The Narrow Door to Containing Inflation
Al-Hayat - 03/03/08//
According to statistical estimates, last week's record oil barrel price of $103.05 was only nominal, as it slightly exceeded the peak price of $40 it hit 18 years ago which is equivalent to $102.53 in today's terms.
This means that the greenback has lost a little over 63% of its value against oil, a number of mineral and non-mineral commodities as well as agricultural crops. Consequently, the nominal face value of global wealth estimated in dollars, central and commercial bank monetary reserves as well as money held by institutions and individuals has diminished by the same percentage since 1980. This also implies that the prices of oil and fuel have inflated by 6.02% annually since then. This inflation has led to fake fortunes which gave rise to investment hysteria. Consequently, demand spiraled. So did prices, thus eroding wages, household incomes, business returns and savings.
The US economic quagmire has created global confusion with respect to growth since the quake instigated by the subprime mortgage crisis and its repercussions. This is not to mention the consequential losses incurred by international financial institutions, which according to experts have reached an estimated $500 billion. The crisis also exhausted the resources of capital markets and inflicted irreparable losses on big cap stocks. As a result, the confusion is now fueling fears in the economies of rich, poor and emerging economies, including the oil producing and exporting countries, especially with the depreciation of the dollar against major currencies, notably the Euro, the common currency adopted by many economic weights in the European Union.
The dollar depreciation eats at the global economy in two ways. Firstly, it increases inflation rates and halts growth, leading to economic distress and eventually sparkling fears of a decline in the level of human welfare. Secondly, it reflects on the value of currencies pegged to the dollar, as these currencies depreciate along with the dollar. Since these currencies are also linked to the dollar in terms of standard interest rates, their value moves along with the dollar whenever the US Federal Reserve cuts or raises interest rates.
Growth seems to be the primary global concern as revealed by the actions of central banks in major economies which are focusing their attention on inflation as it erases the outcomes of development and reduces growth rates. Concern over growth also intensifies since the per capita share of growth reflects the degree of self-sufficiency and the satisfaction of need. However, economists do not give much weight to GDP statistics, nor do they see it as an indicator of human welfare. A survey on living standards indicates, for example, that life in the west has been in a recession for decades even though GDP has increased threefold since 1958. Life conditions, moreover, have not changed since the 1950s despite the variety and diversity of entertainment means. Consequently, since 1990 the UN has been publishing the Human Development index to verify the quality of life standards and to create conditions for a dignified human life through healthcare, education and food.
The unprecedented record rates of global growth since the turn of the millennium have not meant better living standards for all. In general, the rich control the lion's share of GDP. Moreover, major fortunes tend to grow at rates much higher than the income growth of the self-sufficient, especially the wage earners and fixed income groups who constitute the vast majority of world population. Their wages shrink at inflation rates and are not adjusted according to inflation rates until years have passed, except for countries that adopt the flexible salary scales that move in parallel with compound high cost of living inflation indices.
The present inflation rates, partly resulting from the rising price of fuels and raw material and partly from the depreciating dollar, preoccupy governments and central banks in major economies that wish to control inflation and its implications on growth. Central banks in China and Russia are attempting to control inflation by raising interest rates on local currencies. The European Central Bank is keeping a watchful eye on the implications of crises and rising energy prices on European economies and so is the Bank of Japan. These central banks aim at absorbing the surplus liquidity by raising interest rates while facing the possibility of raising investment costs and sacrificing a few basis points in their previous growth rate.
Then there is the other concern for countries whose currencies are linked to the dollar. Tying their monetary policies to dollar fluctuations reflects in gains or losses for the value of their currencies. They are also forced to follow interest rate cuts on the dollar which leaves them with high inflation rates that exhaust their economies. These countries adopt a nominal fixed exchange rate system that pegs their currency to a major currency or a basket of currencies. This system, adopted by a number of Arab countries including the GCC countries, forces the central banks to interfere as the monetary authority either by selling or buying the local currency to stabilize exchange rate and resist pressures on the exchange rate. When current accounts rise, foreign currency inflows mount. As a result of transforming export returns to the local currency, pressures on the exchange rate increase forcing the central bank to intervene to reduce the appreciation of the domestic currency against the pegging currency by selling its currency and buying the pegging currency. This raises the level of foreign currency reserves and expands the money supply in its narrow sense, consequently leading to a surplus in domestic liquidity and unleashing inflationary pressures. More often than not, the central bank loses its ability to control inflation and neutralizes the monetary surplus by issuing treasury bills and certificates of deposit (COD) to absorb the liquidity resulting from foreign revenues, including those generated by oil.
As a result of this peg, central banks adopt a balance in inflation rates. Between 2001 and 2004 (according to the Unified Arab Economic Report - 2007), in response to the increase in international oil prices, the Federal Reserve cut interest rates on the US dollar. This led to lower interest rates in economies whose currencies are linked to the dollar such as the GCC economies. These developments fed the liquidity boom resulting from oil revenues and led to the conflict of goals: the goal of stabilizing exchange rates and the goal of stabilizing prices. Between the beginning of 2004 and the end of the second quarter of 2006, the Federal Reserve raised interest rates which neutralized the effects of rising oil prices on domestic liquidity.
Currently, GCC countries are facing the same phenomenon. They are facing severe inflationary pressures and a seemingly endless dollar decline. They are facing the same results as the US attempts to retrieve the value of its foreign currency consumption, whether it was the price of oil and fuel or useless wars!
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