What's at the root of the sudden surge in global commodity prices? And how should Latin America respond? Members of the Latin-American Shadow Financial Regulatory Committee (LASFRC), a group of the region's former senior policymakers, explored these questions last week during a three-day private meeting at the Center for Global Development.
Their perhaps surprising answer: global financial turmoil, particularly the U.S. subprime crisis, is partly to blame. Excess liquidity from bank bailouts designed to squelch the U.S. mortgage meltdown, plus money from burgeoning sovereign wealth funds, is chasing a limited pool of assets, leading to a rapid spike in the prices that adjust most readily: commodities, especially food and fuel.
“Everybody is talking about the structural factors that underpin increases in food and fuel prices,” said CGD senior fellow Liliana Rojas-Suarez, who heads the group. “These are real—demand is increasing faster than supply and we should expect a long-term, steady rise in prices. But the very sudden price surge we have seen in recent weeks in food and oil is something else. It is driven by a surge in the global money supply. It's not as if everybody suddenly started eating more or driving further.”
A public statement issued by the shadow committee at the end of their meeting, Sailing in a Stormy Sea: Latin America's Response to Global Financial Turmoil and the Food Price Crisis, sets out this diagnosis and the policymakers' prescription in detail.
According to the statement: “If monetary factors are the driving force behind the sharp rise in food and energy prices…[then] nominal food and energy price increases should be to a large extent neutralized by allowing a nominal appreciation of the domestic currency. This policy should result in no major change in the long-term real exchange rate.”
The statement explains that countries across the region differ widely, and that the appropriate policy prescription—including on exchange rates—will vary depending on country circumstances.
Until recently, most Latin American economies appeared immune to the adverse effects of the US mortgage sub-prime crisis. However, since mid-2007, food inflation and rising oil prices have exerted pressure on domestic inflation and unduly burdened poor households who must spend an even larger share of their income on food, posing new challenges for monetary and exchange rate policies, the committee said.
“In countries that are net importers of food, the rise of international prices has reduced real income especially among the urban poor and, to a lesser degree, among the middle classes and non-food-producing rural dwellers,” the statement said. “In the case of net oil importers, the crisis has increased the cost of the domestic consumption basket. The combined effect of higher international energy and food prices has deteriorated the terms of trade, unsettling social conditions and generating political stress.”
“Several central banks in the region have been operating as though the current acceleration in commodity prices is due to the structural changes explanation,” Rojas Suarez said . “So they have allowed domestic prices to rise rather than appreciate their exchange rate in an effort to hold down price increases,” she said.
In some countries that are net importers of food and fuel, and that have sound fiscal institutions, allowing their currencies to appreciate further against the dollar could be an appropriate way to reduce inflationary pressures due to the surge in global commodity prices, she said.
The committee warned that countries in the region should not overlook the possibility of possible future sharp U.S. interest rate hikes to rein in inflation. Accordingly, they recommend that central banks in the region prepare for this situation by developing contingent credit lines, further accumulating international reserves, and pursuing counter-cyclical public expenditure and regulatory policies.