The Trans-Atlantic Inflation Puzzle

By ELGA BARTSCH and JOACHIM FELS
FROM TODAY'S WALL STREET JOURNAL EUROPE

The main driver behind rising global inflation pressures is well understood: a very lax global monetary policy stance, particularly in the U.S. and in many emerging-market countries. This has fueled higher food and energy prices, and other prices are likely to follow – especially as most central banks around the world are unlikely to tighten policy sharply anytime soon.

So it is not surprising that inflation is rising everywhere. What does appear puzzling is that, at 4%, euro-area inflation is at about the same level as that in the U.S. and has actually risen by a greater amount over the past year. That's despite a significant appreciation of the euro against the dollar during the same period.

Corbis

The fact that the economic slowdown started earlier in the U.S. than in Europe accounts for part of this phenomenon. Another factor that helps to explain the more muted rise in overall U.S. inflation is the impact of the weak U.S. housing market on rent increases. Owners' equivalent rent, which is meant to gauge what homeowners would pay to live in their homes if they were renters, slowed to 2.6% year on year in May from a peak of 4.3% in December 2006. It accounts for nearly one-quarter of the overall U.S. consumer price index. But note that the euro zone's harmonized index of consumer prices excludes the costs of owner-occupied housing. So even though the euro zone's housing market is also weakening, this effect won't tame official inflation figures in Europe.

Moreover, the U.S. unemployment rate has now risen by more than a percentage point to 5.5% in June from its cycle low of 4.4% in March 2007, while the unemployment rate in the euro area has continued to fall until recently (to 7.2% in May). Thus, "slack" in the labor market has increased in the U.S. but has declined in the euro area. This trend is also reflected in slowing wage increases in the U.S. and accelerating wage rises in the euro area.

In addition, a pickup in productivity growth in the U.S. has weighed on unit labor cost growth recently, while a slowing of productivity has contributed to rising unit labor cost growth in the euro area. This means domestic inflation pressures appear to be lower in the U.S. for now, offsetting some of the impact of rising import prices due to a weak dollar.

However, the different positions in the economic cycle and different ways of calculating inflation cannot explain another trans-Atlantic puzzle: Despite divergent policy paths – aggressive easing by the U.S. Federal Reserve since last August versus a rate hike earlier this month by the European Central Bank – market expectations of longer-term inflation trends in the U.S. and the euro area are virtually identical.

Inflation-linked bonds suggest that investors expect inflation in both the U.S. and the euro area to average 2.6% to 2.7% over the next five years and around 2.5% over the next 10 years. This contrasts sharply with the popular mantra that the Fed, due to its dual mandate of controlling inflation and promoting growth, is more lenient toward inflation than the ECB, which is generally seen as a hawkish institution focusing on its primary mandate of price stability. The two central banks' divergent monetary policy stances and strategies would suggest higher long-term inflation risks in the U.S. than in the euro area.

But supply-side factors can explain why inflation pressures in the U.S. may be tamer than those in the euro area on a lasting basis. In our view, more flexible labor and product markets in the U.S. may help the Fed contain inflation. Meanwhile, the ECB faces more of an uphill struggle due to Europe's many market rigidities.

Therefore, the Fed's and the ECB's divergent policy paths may be well-justified. This divergence could also last for some time and may yet produce a similar inflation outcome. The fact that the U.S. is much further advanced than the euro area in liberalizing its product and labor markets could be the missing link in explaining why inflation in the two currency zones isn't behaving the way one would expect.

The piecemeal supply-side reforms and incomplete single market in the euro area are factors that potentially will make core inflation more prone to spillovers from the commodity price shock. It may thus be easier for euro-zone companies than for American companies to pass on higher commodity prices to consumers and for workers to demand wage compensation for such price spikes.

The ECB's own research has found a much greater degree of price "stickiness" in the retail sector in the euro area than in the U.S. While in the euro area consumer prices are typically adjusted only every four to five quarters, in the U.S. price changes at the retail level are happening twice as often.

