This week has seen more moves to ease the Credit Crunch in the USA. The Fed has taken the drought in the money markets seriously, and has kept a big flow of liquidity available to ease the worst of the problem. The Term Auction facility is now up by another $50 billion to $150 billion. There are $100 billion of 28 day repurchase agreements, and $62 billion of reciprocal currency facilities with other Central Banks. There are some signs that rates in US money markets are falling from the extreme differentials of the worst of the Credit Crunch as a result of all this extra liquidity.
Now the jeremiahs are worrying that this will be bad for inflation, forcing higher interest rates ere long when the Fed realises the evil of its ways.
The latest figures for the US economy do not illustrate an inflationary problem. Over the year ended 31 March 2008 US productivity grew by a satisfactory 3.2%. Because people across the economy were working 3% smarter, with modest wage and salary rises overall, costs were under good control. Unit labour costs only grew by 0.2% for the year, hardly evidence of an incipient inflationary lift off.
The price increases are all coming from the price of food, energy and raw materials, which have been rising dramatically worldwide over the last six months. The surge in food prices is most alarming, as it is pricing the poorest out of their basic diets. The big rise in oil and other energy prices has a knock on effect to all prices of goods that need energy to produce them and energy to transport them.
The flooding of rice lands in Asia, the impact of the severe winter in China on agriculture and the demand for energy, and the diversion of crops for bio fuels have all helped force prices upwards. The Indian government is now seeking to stop â€œspeculationâ€ in food by preventing Indians buying and selling certain food based contracts. Several Asian countries are imposing export bans on staple foods.
These responses are understandable but they are not going to solve the underlying problem. There are â€œfinancialâ€ buyers of wheat and rice futures contracts, but it is difficult to distinguish a â€œspeculativeâ€ buyer from a trade user of such contracts. If just a few countries seek to ban trading in such items, the trade will continue elsewhere in the world. It is unlikely that Chicago will shut down its commodities trading markets, and if it did farmers would be up in arms as well as speculators. Nor will export bans solve the problem. The country that imposes an export ban on Item A will still want to import Item B and will be relying on other countries not imposing export bans. If too many export bans are put in place the world will become poorer, as trade will be damaged.
The shortages and high prices are squeezing us all, but they are especially bad news for the poor. The prices going up are the prices of the basics â€“ food and fuel. The answer has to be more production of both, to cater for the growing demands of a rapidly rising world population. The high current oil price is leading to more exploration and more oil finds. The high prices of grains should lead to more land going under the plough, and the adoption of more intensive methods of growing grains in developing countries. In the meantime the UN needs to redouble its efforts to help the poorest in the worst affected countries. The answer is not to move to protectionism, the system which intensified the slump of the 1930s.