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About Middle East

Middle East Burning

作者:謝國忠  2011-02-28



Popular revolts have toppled governments that have ruled for decades in Tunisia and Egypt. The revolts are spreading to other Arab countries and even to Iran. The chances are that the region would be totally transformed politically in a year or so. The affected region has over 400 million in population. Its global significance cannot be underestimated. It may be the biggest global change in two decades.

Social revolutions have complex social background. It usually involves multiple pressure points festering for many years. The tipping point involves some trigger. In this case the rapid inflation, especially food inflation, in the second half of 2010 was the trigger.

The developed economies suffer from high indebtedness. Their central banks seem to adopt very loose monetary policy to reduce the debt burden. This force is likely to continue for years to come. Inflation in the world will likely remain high.

A large share of the global population, including the low income groups in the developed economies, have not benefited from globalization but are suffering from inflation. Their reaction will put the global stability in jeopardy. The major central banks may change their attitude towards loose money only when the riots happen in their own countries.

Loose money triggers riots


Loose money triggered the riots in Tunis and Cairo. The FAO food price index rose by 41% in 2010. I am sure that many clever analysts would argue that there is no relationship between the Fed’s loose money and food price. The food and energy prices began to surge right after the Fed began to talk about QE 2. It is too much of a coincidence to explain away.

Inflation is redistributive, usually unfairly. First, low income people tend not to have debts, because they are usually not qualified to borrow from banks. When inflation surges like now, their bank deposits erode in real value. Whom do their losses go to? The people who have debts and real assets like property speculators gain the same amount. Inflation essentially robs the poor and gives to the rich.

Second, low income people tend to have insecure jobs and cannot bargain wages up along with inflation, especially when inflation surges like now. The reduced purchasing power for their wages often pushes them into an unsustainable situation. They simply cannot make their ends meet.

40% of Egypt’s population live with less than $2 per day. The unemployment rate is nearly 10%. When food and oil price rise by over one third, one can imagine why people were pushed into rebellion.

Some Arab countries benefit from inflation. When oil price surges, Saudi Arabia, Kuwait, etc., get more money. They can deal with food inflation by distributing extra proceeds from oil to consumers. Most Arabs live in countries without such benefit. The way out for them is redistribution. As wealth and income inequality is extremely high in these countries, redistribution is a way to cope with inflation.

For example, the Mubarak family is rumored to have between $17-70 billion in wealth. Egypt’s GDP was a bit over $200 bn last year. Repossessing the Mubarak wealth could go a long way to solve Egypt’s economic difficulties. In that regard, Egypt is making progress. Foreign governments are already freezing the wealth of Mubarak family and their friends and associates.

Also, the monopoly businesses that charge high prices due to their special government connections will be made to decrease prices. Steel is expensive in Egypt, because only one guy can sell it. The government connected businesses keep prices high for commodities through government mandated monopolies. It is essentially income redistribution from the masses to a few. When such monopolies are removed, people save money and can cope with inflation better.

Algeria, Jordan, Syria, and Yemen are all similar to Egypt in their economic situations. Inflation and income inequality are an explosive combination. Their governments will likely fall this year or next. Unless the oil rich countries are willing to share their income generously with the ones without oil, their fate is sealed.

Instability will spread


The conflagration in North Africa may be just the beginning of the inflation triggered instability. While the food price index is at the highest level, rice price is still at half of the 2008 peak. The odds are that East Asian governments are releasing reserves to keep the price down. How long could the artificial suppression of the price last? When the tipping point is reached, rice price could double or even triple. Instability could spread to rice eating Asia.

14.3% Americans lived in poverty in 2009, according to the US Census. Including ones that have given up on looking for job, one sixth of American workers are under or unemployed. A huge chunk of American people have no cushion against massive increase in the cost of food and energy. In addition the prices of imported consumer goods that low income Americans depend on are rising and are likely to rise much more late in the year. Fifty million Americans are not so different from Egyptians in their economic plight. Riots could come to American cities.

Arab economic difficulties will persist


The regime change can alleviate the Arab economic difficulties through redistribution. It won’t solve them. The Arab countries have very young populations and high unemployment rates. Egypt’s population, for example, has doubled in three decades. One third of its population is 14 years old or younger. Half of its population is under 24. It needs to create more jobs than the US that has 3.6 times as many people. The population is still growing at 2% per annum. The young and fast growing population in the Arab World requires very high competitiveness in the global economy to create sufficient number of jobs. Its economic structure isn’t set to do so.

The oil rich countries are suffering Dutch disease. The oil money pumps up their cost structure, which makes non oil industries uncompetitive. The resulting surplus labor is absorbed through redistribution of oil wealth, for example, through direct allowance or creating unneeded government jobs.

The resource poor countries like Egypt simply don’t have the resources to invest to boost economic efficiency sufficiently to be globally competitive. Gradual improvement that it has been experiencing isn’t sufficient to decrease it problem. It needs to make a jump in competitiveness. That may require investment several times its GDP.

