The Federal Reserve maintains that its aggressive easing campaign is not posing a significant risk of an inflationary blowback. In making this case, the Fed argues that while the U.S. dollar is in fact considerably weaker, a declining exchange rate has not been strongly correlated with rising inflation in recent decades.
But that’s a difficult case to make when you consider the many countries in the developing world that are attempting to quell the local inflation that has resulted from ties to a depreciating dollar.
The inflationary impacts of monetary policy take a long time to be felt in the sophisticated U.S. economy. But they feed much more rapidly through the economies of developing countries, where average contract lengths are shorter and pricing structures are less mature.
Most striking has been the shift in Chinese currency policy. After years of battling U.S. politicians, who (wrong-headedly) claimed that the yuan’s dollar peg amounted to an unfair export advantage, Chinese authorities have initiated a steady appreciation of their currency versus the dollar. As China’s central bank governor recently put it, a stronger currency “helps to rein in inflation.” China’s consumer price index, which a year ago was running at less than 2 percent year-over-year, is now close to 6 percent. In 2008 the yuan has strengthened by more than 3 percent against the dollar, although the yuan price of gold is up some 40 percent since early last year.
A number of emerging economies in the Middle East and Southeast Asia are putting similar policies in place. Vietnam, with a 12-month inflation rate of more than 15 percent, is instituting a steadily more aggressive currency-appreciation strategy. On a four-week annualized basis, the dong is now strengthening against the dollar at a rate topping 7 percent. A month ago, the rate was only 1 percent. Indonesia, with an inflation rate of more than 7 percent, has allowed the rupiah to strengthen nearly 3 percent since January. In Singapore, where inflation is approaching 7 percent, up from about 0.2 percent a year ago, the Singapore dollar is up by about 5 percent since late last year.
The inflationary price of pegging to the dollar also has become increasingly difficult to bear in some Persian Gulf states. In the United Arab Emirates, rising inflation sparked riots in Dubai late last year. Saudi Arabia, which has maintained a steady peg to the dollar, has seen its cost of living rise 7 percent over the past year, versus a 12-month rate of 3 percent a year ago. So far, only Kuwait has abandoned its dollar peg, but others are considering it.
There is some confusion as to the source of this inflationary uptrend. Some analysts point to rising prices of oil and other commodities, as if this were an exogenous factor unrelated to monetary conditions. While it’s true that real demand has played some role in the commodity-price run-up, it’s unlikely that demand will remain a major factor with global growth widely expected to cool.
For dollar-denominated commodities, it’s the weakening of the unit of account — that is, the dollar itself — that has caused much of the rising price trend. As described, the most significant inflationary consequences of a depreciating dollar are now being witnessed in non-U.S. venues that are closely tied to the dollar. But the U.S. economy is highly unlikely to escape unscathed. As it stands now, U.S. inflation is already shifting to higher levels — with core consumer prices at 2.5 percent year-over-year and headline prices running at 4.4 percent.
The Fed-engineered erosion of the dollar’s purchasing power still hasn’t hit home in a big way. But that doesn’t mean it’s not coming. While some developing countries are taking steps to manage their currencies to mitigate imported dollar inflation, the European Central Bank is offering no signs that it intends to weaken the euro. Until it does, on a trade-weighted basis, the present dollar weakness should continue.