Inflation & Some Emerging Markets

Have the recent run up in the emerging markets been on easy credit?

Vietnam has experienced a crack-up boom. They are under a grueling 25% inflation currently. The local currency, the dong, has lost 25% against consumer prices. Why? This is largely because of the run-up in food & energy commodity prices. High food prices will harm a people that spend a majority of their income on the basics. Even recently, Ho Chi Minh has banned the importation of gold. The government of Nguyen Tan Dung temporarily withdrew all licenses of gold importers, effectively banning the hedging against inflation with that yellow metal. The stock exchange is down roughly 60% this year.

Here's a brief run down of estimated inflation numbers in Asia. (thanks to Jim Juback at MSN Money)

Fun times?

But, why would this be? Let's think foundationally...what has happened to cause this?

Let's first start with the definition of inflation. Here would be the best source to show you the engagement even over the simple definition of inflation. There are two camps: one says that inflation is an "increase in the money supply" and the other says that inflation is an "increase in consumer prices".

By the way, folks, a consumer price is this: food, real estate, gasoline, natural gas. Basically it's the price of something a consumer uses (i.e. consumes). Make sense?

Back to the inflation definition. I would propose we use the former definition, not the latter. Why? Well, the former is more of a root definition. The latter is merely a product of the former. For instance, if I print more and more money then the price of an item will eventually go up. This is basically the law of supply & demand. If there's an increase in the amount of US Dollars in the market, then the value of that dollar is lessened. For instance, if coffee is selling for $1.00, and there's $1 Million dollars in circulation (yes, this is crazy simplistic) but then there is $2 Million dollars in circulation, then the price of coffee would double due to the devaluation that just happened....basically.

So, inflation is created from an increase in the money supply. Then, consumer prices rise.

Why are the emerging markets racked with inflationary pangs???

What happened in 2002 - 2007? Well, the Fed bottomed out the lending rates, credit became ridiculously easy because borrowers were paying their loans on time, and money gushed forth. The horse and rider were thrown into the sea of money supply. It was amazing! Lenders were accepting 1% payments on debts, and throwing the rest of the bill on top of the overall loan, ensuring certain borrowers would be underwater from the very first payment!! Low-hanging-fruit abounded, and the fruit was tasty. US Debt was bought up by foreign countries, starving for cheap US securities. It was the safest on record, and the cheapest. And did we feed them!

So, that defines the increase in the money supply. Here's a chart I got from the folks at GaveKal. These guys are genius, visit them here. Notice that in 2002 - 2006, the money supply in the US increased at a nice clip. As this cash was bought up by foreign countries, they then experienced incredible gains in their stock markets. (Just look at the ETF: ICHKX and it's gains over those years)

However, now with the money supply decreasing, and lenders fearful of lending, we're now starting to see the rise in consumer prices.

Remember, form 2002 - 2006, we saw the increase in the money supply. Now, we're seeing just the start of the rise in consumer prices...

What will happen as a result? Well, we'll definitely see!