OPEC, mostly Arab countries, exports forty million barrels of oil or $4 billion per day. If that money is invested in the Arab World, for example, in infrastructure, it could be sufficient for the region to get into a virtuous cycle. That possibility is non-existent. The oil rich countries are recycling their earnings into the west, especially into the US financial markets.

Some Arab governments that are yet to fall hope that the current situation would be short-lived. They are very wrong. Demographics is destiny. Arab countries have entered the era of youth-led revolutions. It would last for a long time. Egypt may have a new government in six months. It’s not clear how long it would last. Frequent government changes would become the norm in the Arab World.

Neo-Keynesianism on trial


The global economy has been governed by people who believe in the magic of monetary stimulus. It works through asset inflation that boosts demand temporarily. When loose money only generates asset inflation, not CPI inflation, it feels like free money. The people in the know have congregated around the money game and have become fabulously rich. They gather in Davos to celebrate the success of this brand of capitalism every year.

The 2008 financial crisis didn’t convince this ruling class of the error in their thinking. They poured more money to bail out the financial institutions that played the wrong hand in the money game at the wrong time. The bailed out billionaires gathered this year in Davos again to celebrate the survival of the system.

The financial crisis in 2008 didn’t stop the practice of economic management by printing money. Burning streets will. What’s occurring in North Africa may be too far for most of us to feel the relevance. Similar events may come to a place near you. North Africa erupts first because they haven’t benefited much from global asset inflation through trade or investment and, hence, suffers from high unemployment, and feels the pain of inflation most accute because of their high share expenditure on food. A considerable chunk of the global population suffers from the same plight, even in rich countries. There is a point where social tension boils over. That point is the lowest in North Africa. As inflation keeps rising, more populations cross this point.

The major central banks in the word hold interest rate near zero for the first time in history. The game is the same as before: incentivize speculators to push up asset prices. As wealth effect kicks in and demand rises, profits increase and asset prices can keep rising. The US economy grew on consumption last quarter. One wonder why the over indebted US household sector could increase consumption like that. The trick is to increase its asset value. Such bubble thinking permeates the US macro policy thinking.

Every bubble bursts eventually. But, policymakers hope that, when it happens, they are dead. When they are not dead like in 2008, they should try to revive the bubble. They have succeeded to shift the bubble from the western property market to other asset classes including property in emerging economies. Global stocks have doubled from the lows during the crisis, boosting paper wealth by $30 trillion. It is the reason that the luminaries in Davos were having a good time.

We know bubble bursting can’t stop printing money. It leads to more money printing. The unrest in developing economies may not stop it either. The central bankers in the west can’t feel the pain for the suffering so far away. The fire, however, will eventually burn under their feet.

Maybe the Fed will change its mind when the streets of Washington burn like Cairo’s.

Oil price enters uncharted territory


The waves of Arab revolutions are spreading to oil rich countries. They have the money to buy peace. Hence, these countries may not become that volatile. But, the increased volatility in these countries could increase oil price sharply. One grievance from the revolution is surely about ‘low’ oil price, because these governments have to keep the price low in exchange for the US’s military protection.

Shocks like what we are witnessing have an impact on oil price under any circumstance. The loose monetary policy around the world amplifies the impact. It is widely known now that financial investors, not users and suppliers of oil, dominate oil futures market. The zero interest rate environment decreases speculation cost and increases demand for inflation hedging.

The oil price made its historical high in 2008 due to the Fed’s cutting interest rate, not surging demand. The monetary environment is looser now. The Middle East Instability provides psychological support to speculators. It is possible that oil price will surpass its 2008 peak.

The world slides into stagflation


The UK is experiencing inflation twice as high as the Bank of England’s target, while its economy contracted. The UK economy is in stagflation. The market is expecting the Bank of England to raise interest rate. I seriously doubt it. The UK’s budget deficit was over 10% of GDP last year. Its new conservative government is cutting expenditure to forstall a national bankruptcy. The Bank of England isn’t likely to tighten when the government is contracting fiscally. Further, the UK’s indebtedness is very high. One way out is to inflate it away. The chances are that the Bank of England will accept high inflation for years to come. Even if it raises interest rate, it would be cosmetic and for propaganda purposes. The pace would be deliberately slower than inflation acceleration. Pound sterling has strengthened on the BoE rate hike expectation. I think it is one of worst currency in the world.

The US economy is in a similar situation. The US fiscal deficit has become politically unpopular. The Obama Administration has to cut spending. The fiscal contraction in a sluggish economy makes it extremely difficult for the Fed to tighten. This is why it insists that deflation rather than inflation is the bigger risk. It explains away the current inflation as temporary. It is self-justifying its loose monetary policy. The Fed is pursuing negative real interest rate to inflate away the US’s debts.

Global crisis is still ahead


I still think that the world would experience another crisis in late 2012. The trigger would be either a collapse of the US treasury market or an inflation-induced hard landing in the emerging economies. The political events in the Arab World point to another possibility: surging oil price could sink us all earlier.


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