So European politicians complaining about what they view as an overly tight monetary policy by the ECB should realize that they have it in their own hands to reduce the bank's inflation concerns. Pushing product and labor market liberalization would have the added benefit of making the ECB's job a lot easier.

Talking to Kim Jong Il

FROM TODAY'S WALL STREET JOURNAL ASIA

So the Bush Administration wants to do a nuclear deal with North Korea. For a reminder of the nature of the regime it's doing business with, look no further than the latest spat between Pyongyang and Seoul over the death of a South Korean tourist, who was gunned down Friday by North Korean soldiers.

The circumstances surrounding the death of Park Wang-ja, a housewife vacationing at the North Korean resort of Mount Kumgang, are unclear. The 53-year-old was reportedly walking on a beach when a soldier shot her twice: in the chest and in the buttocks. Pyongyang says Ms. Park had wandered into a restricted military zone. It is refusing to allow South Korean officials to verify this claim or investigate the matter.

The murder of its citizen by the military of a foreign power creates a diplomatic challenge for any government. No less so in Seoul, where President Lee Myung-bak assumed office in February on a pledge to take a tougher stance with Pyongyang.

His immediate reaction upon hearing of the killing Friday was to go ahead with a parliamentary speech calling for the resumption of "full dialogue between the two Koreas." Yesterday his Grand National Party called for direct talks with the North to smooth things over.

Pyongyang responded to the Lee government's low-key reaction with its usual subtlety. The President's proposal was "deceitful," it said, and the GNP's call for talks was "an intolerable insult."

As for an apology – which the speaker of the South's National Assembly had the temerity to suggest was due – forget about it. Rather, the North is demanding an apology from the South for suspending tourist traffic to Mount Kumgang in the wake of the killing.

Mr. Lee's new government is already under political stress for its decision to resume U.S. beef imports, which had been suspended in 2003 over fears of mad cow disease. Thousands of South Koreans have taken to the streets in protests in recent weeks. Yesterday Parliament initiated an inquiry into the deal Mr. Lee struck with Washington.

In the U.S., the Bush Administration has announced its intention to remove North Korea from the list of terror-sponsoring states in return for the North's promise to dismantle its nuclear program. The killing of a middle-aged female tourist, and Pyongyang's feverish refusal to apologize or admit any responsibility, shows how much the world can rely on its promise.

BEST OF THE WEB TODAY

Terrorist Telephone

By JAMES TARANTO

An article in Friday's New York Times drew lots of attention from those who like to wring their hands about U.S. "torture" of terrorists, but to our mind it's awfully thin:

Red Cross investigators concluded last year in a secret report that the Central Intelligence Agency's interrogation methods for high-level Qaeda prisoners constituted torture and could make the Bush administration officials who approved them guilty of war crimes, according to a new book. . . .

The book, "The Dark Side: The Inside Story of How the War on Terror Turned Into a War on American Ideals," by Jane Mayer, who writes about counterterrorism for The New Yorker, offers new details of the agency's secret detention program. . . .

Citing unnamed "sources familiar with the report," Ms. Mayer wrote that the Red Cross document "warned that the abuse constituted war crimes, placing the highest officials in the U.S. government in jeopardy of being prosecuted." Red Cross representatives were not permitted access to the secret prisons where the C.I.A. conducted interrogations, but were permitted to interview Abu Zubaydah and other high-level detainees in late 2006, after they were moved to the military detention center in Guantánamo Bay, Cuba. . . .

The book says Abu Zubaydah told the Red Cross that he had been waterboarded at least 10 times in a single week and as many as three times in a day.

The book also reports that Khalid Shaikh Mohammed, the chief planner of the attacks of Sept. 11, 2001, told the Red Cross that he had been kept naked for more than a month and claimed that he had been "kept alternately in suffocating heat and in a painfully cold room."

To sum up: The New York Times reports that a new book reports that unnamed sources reported to the author that a report exists that says terrorists reported being tortured.

