As food and energy prices continue to soar, the damaging game of blame and counter-blame between the US and the developing world continues, with neither side prepared to admit that their policies are contributing to the commodity price surge.

Emerging countries and, in particular, China, have long argued that the US central bank is responsible for fuelling global inflation in food and energy. They claim that near-zero interest rates, combined with the US Federal Reserve’s latest $US600 billion money printing program has resulted in a tsunami of cash flooding into their economies, driving up prices for food, energy and other commodities.

And this is creating strong political and social tensions in countries where the average household spends anywhere between 3550% of their income on food and energy.

But last week, the US Fed boss, Ben Bernanke, struck back. Speaking at the National Press Club in Washington last week, he argued it was “entirely unfair” to blame the Fed for surging commodity prices.

Rising global food prices, he said, were partly due to increasing demand. As emerging countries became wealthier, their demand for food had increased. And this increase in demand had caused food prices to jump.

And, he countered, emerging countries were themselves to blame for their inflationary woes. They had the tools to tackle rising inflation — such as raising interest rates to lessen demand pressures. They could also let their exchange rates rise, which would blunt the inflationary impact of rises in the costs of imported food and energy. But, he said, adjusting exchange rates was “something that they’ve been reluctant to do in some cases”.

Bernanke’s arguments have some merit. Higher food and energy prices are partly being driven by stronger demand, due to the global economic recovery, as well as by disruptions to supply as a result of bad weather.

It’s also true emerging countries have been wary about raising rates in response to rising food and energy prices because they worry that higher costs are already having a depressing effect on overall economic activity. Higher food costs drain the spending power of consumers, reducing the level of domestic consumption, while higher energy costs put pressure on the profit margins of businesses.

They’re also worried that higher interest rates would add further upward pressure on their currencies. As a result, central banks in emerging countries have failed to lift interest rates to pre-financial crisis levels, and have instead tried to rein in surplus liquidity by fiddling with the levels of reserves that their banks must hold, and by imposing limits on bank lending.

Bernanke’s argument that higher exchange rates would dampen the domestic inflationary impact of higher global food and energy prices is undoubtedly correct. But many emerging countries are extremely reluctant to allow their currencies to rise strongly, because their economic growth model relies on having a strong export sector. Allowing their currency to rise would undercut their competitiveness in global markets, and deal a heavy blow to their economic growth prospects. As a result, emerging countries are prepared to tolerate higher inflation because they know that competitiveness, once lost, is extremely hard to recapture.

As a result, a vicious circle of rising commodity prices continues. The US is relying on extremely loose monetary policy to fire up economic growth, which is causing cash to pour into emerging markets. But because the emerging countries are not prepared to compromise their economic growth prospects, they’re also being forced to run loose monetary policies, which are helping to propel commodity prices higher.

The problem for Bernanke is that rising commodity prices — particularly rising oil prices — will eventually pose a threat to the US economic recovery itself.

*This article was originally published at Business Spectator

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Peter Fray
Peter Fray
Editor-in-chief of Crikey
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