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SOVEREIGN MAN

More boots on the ground inflation observations

May 5, 2011
Punta del Este, Uruguay

As I travel throughout the world, I pay very close attention to price levels.  I don’t believe a word of it when monetary authorities play down inflation concerns or tell me that rising prices are “transitory”. My boots on the ground observations tell me otherwise.

It’s sort of like the growth of a child– parents who see their kids all the time don’t notice day to day changes, but the distant auntie who visits every few years immediately remarks “Look at how big you’ve gotten!”

Prices are the same way. We might not notice subtle weekly changes in the grocery store prices, but when you spend a few months or years away, the differences are like a splash of cold water in your face.

Uruguay is a great example. I lived here for a short time a few years ago, but I haven’t been back since December 2008. That’s a long enough time to notice even the smallest change… and while I’m pleasantly surprised at the country’s improvements, the growth in prices has been astonishing.

Grocery prices are anywhere between 30% and 75% more than I used to pay– bananas are running about $1.20 per pound (up over 60%), carrots are about $1 per pound (up 70%), and a staple local wine, the shockingly cheap Don Pascual Tannat Merlot, is around $7 (up 75%).

Here’s another example– I went to McDonald’s yesterday here in Punta del Este. Now, normally I avoid McDonald’s like the plague, but I’ve been quite ill for the last few days, and their McCafe tea selection was just what I needed.

I’m sure you know that the Economist is famous for using McDonald’s as a proxy to gauge relative price levels and exchange rates around the world.  Its Big Mac Index is an illustration of the law of one price: in the long run, all identical goods should have the same price.

In other words, a Big Mac, which is basically the exact same sandwich whether you buy it in Shanghai, Zurich, Vancouver, Chicago, or Punta del Este, should cost the same.

The Big Mac here in Uruguay costs just over $5 (about 35% higher than in the US), and most of the McSomething combo meals are a bit shy of ten bucks.  Even adjusted for taxes, this is much higher than in the US. What’s going on?

Admittedly, the dollar has declined against nearly all world currencies (save the disastrous Argentine peso, Belarusian ruble, Vietnamese dong, and a few others) as Ben Bernanke’s actions make it quite clear that he has absolutely no intention of tightening up the Federal Reserve’s balance sheet.

All the new liquidity in the system has to go somewhere, and institutional investors have been parking their newly printed dollars in a number of places: equities, government bonds, precious metals, commodities, and developing markets like Uruguay.

Since December 2008, the inflow of excess dollars into Uruguay has bid up the Uruguayan peso by 26%.  Proportionally, though, more money has made its way into energy and agricultural commodities, and those prices have increased even more.

Corn, for example, has nearly doubled in the same period. Oil has increased three-fold. Even when you adjust these higher prices against the stronger peso, Uruguayans are paying much more for food and fuel.

Inflation in Uruguay hit 8% in March.  Bear in mind, this is a society that has seen hyperinflation before, and it took the government 26-years (from 1972 to 1998) to bring inflation down from 80% to 8%.

In the US, Ben Bernanke can get away with telling people lies about “transitory inflation.”  Uruguayans, however, would flood the streets banging pots and pans until he resigned.  These people have deep, personal experience with hyperinflation and have no intention of returning to those days ever again.

As such, the government in Uruguay, as well as developing markets around the world, have been tightening up money supply and allowing their currencies to appreciate… hence the $5 Big Mac in Punta del Este.

So what happens in the long-run? Does the ‘law of one price’ suggest that stronger currencies like the Uruguayan peso are all overvalued and due for a dramatic fall?

No. The developing world has saved the US from the worst inflation effects thus far because of the dollar’s special status as the world’s reserve currency… but this is fading quickly.

Central banks around the world recognize that the dollar is fundamentally weak, and everyone is scrambling for solutions– holding other currencies like China’s renminbi in reserve, or buying gold.

In the long run, this means that prices in the US will rise to match higher prices overseas… rather than overseas currencies weakening against the dollar to match lower prices in the US. In other words, folks in the US will soon be paying $5 for their Big Macs like they do in Uruguay.

Again, this will be a gradual process… don’t expect to wake up tomorrow to $20 loaves of bread. But over the next few years, you can absolutely expect accelerating inflation to take a greater and greater bite out of your purchasing power… unless you take action.

Despite any short-term corrections that may come, precious metals remain among of the best hedges against rising prices. We’ve discussed before how many foreign banks have gold-denominated accounts– so you get the inflation protection of precious metals, the liquidity of the banking system, and the protection of holding assets overseas.

