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Euro-Zone Combats Stagflation with Strong Euro, as Asia Riots on Food Inflation

Economics / Stagflation Apr 17, 2008 - 01:17 PM GMT

By: Christopher_Laird

Economics Best Financial Markets Analysis ArticleInflation and stagflation, Euro, gold, and Asia
Stagflation is behind the strong Euro, but also lots of general commodity inflation. Gold loves the stagflation mixture. If there is one gold bullish factor above all the others, it is if stagflation stays with us. Asia also has its very serious problems with inflation, namely food prices.

After hearing ECB President Trichet spend most of his time talking about inflation in the EU, one clearly gets the idea that, despite the incredible damage the credit crisis is doing to the world economy, inflation remains their main problem. German wage growth is one major concern.

Once inflation works its way into wage growth, wages propel inflation relentlessly upward. Central banks know very well that it is best to stop inflation early in the few percent range, lest prices and wages cycle together and things get out of hand. The EU is facing that dilemma right now.

Rising Euro as ECB combats inflation

Correlated to the inflation problem is relentless pressure for a rising Euro. When the ECB holds off cutting interest rates, and the other central banks, the BoE, Fed, cut, the Euro rises. A strong Euro has reached a pain threshold that causes France and others to scream for a weaker Euro policy. France has had big pressures on their exports because of the strong Euro.

But Germany, the strongest EU economy, won't abide inflationary policy, and the ECB ends focusing on inflation, won't cut interest rates, and is caught in a stagflationary situation. The US is also in that dilemma. If they cut rates, inflation rages. If they don't, the financial markets threaten to implode. They face the dilemma of economic stagnation combined with inflation, stagflation, a combination gold just loves. We could be in the first stages of a persistent several year driver for gold prices based on this stagflationary dilemma. Stagflations persist for years. This happened in the US in the 1970's, and gold reached real highs in relation to other prices then.

If central banks succeed in stopping a big economic downturn, then is the only other option stagflation? If so, gold will go out of sight in a couple of years.

Real gold highs

I have to comment on gold's real prices now. Even though gold broke over $1000 this year, if we were to compare gold prices to other things, gold is still far cheaper right now than it was in say 1980. That is another way of saying inflation adjusted gold is still cheap. 

If gold were to reach the price spike of $870 in 1980 prices, it would have to be at roughly three times that today, or $2610. That is because most everything else is 3 times as expensive today compared to 1980 (Consider oil, housing, autos, etc). Gold at sub $1000 is still really cheap related to everything else. That means if stagflation stays, gold has a long way to catch up, even if only to recapture inflation since 1980. Imagine gold at $2610 in a few years, if this happens.

Well, stagflation is here and it's becoming worldwide. It would seem the ECB is taking a wiser approach to focus on combating inflation, and then letting the economy digest the financial losses building from the credit crisis. If they can hold that line, and the economy does not implode, they will emerge in a few years with a much stronger economy, as inflation would be tamer and people's real incomes are not whittled down by rising prices. In fact, the EU is finding that the strong Euro has helped to insulate the EU from the inflation around the globe today.

Lack of flexibility causes a strong Euro and threatens its viability

But the ECB inflation battle results in a strong Euro, and that is actually threatening the longer term viability of the Euro. If any major EU country bolts, such as France, I guarantee the Euro will drop drastically. Germany and France are very much at odds over this. You may be interested to know that France can leave the Euro if it wants to under the initial Euro treaties. So can the other participants. I think this is an underestimated possibility, the threat of a major country leaving the Euro, when people think of the future of the Euro. Germany is equally unhappy about having to ‘carry' the Euro and the weaker economies.

It is important for Euro fans to ask themselves if a unified currency spanning many different economies, some strong like Germany, and some much weaker like France, is a truly workable idea in the long run. This is particularly so in difficult economic times, such as our present stagflationary environment that seems to be spreading.

I want to pose a question that is radical. Is it possible the Euro will ultimately lose some major participating economies? If so, look out!

Food inflation is Asian Achilles heel

It can be claimed that Asia is seeing inflation on the order of 10%, and China and India have some real problems with this now. The food riots and such, as food prices rise 40 to 100%, put incredible pressure on Asia's Achilles heel, their huge poor population. The fact is that their huge poor sector spends about half their daily income on food alone. IF food prices double, then what is left over?

Don't be surprised. If you make $2 a day, and were formerly spending $1 a day on food, and then food doubles in price, you get to the point of not being able to eat enough. In the richer nations, food accounts for say 7 to 10% of cost of living, but in poor nations food is over 50% of living costs, so these food riots are fairly easy to explain. This applies to Egypt, India, China, the Philippines, and a total of 33 countries right now. Food inflation is not tolerable for these countries.

I saw a story about a woman in India whose husband is a day laborer, and they have two kids. As food prices rose, they first sent the kids away to more prosperous relatives. Then, finally, last week said they could only eat one meal a day… because they literally could not afford enough food. Now that is what I call a critical situation. Don't think China and the other huge poor nations aren't panicking about this.

So, as world inflation rages, food becomes a critical problem. It is said that, unless the world has record grain harvests in 2008, there will be a real world famine in 09…God only knows what that could lead to.

Rising food and oil prices are also increasing stagflationary pressures. Oil/diesel is a key cost of growing food. Rising food prices are key drivers to inflation worldwide. So it appears that stagflationary forces are here to stay across the world.

Our latest newsletter is a special report about financial and personal survival in these trying economic times. 

By Christopher Laird

Copyright © 2008 Christopher Laird

Chris Laird has been an Oracle systems engineer, database administrator, and math teacher. He has a BS in mathematics from UCLA and is a certified Oracle database administrator. He has been an avid follower of financial news since childhood. His father is Jere Laird, former business editor of KNX news AM 1070, Los Angeles (ret). He has grown up immersed in financial news. His Grandmother was Alice Widener, publisher of USA magazine in the 60's to 80's, a newsletter that covered many of the topics you find today at the preeminent gold sites. Chris is the publisher of the Prudent Squirrel newsletter, an economic and gold commentary.

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