Understanding The Inflation Merry-Go-Round

Posted on March 22, 2011 in Specials


By Ankita Verma:

Unless you are living under a rock, you would have undoubtedly heard the deafening noise of inflation. By inflation, I don’t just mean the pinch in the pocket we felt with the onion prices hitting Rs 70 per kg till about a month ago. Inflation is a much more global phenomenon with widespread repercussions. One blames not only the regional issues or decades of oppression, but the rising inflation of agricultural products in United States for the Arab Crisis. And no, it isn’t as far-fetched as it may sound in the first go. Citizens in Algeria marched to the capital chanting, “Bring us Sugar!”, and the protest spread from country to country, a pattern which can’t be explained by local conditions alone. After all, the world’s poor are the hardest hit by food-price inflation.

So did the food inflation happen suddenly? Definitely not. We just noticed it too late. The retail price of food items is affected firstly, by cost of agricultural commodities and secondly, oil. Throughout the last year, a belligerent US economy, keen to get back on the path of recovery, bid heavily for global goods like oil and food. It led to soaring commodity prices. Foreign central banks were forced to increase supplies of their own currencies to soak up the US dollar liquidity. Emerging economies like India bore the brunt of it with inflation reaching record high figures. But the worldwide inflation has gone back to bite the U.S. as it is forced to buy food commodities at highly inflated prices. Plus the surging price of oil, thanks to the Arab crisis, means that the inflation merry-go-round will continue to spin.

To add to it, the U.S. Government recently mandated that ethanol is to be an additive in gasoline. How does it link to inflation? The demand for ethanol has risen dramatically. Refineries in the United States produce ethanol from corn. If crude oil prices continue to rise, then demand for corn for ethanol production will also rise likewise. Corn is necessary component of the farm sector, as almost every farm animal raised in US is force-fed corn. Using food crops to make bio-fuels in the situation of food shortages and prices going through the roof, defies logic.

All this makes America’s food inflation crisis now imminent, a fact reiterated by The National Inflation Association (NIA). It announced in its November 5th, 2010, food price projection report that food inflation would take over as America’s biggest crisis in 2011, surpassing the mortgage crisis and high unemployment.

More food for thought: It is believed that inflation is only set to rise now. 2010 saw a dramatic rise in worker wages throughout China. After years of widespread perception that China has a bottomless store of cheap labour, protests, strikes and general worker’s dissent, has forced companies to raise their salaries by as much as 50%. As it is now termed by Nobel Laureate Sir William Arthur Lewis, China has reached its ‘Lewis Point’ and it will have a cascade effect worldwide. What exactly is the Lewis Point? It is a state when a nation runs dry of its cheap labour and employers are forced to increase wages and benefits out of compulsion. This is a classic case of demand-push inflation.

The developing world has gained ground in consumption, fuelled by economic growth and industrialization. As the standard of living rises in the developing nations, so too does the demand for resources. If the world’s two biggest economies are heading to an inflation crisis, what can be said for the remaining world?

Image: http://www.ekcupchai.com/2011/01/02/rising-prices-%E2%80%93-the-ugly-truth/