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

About the author

James Hickman (aka Simon Black) is an international investor, entrepreneur, and founder of Sovereign Man. His free daily e-letter Notes from the Field is about using the experiences from his life and travels to help you achieve more freedom, make more money, keep more of it, and protect it all from bankrupt governments.

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