China isn’t the only developing economy facing inflation pressures. Economists are projecting that consumer price inflation in Brazil will hit an annual rate of 5.2% this year. That’s well above the government’s target of 4.5%.
The central bank is expected to start raising interest rates as early as its next meeting on April 27. The target overnight interest rate, known as the Selic, is projected to hit 11.25% by the end of the 2010, up from 8.75% now.
All economies have what’s called a speed limit to growth. Growth rates below the speed limit don’t push up inflation at rates faster than the central bank will tolerate. Above the speed limit growth produces dangerously high rates of inflation.
For the United States right now that speed limit is somewhere around 2.5% to 3.5% depending on what economist you talk to.
For Brazil’s developing economy the speed limit for growth seems to be somewhere around 4.5% to 5% right now. The Brazilian economy is on track to grow by 5.5% in 2010. Hence the need to slow growth by raising interest rates.
Why do economists think Brazil is in danger of exceeding its economic speed limit?
Brazil’s factories are running at almost full capacity. When a company uses the last bit of its production capacity it has to put older and less efficient machinery to work. That inefficiency leads to higher costs that eventually get passed on as higher prices.
Even though unemployment was still at 7.4% in February the labor market is now tight enough to produce wage increases at a pace that exceeds productivity growth. Any economy has pockets of potential workers with skills that don’t match an economy’s needs. As cruel as it sounds, these workers are for all intents and purposes permanently unemployed. (Better education sand training can over time reduce the number of permanently unemployed.) When an economy can’t find more workers with the right mix of skills—no matter the unemployment rate—wages start to rise for those workers with needed skills. That’s happening in Brazil right now.
And finally any fast-growing economy runs into bottlenecks as growth speeds up. Ports aren’t able to handle all the ships that need to be loaded or unloaded. Goods have to sit in warehouses waiting for trucks. Congestion ties up highways. All that increases costs throughout the economy. And such bottlenecks are especially hard to avoid in a developing economy that’s building infrastructure as fast as it can—but still lagging behind demand.
Multiply what’s happening in Brazil—and China—by all the world’s other developing economies and you can understand why global inflation and global interest rates are headed higher in 2010.
For the fourth time this year China’s central bank announced Sunday the biggest Chinese banks must hold greater cash reserves. China’s financial leaders are struggling to keep inflation in check. A world addicted to cheap manufactured goods from China could possibly be in for a shock. Meanwhile, Donald Trump, pandering for a presidential bid, proposed a 25 percent tariff on Chinese imports that was roundly ridiculed by economists. I read this here: China struggles to curb inflation that threatens global growth
My take on this is that a buying opportunity will be coming up for Brazil. Remember, the reason there is the treat of inflation is that the economy is growing at 5+%. Historically, markets beat inflation; a drop when the rates go up, followed by growth that is faster than the underlying inflation. The main danger is if the rates are set too high and growth is stymied. Personally, I don’t think this will be the case.
Wage increases, even in a devalued currency, and full employment, sound good as far as beer consumption is concerned : I’ll buy more ABV if it dips.
But then again, they may already be F’ked…
China GDP Grows 11.9%, Highlighting Overheating Risk (Update2)
“http://www.bloomberg.com/apps/news?pid=20601087&sid=a8o4.BfcxdjU”
So the next time the chinese complain about iron ore, I say F’em
“China ’Power’ Over Metals for Smart Bombs Prompts U.S. Hearing ”
http://www.bloomberg.com/apps/news?pid=20601087&sid=aYbxhwkBPRWs&pos=9
mbakron,
A good point but how can we put some facts to this logic. What information do we use to determine “fair value” without price jumping from fear. I do not know the difference between a new price based on new long term economic standards and just short term fears. More over what does an investor do with your advice when the “fear” is the new long term trend that may set the standard until politicians world wide get there countries balance sheets under control?
Laser,
The price of gold goes up as people demand gold. Fears of inflation drive up demand for gold, and thus the price. But people have been fearing inflation for a long time now, so the price has ALREADY gone up. If you ask me, I’d say gold is overpriced, but I could be wrong. Of course that doesn’t mean that overpriced things can’t get even more overpriced. They can, and often do so spectacularly. But you don’t want to be left holding the bag when they come back down to earth.
Would this indicate that it would be a good time to buy into gold? Does inflation always mean price of gold going up or are there lots of other factors? (I’m new to this so…)
Does this mean the party is over for the stock market ?
“My friend says if you juice an economy with near zero interest rates, and toss in a couple trillion dollars,,,, of course the stock market will go up.”
Does this mean that the markets are now about to go down ?
With Brazil still forcasting 5.5% growth do the higher interest mean that Brazil will be off limits when looking for stocks. With all that growth it seems there should still be great companies to but into.
Jim,
With this article, should we re-think our positions in stocks in Brazil and China, ex. ABV? It would seem with “trouble on the horizon” possibly using MF’s or ETF’s for Latin America and/or Asia may be wise at this time. Your thoughts.
But I am glad that Brazil is doing well.
I sold some my Brazil stocks. Still have few though.