Capital inflows

This risk is most obvious in those countries—mostly emerging markets—where domestic conditions call for tighter monetary policy. China is Exhibit A. With a vigorous domestic recovery under way, China ought to tighten soon, before asset prices bubble out of control. But China is loth to allow the yuan to appreciate rapidly. And it will not be pressured by high consumer-price inflation, as it was in 2008. Thanks largely to soaring pork prices, China’s annual inflation rate reached almost 9% early that year. Today it is negative and few expect consumer prices to rise by much more than 3-4% in 2010.

Asset-price rises are also a problem for emerging economies with flexible exchange rates. Many have seen their currencies soar as foreign money pours in. Raising interest rates to tighten domestic monetary conditions can attract yet more foreign money. Increasingly countries are turning to controls on capital inflows. Brazil has already introduced a 2% tax on foreign portfolio investments to stem the rise in the real. On November 10th Taiwan banned foreign investors from putting money into Taiwanese fixed-term deposits. More such measures are likely, increasing the chance of distortions.

In weak, rich economies the danger is not too little too late, but too much too soon. Jumps in asset prices risk causing premature inflation jitters. Oil prices, especially, pose a danger. In recent months year-on-year headline inflation rates in most of the world’s big economies have been negative, largely because oil prices have been far below the heights of mid-2008. That is about to change dramatically, as the slumping oil prices of late 2008 and early 2009 affect the comparisons.

In America headline consumer prices fell by 1.3% in the year to September. By December they could be up by 3%. Even if oil prices stay around $80 a barrel, these “base effects” could keep America’s headline inflation above 2% for much of the first half of 2010. Many expect commodity prices to continue rising. Analysts at Goldman Sachs expect a barrel to cost $95 by the end of next year. Long-dated futures contracts are now flirting with the $100 mark.

An energy-driven headline inflation rate of 3% hardly spells disaster. Core inflation, which strips out jumpy food and fuel prices, is low, at 1.5%, and falling, thanks to the huge amount of slack in the economy. With a jobless rate of 10.2% and oodles of idle capacity, America still faces a bigger threat from deflation than from inflation.