INFLATION DRIVER #10: DOLLAR PEGS AND CENTRAL BANK STERILIZATION OF INFLOWS
As we discussed in driver number 9, worldwide money supply is growing fast, and excess money chasing goods and services creates inflation. China, Russia, Persian Gulf countries, India, and Brazil are growing their money supply way above the rates the governments desire. In fact, world money supply growth is estimated at 13-14% over the last 12 months.
Countries that run current account deficits, such as the U.S., Britain, and others have substantial trade imbalances with countries running current account surpluses, such as China, Russia, Singapore, Norway, and the Persian Gulf oil producers. As money flows into the surplus countries as a result of their exports, the receiving country must sterilize the inflows of foreign currency. To do this, the surplus countries’ central banks must print money in their own currency in an amount equal to the inflows of dollars, or pounds, or other currency. This results in an expansion of their money supply. Eventually, having increases in money supply that exceed increases in productivity leads to inflation as we discussed earlier.
When a country has a surplus and their currency is partially or completely pegged to the dollar (e.g. China, Saudi Arabia, and other Persian Gulf states), they are in a difficult position. They must raise the value of their currency and their interest rates if they want to solve their inflation problem. However, current account countries are slow to act in this manner because even though inflation is rising, their standard of living is rising faster due to their current account surplus and the wealth the country is accumulating. This inflation ends up in the feedback loop discussed in driver number nine, and is how currency sterilization activities by current account surplus countries lead to an increase in global inflation.
The last several days, we have highlighted the ten reasons why inflation is reinforcing itself and will continue. Our strategy is to protect ourselves and our clients from inflation by owning precious metals, food and food related, and energy related investments. Although we continue to like all three groups, energy has risen a great deal and food related have risen somewhat. Therefore, the most attractively priced group right now appears to be precious metals.
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