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starbucks4ever (98.98)

Emerging markets' inflation

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November 29, 2010 – Comments (4)

A new trend is in place: emerging markets all suffer horribly from food inflation, while the rich West hardly notices it at all. What's the matter?

To see why it's happening, consider two consumers: Sam and Janet (note: these names were chosen just to remain consistent with Krugman's naming convention :) Let's say Janet works at a factory in Eastasia where she gets paid $1 a day, which she then spends on a loaf of bread. The baker is making his bread in a tiny village bakery, which is just a tent on the outskirts of the village, which he inherited from his grandfather, and the three generations of his family haven't seen a government official for decades. One dollar is a cheap price for a loaf, but aside from flour, he doesn't have any major expenses, so he can charge a buck and still make a small profit.

Let's say Sam also works at a factory, but he lives in Oceania. Oceania is vastly different from Eastasia. For a while, the wages and the bread prices were both $1. But then Oceanian officials decided that bread production needed improvements. How can one be sure that the baker is baking bread in a correct manner? To be sure of that, let's make all bakers get a licence. Also, how can one be sure that his bakery stands in the right place? The only way to be sure of that is for the officials to allocate land for the bakeries and require all bakers to purchase that land. Then, how can one be sure that the bakery will not catch fire? Again, the way to be sure is to require all bakers to comply with standards written by officials. And since that regulation business obviously cannot and should not be free, let's make bakers pay a thousand dollar fee for every official signature. The officials spent many years, maybe even decades, writing newer and newer rules until their tables collapsed under the weight of papers.

By the time they were finished the loaf of bread cost $100. The baker was still taking only $1 for himself. But complying with officials' demands cost him another $99, so $100 a loaf became the new fair market price. Obviously, Sam would never be able to buy that bread with a $1 wage, and he would soon expire from hunger if the Central Bank had not responded with a gigantic stimulus program called "Quantitative Easing" that saved both Sam and Oceania's economy. Fortunately, Oceania had adopted a fiat currency system just when the difficulties became too noticeable to ignore, and the Oceanian central bank just kept printing more money until Sam was getting paid $100 a day.

As far as Sam was concerned, his purchasing power was still about the same as Janet's, even though the terrestial radio whose broadcasts he sometimes listened for free to on his way to work was telling him that he was 100 times richer than Janet. But Sam always took these claims with a grain of salt. In his mind, he itemized his bread expenses as follows. $1 was the "real", or "economic" cost of bread. The other $99 was the excise tax he had to pay to the officials whom he didn't like and whom he would happily have exiled to Eastasia with all their offices, writing desks and volumes of rules telling bakers how to bake bread.

But one day (yes, there had to be that one day because, remember, every story must have a happy ending!) Sam - and the general populace of Oceania - (even the Oceanian officials, who, technically speaking, were also part of the population) felt vindicated and realized they had the best of all possible economic systems. There had seen a severe drought in Eurasia in the prior year and grain prices doubled. In Eastasia, the baker was now charging $2 a loaf. Oceania was in a better position because its printing press was letting it import some commodities from Eurasia for free (this economic paradox, poorly understood by professional economists in Eurasia, should be a subject of a separate post), but eventually even the Oceanian baker had to accept $1 in extra costs and to pass that dollar to his consumer Sam. What was the rate of inflation in Eastasia? 100%. What was the rate of inflation in Oceania? 1%. Yes, it was that low because to Sam, $101 was essentially the same as $100.

The excise tax buffer was shielding Sam from all commodity price fluctuations! 

Moral: when the real economy is dwarfed by a virtual bubble, it is the virtual bubble that matters.

4 Comments – Post Your Own

#1) On November 30, 2010 at 2:53 AM, walt373 (99.75) wrote:

Nice story :D

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#2) On November 30, 2010 at 12:46 PM, lemoneater (79.38) wrote:

When Janet travels to Oceania for vacation and gets her $1 Eurasian changed at the airport currency booth will it equal $80 Oceanets? (I'm figuring on a 20% service fee.)

 

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#3) On November 30, 2010 at 12:58 PM, starbucks4ever (98.98) wrote:

#2,

It won't. Sam will not exchange 100 Oceanian dollars for 1 Eastasian dollar because he lives and works in Oceania. Eastasian bread is useless to him.

 

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#4) On November 30, 2010 at 3:49 PM, lemoneater (79.38) wrote:

:). I guess Janet is still waiting at the airport.

(Did you ever watch Terminal with Tom Hanks?) 

The first time I went to Scotland was about thirteen years ago. A girl from Quebec was waiting in the Glasgow airport with me. She was very upset because the Canadian dollar at that time was very weak against the British pound. She said she could hardly afford to do anything. She hadn't realized there was such a difference in currency values. I felt the pain somewhat because the pound was 1.60 to the dollar, but I had the advantage that I was staying with friends and didn't have to pay for food or lodging.

 

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