The Search for A New Global Equilibirium

written with Dr Alexander Mirtchev

For as long as there has been the systematic issuance of currency, there have been governments keen to control that currency. Some policies, of course, have been effective, while others decidedly less so.

Exemplary of the latter category is the attempt of the Roman emperor Diocletian (284-305 AD) to find a solution to the socio-economic turbulences besetting his world.

Faced with Barbarian incursions, domestic unrest, declining production and rising prices, the emperor imposed price controls and debased the currency, the silver denarius. These measures resulted in shortages, even more rapidly increasing prices, a barter economy with a growing black market and concomitant social hardship and unrest.

Diocletian’s successor, Emperor Constantine (306-337 AD), famous for his conversion to Christianity and for founding the city of Constantinople, was, in his time, probably at least as famous for his monetary reform.

He introduced a series of bold policies and measures, some comparable with the modern understanding of fiscal discipline, epitomized by the replacement of the debased denarius with a gold coin, which he named the solidus, in a brilliant early example of public-relations spin.

This currency remained “solid” for 700 years, a span of time unrivalled by any other currency at any time. Notably, hoards of these coins are still found as far away from Rome as China.

History’s lessons have a tendency to repeat themselves. In response to the financial meltdown and in pursuit of recovery, governments around the world have adopted policies reminiscent more of Diocletian than Constantine’s vision.

Confronted by multiple challenges in the wake of the global financial and economic crisis, governments have adopted a series of policies almost as a matter of course, with one of the notable ones being so-called quantitative easing — increasing money supply to ramp up liquidity.

Some central banks, most significantly the U.S. Federal Reserve, are maintaining the policy of directly monetizing the federal debt (also known as quantitative easing) — considering it, if not non-inflationary, then as a preferred remedy for the possibility of deflation.

In November 2010, the Fed introduced a $600 billion program for the direct purchase of Treasury securities over six months in order to drive down long-term rates and thus stimulate recovery from the “great recession” and begin to lower unemployment rates.

Irrespective of various policies, in the West to the BRICs and elsewhere, inflation concerns are surfacing worldwide.

The Bank of England also has continued a program of asset purchases to the tune of £200 billion, despite an increasing divergence of opinions within the Monetary Policy Committee. The European Central Bank has been conducting an extensive program of asset purchases since May 2009 that are still ongoing.

However, as noted by Adam Fergusson in his book “When Money Dies,” quantitative easing could be considered a “modern euphemism for surreptitious deficit financing in an electronic age” which “can no less become an assault on monetary discipline” that increases inflationary momentum.

In another important line of post-crisis developments, a number of other countries have also succumbed to the perceived economic advantages of policies that could also contribute to inflationary build-up. Some, like China, are conducting a pegged exchange-rate policy that affects their money supply.

Meanwhile, India and Turkey — although pursuing a floating exchange rate policy — are susceptible to the effects of global quantitative easing. Indeed, several high-growth emerging economies, in particular Brazil, are responding to the massive influx of short-term cash into their economies by putting in place restrictions on foreign investment and other capital controls.

Without trying to divine considerations that were relevant centuries ago, Constantine would have probably questioned such approaches.

The bottom line is that, irrespective of various policies, in the West to the BRICs and elsewhere, inflation concerns are surfacing worldwide. Although U.S. inflation seems to remain within the forecast range, with persistent unemployment keeping labor wage demands at low levels, rising commodity prices and other inflationary pressures are applying opposing pressure.

Inflation in Britain rose to 4% in January 2011, double the government’s target. European Central Bank inflation forecasts, although more optimistic than those in Britain, were still raised to 2.3% from 1.8% on the back of oil price hikes. But in certain countries, inflation has leaped over the EU average, such as the 3.2% registered by Belgium in January 2011.

In the world’s rapidly developing economies, the situation is different — but the bottom line is similar. China’s whirlwind return to growth has been accompanied by rising consumption and wage pressure. When combined with the ongoing weakness of the Chinese currency, it is hardly surprising that, according to government figures, price levels climbed 4.9% year-on-year in January 2011.

Although far from being comparable with the situation in the 1920s Weimar Republic, the inflationary trajectory can be seen as moving toward a tipping point.

Meanwhile, Russia’s consumer price index reached 8.8% in 2010, exceeding the 5.5% the government had deemed feasible at the end of the summer, and has now gone above 10%. And Brazil is facing a rate of growth that is the envy of a number of economies, but with an inflation rate that has been projected to reach 5.8%, well above the central bank’s inflation target of 4.5% for the year.

While the “Great Recession” is far from over, and another downturn is not inconceivable, commodity prices are soaring, helped by drought (China), floods (Australia), civil unrest (throughout the Middle East) and a number of other factors.

In the year from February 2010 to February 2011, all commodity prices were up 50% in U.S. dollar terms. Companies from snack food producers to steel mills are suffering from exponentially increasing raw-material costs. Such a build-up threatens to take on a life of its own and acquire a dynamic beyond the scope of existing contingency plans.

Governments everywhere are responding by devaluing currencies, applying price restrictions, raising interest rates or imposing currency controls — in a way, true to the legacy of Diocletian. In some cases, they are attempting to obfuscate price increases — by changing definitions, altering the composition of indices or applying creative statistics.

Few are fooled, however. Citizens know in real terms how much they pay for food, fuel, household goods … the list goes on and on.

Please continue reading here.