In January 2022, the IMF predicted a year of low growth with high inflation. Since then, the IMF has twice lowered its projections giving a gloomy outlook for global growth. OBELA estimated that the FED and the European Central Bank were in a dilemma where they would either ride with high inflation and some recovery or use the conventional monetary instruments of raising the interest rate and knock down the fragile consumption and investment dynamics to bring down inflation. There was a difference between the Fed having a monetary problem and the ECB recognising the geopolitical inflation issues. The result has been that both decided to raise interest rates and reduce liquidity, with predictable consequences.
The Fed, the US central bank, faced with rampant and rising inflation, announced in January this year that, since monetary policy determines the long-term inflation rate, they should adjust the interest rate to affirm the 2% inflation rate in the long run. The interest rate on three-month Federal Funds certificates was at that time 0.08%. The federal funds rate is the interest rate at which banks and credit institutions lend their cash balances to other similar institutions overnight, on an uncollateralised basis.
In March, they started raising the rate at 0.25% at a time, and in June, it is already at 1.58%. Given that annualised inflation as of May is 8.2%, the real interest rate is -6.7%. The question is whether they will have to raise it above the inflation rate to get it under control or whether inflation will come down to meet it in the neighbourhood of 4% due to these hikes. The truth is that not all inflation is monetary, although a significant part of it is in the US. The shortage of microchips, the drought and the geopolitical aspects of energy prices are not financial and will be persistent.
The question mark is the impact on the world economy of absorbing 20% of GDP in financial assets to return the Fed to a standard balance sheet size (from 20% to 40% in March 2020). The impact on capital, equity and commodity markets is unquestionable. The press and politicians will probably blame Ukraine. Still, these liquidity adjustments coupled with rising interest rates lead to a recession that could be global or at least severe for Atlantic-centric countries. The truth is that in the context of falling commodity prices, rising wheat and energy prices are a counterweight to keeping inflation stable.
Meanwhile, the People's Bank of China, its central bank, kept the rate stable at 2.9% from November 2015 to March 2022. Faced with an economic slowdown from a projected 5% growth in January to 4.3% in April, it took counter-cyclical measures, one of which was to cut the interest rate. They are unconcerned about the inflation issue, which does not afflict them, and focused on the recovery of production. The PBOC lowered the one-year lending rate (Loan Prime Rate LPR) from 4.31% in July 2019 to 3.85% in April 2020, starting the pandemic. The fall in projected growth in 2022 reduced it further to 3.70% in January 2022. Five-year rates were similarly cut from 4.85% in July 2019 to 4.65% in April 2020 and 4.45% in May 2022.
The contrast between the rate hikes in the West due to inflation and the lowering of rates to revive the economy in China shows how the Asian country is tackling inflation through supply increases. This way, wheat, gas and oil that do not go to the West because of Western economic sanctions are sold in China and arrive by train directly from Russia in six days. It could be the beginning of creating a commodity trading centre in China to complement the one that has existed since the 15th century in the Netherlands. It operates, of course, in Yuan.
Changing interest rate levels in the context of open economies would lead to a depreciation of the Yuan as investors would move out of the Yuan and into dollars. However, as China's rates are double those of the US, this cannot happen. On the other hand, there was no opening of capital accounts to avoid a repetition of the attack on the Yen in 1986-1990.
The BRICS leaders have expressed their interest in deepening cooperation between their countries. During the first quarter, trade between Russia and China grew by 28.7% compared to last year's period. Indian coal imports from Russia increased six-fold, and oil imports rose 3.5 times to 1,000,000 barrels per day.
Just as the Asian giant's interest rate diverged from Western monetary policy, so did the price of oil. In the West, the cost of oil is over 100 USD. China and India pay 70 USD for oil from Russia and a preferential price for oil from Saudi Arabia.
With Russia's access to Swift restricted, payments for trade with China and India and recent fertiliser and grain export deals are in Rupees, Roubles and Yuan made through CIPS. China also plans to import oil from Saudi Arabia, which accounts for 25% of its sales, in Yuan.
The Asian giant will undoubtedly emerge stronger in 2022, with a currency now known to be the reserve currency of Russia and other members of the Euro-Asian alliance. Increasingly, the volume of transactions in a currency matters less, and the international reserves in a currency matter more. The IMF says that the Yuan is the world's fifth largest international reserve currency, after the dollar, euro, pound, and Yen. (https://data.imf.org/?sk=E6A5F467-C14B-4AA8-9F6D-5A09EC4E62A4). The dollar's weight declined from 90% of reserves in the 1960s to 59% in May 2022, which seems irreversible. It is the fruit of the Fed's management that has never considered that its interest rate impacts the world positively or negatively; or in any case, it does not care. The rest of the world does, and the management of reserves shows this. The year will probably close with inflation rates bordering double digits and growth rates close to 2% after inflation. The US will grow 2.3% in 2022 and 1.8% in 2023. (Conference Board) Latin America will be luckier with growth rates bordering 3% in Central America, Mexico with less than 2% and South America between 1.5% in Chile and 0.8% in Brazil with high peaks in Colombia, Bolivia and Peru of 3% or more.
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