We’ve said it before, and so have others. Now Martin Wolf says it, and far better than yours truly ever could. The U.S., along with the developed economies generally are importing inflation. It’s time to act.
This is not solely a task for the Federal Reserve, writes Wolf in today’s Financial Times. Monetary policy here, and abroad, needs to tighten, he advises. But there’s precious little of that at the moment, and the risk is that global inflation, already bubbling, will take root and become a bigger threat down the road.
The warning signs have been flashing for some time, Wolf reminds, starting with the multi-year bull market in commodities. This is not the result of manipulation by traders; it’s the reflection of a fundamental shift in the supply/demand equation in the global economy.
The “continuous rise in the relative price of commodities is a symptom of an inflationary process,” Wolf writes. “Whenever excess demand hits, the goods whose prices rise first are ones with flexible prices, of which commodities are the prime example. Commodity prices then are a pressure gauge. If we look at what has been happening in recent years, the gauge is showing red.”
The only question, then, is what to do? Ideally, China, India and the emerging markets generally will recognize that their Bretton Woods II strategy–keeping their currencies undervalued relative to the dollar–is contributing to the global imbalances that are fueling inflationary pressures. It’s time to unwind, or at least downshift the strategy that has been so popular in the 21st century.

It’s unclear if the developing world will make the hard decisions to nip inflationary momentum in the bud. Meantime, the U.S., Europe and the developed world is importing inflation, much of which is stoked by rising demand from the emerging economies. Complicating matters is the weakened state of economic affairs that the U.S. is now in. That’s inspiring a looser monetary policy in America than current global conditions merit.
“Today, the hapless Federal Reserve is trying to re-expand demand in a post-bubble US economy,” Wolf observes. “The principal impact of its monetary policy comes, however, via a weakening of the U.S. dollar and an expansion of those overheating economies linked to it. To simplify, Ben Bernanke is running the monetary policy of the People’s Bank of China.”
To be sure, if the world’s leading central banks acted prudently and started tightening, the global economy would suffer. But make no mistake: inflation is rising because demand has been rising, and to some extent the higher demand has been engineered by central banks in the developed world to stimulate strong domestic growth, which includes keeping the export machine humming. It’s been a nice party, but it can’t go on forever, at least not without repercussions in the form of higher inflation.
No, it’s not too late to keep inflation risk under control, but the time is running short. What’s more, this is a job for more than one central bank. But like any prudent economic decision, it’ll come at a price. Pick your poison: lower inflation or lower growth. History reminds that it’s always easier to let inflation run higher, largely because the pain increases slowly, over time, with no obvious victims, at least initially. That makes inflation politically easier to swallow. But there’s no free lunch. Eventually, someone will pay, and it’s always the man in the street.
It’s a safe bet that supply and demand will reach equilibrium. It’s the decisions in the interim that keep everyone guessing.