Nations Jousting With Inflation Might Not Find a Happy Ending
THE WALL STREET JOURNAL EUROPE
August 20, 2008
HERE IS A comforting story, widely believed by investors. The demon Inflation, long thought to be chained to the rock of sound monetary policy, somehow managed to capture the fair maiden Commodity Prices. But then a rather shambolic knight, Sir Slow Economy, came to the rescue. Commodity Prices fell into a swoon, Inflation will soon be chained back, and King Central Bank will throw a rate-cutting party.
Commodities have certainly been the main source of inflation. In the U.S., the overall inflation rate is alarmingly high at 5.6%, but cut out food and energy prices and the rate is a nearly acceptable 2.5%. The gap between headline and so-called core inflation is wider in poor countries, where commodities account for a higher portion of total consumer spending.
The story advances. Commodity prices have fallen sharply, although most are still higher than a year ago. From the July peak, copper is down 15%, crude oil 25% and corn 30%. The presumed culprit is slower growth. The euro zone, Japan and the U.K. are all flirting with recession and Chinese growth has fallen to below double-digit rates.
The next episode is supposed to be a drop in overall inflation. Lehman Brothers is calling for U.S. inflation to drop below 2% in 2009, and pave the way for cuts of half a percentage point in the overnight interest rate.
Sadly, this happy ending could prove no more than a fairly tale. To start, the growth slowdown may end quickly. As yet, overall U.S. gross domestic product has refused to oblige predictions of imminent collapse. And lower commodity prices could help restore higher growth in the euro zone and China, leading to renewed inflationary pressure.
But even if growth slows, the inflationary monster may still roam. Workers are still eager for higher wages to catch up with higher commodity prices. Will there be money to satisfy them?
Sure, the credit crunch is making lenders more cautious. But workers in strong industries and countries will get some of what they want. And with real interest rates still low and government borrowing set to increase sharply, demon Inflation may yet find other victims.
Pound pressure
The U.S. dollar's abrupt rally from the ultradepths did not sweep only the flying euro bird off its perch. The pound, already hovering at its lowest-ever level against the euro, has lost roughly 10 cents of its dollar value in just two weeks, taking it to a 22-month low. Sterling may stabilize for a while, but its decline is likely to resume soon -- and go far.
For almost two years, the pound has been at stratospheric, quarter-century highs against the dollar. What propped it up against the dollar was extreme dollar weakness and the highest interest rate among leading economies. But once British homes and the City began deflating, the pound was no longer sound. The U.S. economy looks comparatively strong, while the market expects U.K. rates to fall faster than anywhere else.
Mervyn King, governor of the Bank of England, is counting on the pound to fall. Long-dormant U.K. manufacturing -- output up a minimal 2.6% in five years -- needs to take the baton from long-fizzing, now fizzled out, financial services, and generate jobs, exports and a lower trade deficit.
But the evidence so far isn't encouraging. True, the pound's 15% fall against the euro in the past year has helped generate an 18% rise in exports in April to June compared with a year earlier, while imports rose by 11%. Yet in the first five months of the year, the U.K. trade deficit with the euro zone was £24.6 billion ($45.9 billion), little changed from a year earlier. The overall U.K. deficit in the second quarter was 20% worse than in the previous year.
The omens for sterling's economic rescue act aren't good. Consumer demand in the euro zone, which takes a little more than half the U.K. 's exports, has weakened. The American consumer is unusually frail -- and even at 1.86 to the dollar, the pound remains a barrier. To help rescue the U.K. economy from deep recession, the pound will have to fall much farther. The worry for Mr. King is that a falling pound will lead to fewer imported goods -- but more imported inflation.
U.K. retail
The U.K., a nation of shopkeepers? Napoleon Bonaparte would have to eat his words. The country's retail sector suffers from oversupply and erratic management. For better offers, foreign predators would be advised to look elsewhere.
Baugur, the Icelandic investment company has just offered a derisory "low tens of millions of pounds" for Woolworths Retail, once a great name on the High Street. The problems at Woollies are extreme, but the sector's shares are down 40% this year. Only the banks have done worse in the U.K. The five largest nonfood retailers are selling at barrel-scraping 8.9 times current-year earnings.
At those prices, bid talk has flurried around three of the five: Kingfisher, Marks & Spencer and DSGI (formerly known as Dixons). But the industry suffers from a long list of structural problems, including declining foot traffic in city centers, excessive out-of-town expansion, too many similar formats, competition from the Internet and the march of Tesco, by far Britain's most successful retailer. The credit crunch will only make matters worse.
Marks & Spencer is a prime example. The midlevel apparel and upscale food merchant's much trumpeted three-year turnaround hit problems when Chief Executive Stuart Rose tried to move from disaster recovery to growth.
While the U.K. is overcrowded, new shopping nations offer brighter prospects. Consumers in Russia, Turkey, Thailand and so forth are getting more spending money and can be lured by the expertise of foreign retailers. But with the exception of Tesco, major U.K. retailers don't seem to have what it takes to cross borders.
Still, a foreign retailer might look at these weak British players and see an opportunity. That seems to be the thinking of Best Buy, the U.S. electronics behemoth, which is due to land in the U.K. early in 2009.
But while Americans share a language with the U.K., and can understand the British easy-fire labor laws, they should be wary. U.S. natural-food retailer Whole Foods opened a giant store in London a year ago and now is "carefully evaluating all aspects" of its U.K. operations after reporting a £10 million loss. |
