Rising or sustained high rates of inflation in major developing economies have been widely noted in the financial media – annual consumer inflation increasing to 5.1% in China in November and being 5.6% in Brazil, 7.3% in Turkey, 11.1% in Argentina and 11.4% in India. In some countries, particularly China, discussion of the causes of this inflationary rise has focused on money supply within the individual country.
That this is not a comprehensive or adequate explanation is shown by examination of international price trends. International commodity prices have sharply risen since June 2010. Of particular relevance to inflationary developments in China, international food prices, which remained significantly subdued for the year up to June 2010, have begun to rise sharply. These food price increases, in contrast to the pattern for a year previously, are broadly in line with industrial commodity price shifts.
Such international food price acceleration is outside the control of individual countries and must be factored into analysis of inflation within them. As rising commodity prices are evidently not rooted in the monetary situation in individual countries, it follows that explanation of inflation in China, or other countries, purely in terms of money supply within their own economies is inadequate. A response purely in terms of monetary policy would threfore also be inadequate as a response to such inflationary pressures. An overall international analysis is required.
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The pattern of inflation in China
A key feature of inflation in China is the extreme disparity between food and non-food price increases. Non-food inflation in China in November was 1.9%. Food inflation, in contrast, was 11.7%. The 5.1% average consumer price index (CPI) therefore conceals sharply divergent trends.
Such a pattern by itself makes it unlikely that the most powerful factor operating in inflation is the increase in China's money supply. If the fundamental cause of the inflationary pressure were excessive rise of monetary stock, compared to the economy's supply side, then one would expect inflationary price pressures to be more evenly spread. This reality is confirmed by analysing trends in international commodity and food prices.
The long term trend in commodity prices
To assess recent inflationary developments it is useful to place commodity price behaviour against a longer-term background. Figure 1, therefore, shows the Dow-Jones UBS commodity price index over a 10 year period.
The trend is evident. Commodity prices rose progressively from a trough in 2002 to a peak immediately prior to the onset of the international financial crisis in 2008. A sharp fall then occurred until the end of 2008. Since then a new rise of commodity prices occurred.
The sharp rise in commodity prices in the second half of 2010
Turing to greater detail within this overall trend, the major international rise in commodity prices since June 2010 may be seen in Figure 2. This also highlights the significantly different behaviour of industrial and food commodity prices in the aftermath of the international financial crisis.
Commodity price behaviour during the international financial crisis
The price fall between the peak in the previous business cycle and the trough during the financial crisis was greater for industrial than food commodities. However, the timing of the declines did not differ significantly. The Economist index of industrial commodity prices peaked in March 2008 and then fell by 55.0% to a December 2008 trough. The index of food prices peaked in June 2008 before falling 35.6% to its trough - also in December 2008.
An increase in non-food and food commodity prices following their December 2008 joint lows initially took place in parallel. Between December 2008 and May 2009, food commodity prices rose by 19.7% and industrial commodities by 23.5% - i.e. an essentially similar upward movement.
Industrial and food commodity prices then diverged sharply from June 2009. Prices for industrial commodities continued to rise while food prices remained stagnant and even declined marginally. This strong divergence of industrial and food commodity prices lasted for a year until June 2010. Between May 2009 and June 2010 industrial commodity prices rose to reach 75.6% above the December 2008 level, while food commodity prices fell to 10.4% above their December 2008 trough.
Therefore from mid-2009 to mid-2010, while industrial commodity prices were rising strongly, food prices declined marginally.
The new upsurge in international food prices
The new inflationary trend is that from June 2010 onwards international food commodity prices also began to rise strongly. By 14 December 2010, food commodity prices had risen to 51.8% above their December 2008 level – a 38% increase since June 2010. In the same period industrial commodity prices rose to 146.1% above their December 2008 level – a 40% rise.
Therefore, from June 2010 onwards international food prices broke with their year long stagnation and began to rise in parallel with industrial commodity prices.
Conclusion - rising food prices and inflation in China
In summary, a new feature of the international inflationary situation since June 2010 is that food prices broke out of a previous year of stability, indeed of mild decline, and began a rapid increase. It was increasing food prices which drove the acceleration of China’s official annual CPI to 5.1% in November. The official acceleration in China's food prices, accounting for one third of its CPI, from 7.5% in August, to 8.0% in September, 10.1% in October, and 11.7% in November tells the clear story.
That the sharp rise in food prices in China in the second half of 2010 was part of a clear and strong international upward trend makes clear that inflationary acceleration cannot be explained simply by monetary conditions within China.1 A far more comprehensive, and international, framework is required.