in India, compared with the central bank’s target of between 17 percent and 17.5 percent. Inflation has held well below the central bank’s estimate of 5 percent for five straight months partly because of the government’s insistence on not passing the full cost of imported fuel to local consumers. It isn’t yet time for monetary easing in India.

China has it worse. Monetary conditions there remain dangerously loose. And China may be reluctant to do much about the undervalued yuan — the root cause of its record trade surpluses and the attendant liquidity glut — until the Olympics are out of the way.

Asian economies may, to a large extent, be insulated from the subprime mess. Still, 2008 won’t be all fun and games.

(Andy Mukherjee is a Bloomberg News columnist. The opinions expressed are his own.)

–Editors: James Greiff, Ron Rhodes.

To contact the writer of this column:
Andy Mukherjee in Singapore at +65-6212-1591 or
amukherjee@bloomberg.net

To contact the editor responsible for this column:
James Greiff at +1-212-617-5801 or jgreiff@bloomberg.net


Strong gdp and high credit losses

CNBC just had a session on trying to reconcile high gdp with large credit losses. Seems they are now seeing the consumer clipping along at a +2.8% pace for Q4. No need to rehash my ongoing position that most if not all the losses announced in the last 6 months would have little or no effect on aggregate demand. Credit losses hurt demand when the result is a drop in spending. And yes, that happened big time when the subprime crisis took the bid away from would be subprime buyers who no longer qualified to buy a house. That probably took 1% away from gdp, and the subsequent increase in
exports kept gdp pretty much where it was. But that story has been behind us for over a year.

The Fed is not in a good place. They should now know that the TAF operation should have been done in August to keep libor priced where they wanted it. They should know by now losses per se don’t alter aggregate demand, but only rearrange financial assets. The should know the fall off in subprime buyers was offset by exports.

The problem was the FOMC- as demonstrated by their speeches and actions- did not have an adequate working understanding of monetary operations and reserve accounting back in August, and by limiting the current TAFs to $20 billion it seems they still don’t even understand that it’s about price, and not quantity. Too many members of the FOMC
are mostly likely in a fixed exchange rate paradigm, with its fix exchange rate/gold standard fractional reserve banking system that drove us into the great depression. With fixed exchange rates it’s a ‘loanable funds’ world. Banks are ‘reserve constrained.’ Reserves and consequently ‘money supply’ are issues. Government solvency is an issue.

With today’s floating exchange rate regime none of that is applicable. The causation is ‘loans create deposits AND reserves,’ and bank capital is endogenous. There are no ‘imbalances’ as all current conditions are ‘priced’ in the fx market, including ANY sized trade gap, budget deficit, or rate of inflation.

The recession risk today is from a lack of effective demand. There are lots of ways this can happen- sudden drop in govt spending, sudden tax increase, consumers change ‘savings desires’ and cut back spending, sudden drop in exports, etc.- and in any case the govt can instantly fill in the gap with net spending to sustain demand at any level it desires. Yes, there will be inflation consequences, distribution consequences, but no govt. solvency consequences.

So yes, there is always the possibility of a recession. And domestic demand (without exports) has been moderating as the falling govt budget acts to reduce aggregate demand. But the rearranging of financial assets in this ‘great repricing of risk’ doesn’t necessarily reduce aggregate demand.

Meanwhile, the Saudis, as swing producer, keep raising the price of crude, and so far with no fall off in the demand for their crude at current prices, so they are incented to keep right on hiking. And they may even recognize that by spending their new found revenues on real goods and services (note the new mid east infrastructure projects in progress) they keep the world economy afloat and can keep hiking prices indefinitely.

And food is linked to fuel via biofuels, and as we continue to burn up every larger chunks of our food supply for fuel prices will keep rising.

The $US is probably stable to firm at current levels vs the non commodity currencies, as portfolio shifts have run their course, and these shifts have driven the $ down to levels where there are ‘real buyers’ as evidenced by rapidly growing exports.

Back to the Fed – they have cut 100 bp into the triple negative supply shock of food, crude, and the $/imported prices, due to blind fear of ‘market functioning’ that turned out to need nothing more than an open market operation with expanded acceptable bank collateral (the TAF program). If they had done that immediately (they had more than one outsider and insider recommend it) and fed funds/libor spreads and other ‘financial conditions’ moderated, would they have cut?

There has been no sign of ‘spillover’ into gdp from the great repricing of risk, food and crude have driven their various inflation measures to very uncomfortable levels,and they now believe they have ‘cooked in’ 100 bp of inflationary easing into the economy that works with about a one year lag.

Merry Christmas!


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