Also, other currencies like the Singapore dollar and Chilean peso will likely prove to be much better stores of value in the long run, particularly for those who find precious metals too risky or volatile.

About the author: Simon Black is an international investor, entrepreneur, permanent traveler, free man, and founder of Sovereign Man. His free daily e-letter and crash course is about using the experiences from his life and travels to help you achieve more freedom.

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Comments on this entry are closed.

  • KJQ

    I’m not so sure that inflation will be slow in the USA. Here in Canada we’ve noticed food prices increasing 5-10% PER MONTH in the last few months. The media claims this is due to higher fuel costs, but that is only part of the picture. I think Americans will start to see prices escalate significantly this year. And by the way, that’s just the tip of the iceberg. Once the US$ is no longer the world’s reserve currency (and it won’t be for long as your Fed keeps printing money at an obscene rate), we’ll all see hyperinflation and worse. I’m just hoping and praying we’ll get hit like New Zealand did, and not like Yugoslavia.

  • Dombrunone

    The Big Mac will only get to $5 in the US when wages also rise by roughly the same percentage. If McD’s tries to take it up there sooner, their volume will drop accordingly.

    • Bear

      If u really think corperate america is going 2 “raise” peoples wages,,, then keep smoking!! WE bailed out Wall Street and the Banks ! In return they 4closed on our houses which they have been making gobs of interest on and sold them for a HUGE bottom line profit! Listen to the news! “BANNER profits” for Corp america!! Their CRUSHING the middle class!! When have your raises [if you even get one] been ABOVE the cost of living increase? And we just bendover for more!!! Y? Other countrys would and have taken to the streets!! Wer to fat from cheep McD’s to get off our ASSES!!

      • Dombrunone

        All supply & demand Mr Bear. I didn’t say I thot wages wud get raised, just that McD’s wouldnt be able to raise prices to $5 right now without losing volume & thus revenue. Thus they won’t do it Fact is, I can make 5 Big Macs for $5 at home, and bring them to work for lunch. Better tasting & healthier too. As far as Corp America goes, did you think they were in business to take losses? They are not crushing the middle class. When was the last time that you upgraded your skills? What makes you think you should make more for the same work than someone in the Far East or India? I have two nephews that graduated from Georgia Tech over the past few years and they are getting raises above the cost of living. But they are continually taking new courses and going for advanced degrees. Why should someone give you a raise with your attitude? ? What have you done for your boss lately? Sounds to me like you’re the one smoking something.

  • http://www.roycobden.com Roy Cobden

    Recognizing that about 80% of Canada’s international trade is with the
    US, I’m also deeply concerned that my C$ will be deliberately devalued in an attempt not to lose too much trade as our exports rise in price relative to the $US.

    We should all understand by now that when tough decisions have to be
    made, the politicians first question is “Will this cost me my
    re-election?”.

    We have just this week elected a majority government with a 5yr term, so
    we know any and all tough political decisions in Canada are being made
    with a “long term” horizon of 2016.

    In contrast, the US, with a 4yr election cycle, is even more hamstrung in it’s so-called long term outlook.

  • TomMcCarty

    It is always somewhat amusing to read rants on how banks can foreclose on multiple homes, which suggests the owner did not pay the the bank as agreed, and the bank after not receiving income for months, if not years, comes in only to make repairs pay taxes and other expenses…. And make a profit.
    Hey knuckle head, you must be outta your mind.
    This scenario you talk about says you had equity…. Or you are a bit disingenuous … Think of that word as playing nice and sending you back to school.
    Get a job flipping burgers if that is all you can do.. Start over
    It is not too late. What you went through is like an American divorce.

  • J Somberman

    We are having greater inflation now than what the government is telling us. Fuel has doubled in the past 4 years and food is up some 30%. But the current people in the oval office are cooking the books so THEY look better on paper and the economy doesn’t look as bad as it really is. They don’t include food and fuel in their figures anymore. If they used the same accounting that they used when the CPI was established the inflation rate is closer to 12%. More lies and bull shit from the people at the top. And the government has now painted themselves into a corner because over the last several years the “leaders” have been spending your children’s, children’s future into a hell hole of drowning debt. Now the only way out for them is to “force” inflation into the mix so they can pay back the debt with cheaper dollars. If you don’t think that inflation is going to haunt the U.S. for a very long time , you have your head in the sand.

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