Greg Ip

Articles by The Economist’s U.S. Economics Editor

Inflation lessons from the Asian crisis

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Feb 9th 2011, 23:01 by G.I. | WASHINGTON

FOR those convinced that America is on the verge of becoming Weimar Germany, the high price of oil and gold are exhibits one and two. Often forgotten is the fact that both are traded in global markets and reflect global, not American, demand. Failing to appreciate the distinction can lead to policy mistakes. Just look at 1998.

A financial crisis tipped east Asia into a deep recession in 1997-98, which spread to Russia and then the United States via Long Term Capital Management. To cushion the spillover to America, the Fed first aborted a nascent monetary tightening cycle, then actually cut interest rates. It could do so in part because collapsing Asian demand crushed the price of oil, sending headline inflation below 2%.

We now know that between cheaper oil and the Fed’s rate cuts, the Asian crisis was ultimately a positive for an economy already operating below 5% unemployment. Growth, and with it the stock market, went into overdrive. The result was the Nasdaq bubble.

Today, we have the mirror image. Surging demand in emerging markets that are at or near capacity has driven up commodity prices at a time when America is awash in unused capacity. Buying gold as an inflation hedge makes a lot of sense, if you live in China or India.

Just as the plunge in the price of oil in 1998 did not signal deflationary pressure in America, its rise today does not signal inflationary pressure here, unless it works its way into expectations and wages, of which there’s no sign yet. (The 0.4% rise in hourly wages in January looks weird; for now, I’d discount it.) In fact, it could do the opposite: by draining more American purchasing power to overseas suppliers, higher oil prices leave less money to spend on stuff made in America. (America is a net food exporter so higher food prices are positive for American growth.) If the Fed were to tighten monetary policy today in response to Asia’s inflation problem, it could be the opposite of the mistake it made in 1998, compounding a deflationary shock at a time when the economy is significantly below potential.



Written by gregip

February 9, 2011 at 6:10 pm

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