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  Global Concern Over Inflation: Rising Prices Widen Gap Between Rich and Poor

Global Concern Over Inflation Rising Prices Widen Gap Between Rich and Poor

By Wolfgang Reuter

Part 2: The Coming Catastrophe

The more money there is in circulation, the faster prices rise, at least in theory.

Indeed, what happened initially was what was supposed to happen: The volume of money grew substantially worldwide. This alone is a reliable indication of rising inflation. Nevertheless, consumer prices remained surprisingly stable.

The reason was an increasingly interconnected world in which competition is constantly growing and barriers to trade are being eliminated. Companies in the major industrialized nations lacked the power to achieve higher prices, because competing products, especially from the emerging economies, were improving in quality and cheaper to boot. This also began to apply to capital goods -- machinery and equipment -- with which businesses in the industrialized nations could boost their own production.

The excess dollars, euro and yen that were not being spent on capital goods went into more lucrative investments. Stock markets in China and India and in other rising Asian economies, as well as in Turkey and South America, were booming. Real estate prices also began to rise in the United States, Great Britain and Spain.

Those who invested their money in these markets could make quick and substantial profits, and those with decent credit ratings could also borrow money at historically low rates and pump it into lucrative investments. In the end, say financial experts, this low interest rate policy even helped a relatively new sector of the financial industry establish itself. The business of investment funds, also known as private equity, would have remained relatively insignificant without the enormous flood of cheap money.

Beginning in 2003, the giant speculation party became downright euphoric. Markets around the globe became overheated. In Germany, the DAX has gained more than 200 percent between the spring of 2003 and today, while the Tec-DAX, an index of high-tech companies, has also tripled in value.

Easy Money

There have been minor corrections, but nothing approaching a general crash. There was simply too much money in circulation worldwide for that to happen. Those who were invited to the party could practically do nothing wrong.

And those were the rich of this world, the people who had enough surplus income to invest it profitably. The gap between rich and poor only became wider.

The share of profits and yields on assets as a percentage of overall budget income increased by 10 percent in the past seven years, but this growth is not evenly distributed. Low-income earners rarely own stocks, bonds or apartment buildings. Their net income has declined by 5 percent in recent years, while the richest 10 percent of the population have in fact added 10 percent to their incomes.

Beginning in mid-2004, the central banks tried to contain the flood they had released by gradually raising interest rates. But the volume of available money was simply too large and the central banks' baby steps on the interest rate curve were too small. The situation had become self-propelling long ago. The volume of money continued to grow.

The US real estate bubble had hardly begun sending shock waves around the globe this summer when the Fed took a step backward and hectically lowered the prime rate by half a percentage point.

But this places the ECB in a predicament. It has a choice to make, but only between two evils.

If it raises rates, the euro will become even stronger, making European products more expensive outside the European Union. This would be more than awkward for Germany, one of the world's biggest exporters. But if the ECB keeps interest rates at the same level or even follows the Fed's example and lowers rates, we could face a "prolonged phase of inflation," says Thorsten Polleit, chief economist at Barclays Capital Deutschland, "and probably at a rate significantly higher than 3 percent."

Prices Rising All Over the World

There are many indications that Polleit is right. Prices are rising sharply, both in Germany and other countries. In a globalized world, rising prices are no longer such a purely national phenomenon as they were only 10 years ago. The emerging markets, in particular, are now demanding payback for the many years they have spent producing and exporting textiles, toys, refrigerators and many other goods for low wages. These countries are now seeing both income growth and higher prices.

In China, for example, the more than 15 percent rise in food prices is almost entirely responsible for overall inflation, International Monetary Fund (IMF) experts concluded at their fall conference in Washington. China's inflation rate is approaching 7 percent. Inflation has already reached 17 to 25 percent in Argentina, despite the fact that the government has manipulated the figures downward to less than half these levels. Inflation is also sharply on the rise in South Africa, Russia and India.

Wealthy People Less Affected

If goods and services become consistently more expensive in Germany, this will only widen the gap between rich and poor. Inflation always has the most drastic impact on people with lower incomes, who spend a larger percentage of their disposable income on ordinary consumer goods than high earners.

Although higher prices also mean higher wages and salaries, the tax authorities are the first to benefit from the incremental earnings -- but not when it comes to high earners. Not much changes for those who have already reached the highest tax bracket, while everyone else is affected by what is known as cold progression: the marginal tax rate changes with each additional euro in income, resulting in a more uneven distribution of the tax burden.

Those who have money can also attempt to beat inflation with evasive strategies. Existing loans, such as mortgage loans, become cheaper relative to income. Besides, high earners can shift their assets to inflation-proof investments like gold or other precious metals.

The public continues to welcome low interest rates. Haven't they contributed to the booming economy? And to the stock markets reaching new record highs? And while the financial crisis may be worrisome to anonymous big bank executives in their offices high up in glitzy skyscrapers, it hasn't affected the real economy. Right?

For Polleit, this is an illusion. "The monetary watchdogs run the risk of succumbing to public pressure, thereby losing sight of their real job, which is to keep the value of money stable," he says.

Translated from the German by Christopher Sultan