That is, not only are we being asked to take the word of terrorists-->claim they have been tortured--but we are being asked to trust terrorists' claims that are reaching us fifth-hand (or fourth-hand if you spend $27.50 for the book). It's a big game of telephone.

And we thought the New York Times was against listening to terrorists' phone conversations.

A Moderate Massacre
"The Palestinian Authority has asked Israel to hand over the remains of Dalal Mughrabi, the Palestinian woman who led the March 11, 1978 coastal road attack in which 36 people were murdered and 71 wounded," the Jerusalem Post reports:

Israel is planning to deliver Mughrabi's remains, together with those of scores of Palestinians and Lebanese, to Hizbullah in the context of the new prisoner exchange between the two sides.

The PA said in its request that it wanted to "honor" Mughrabi by holding a big funeral for her in Ramallah.

Azzam al-Ahmed, a senior Fatah official closely associated with PA President Mahmoud Abbas, described Mughrabi, whose family originally came from Jaffa, as a "the first Palestinian woman to carry out one of the most courageous operations in Israel." He claimed that in her will, Mughrabi, who belonged to Fatah, had asked her family to see to it that she was buried in "Palestine."

"We want to turn Dalal's funeral into a national wedding, a major celebration," the Fatah official said. "The operation she carried out off the shores of her hometown of Jaffa was heroic and exemplary. She will always be remembered as a symbol for the Palestinian women's struggle."

The March 20, 1978, issue of Time described Dalal's "operation":

Their orders were to kill until they themselves were killed. And thus last week a Palestinian suicide mission left a grisly trail of carnage along Israel's main coastal highway from Haifa to Tel Aviv. Slipping ashore from the Mediterranean on the afternoon of the Sabbath, the terrorists hijacked two buses filled with tourists and sightseers, took them on a wild ride down the road toward Tel Aviv, shooting along the way at everyone in sight, and finally destroyed one bus in an orgy of fire and death. Official statistics put the dead at 37 (all but a few of them civilians, among them at least 10 children) and 76 wounded--a toll that exceeded the 1972 Munich massacre (11 dead) and the slaughter at a Ma'alot school in 1974 (26). It was the worst terrorist attack in Israel's history.

The Sabbath massacre came on the eve of Israeli Premier Menachem Begin's scheduled departure for Washington, where he was to confer with President Carter this week on the derailed Middle East peace talks. . . .

The timing of the attack left no doubt about the terrorists' purpose: to sabotage any attempt by Begin and Egyptian President Anwar Sadat to move toward a peace that would ignore or bypass Palestinian interests.

The fullness of time does not seem to have diminished the bloodthirstiness of the Palestinian leadership--and remember, the people who want to honor Mughrabi for murdering children in the name of preventing Israel from making peace with its neighbors are the "moderates."

Amber Alert
"President George W Bush has told the Israeli government that he may be prepared to approve a future military strike on Iranian nuclear facilities if negotiations with Tehran break down, according to a senior Pentagon official," reports the Times of London. Something about this story doesn't seem quite right to us. See if you can figure out what it is:

Despite the opposition of his own generals and widespread scepticism that America is ready to risk the military, political and economic consequences of an airborne strike on Iran, the president has given an "amber light" to an Israeli plan to attack Iran's main nuclear sites with long-range bombing sorties, the official told The Sunday Times.

"Amber means get on with your preparations, stand by for immediate attack and tell us when you're ready," the official said.

Have you ever heard an American refer to a yellow light as "amber"?

Tony Snow, RIP
We met Tony Snow twice. The first, poignantly enough, was at a funeral for a man who died much too young of cancer. Our friend Ken Smith was deputy editorial page editor of the Washington Times, a position for which Snow, when he was editor, had hired him. Smith was only 44 when he perished in 2001. After the funeral, a group of us, including Snow, gathered in the yard of another Smith friend and raised our beer bottles in Smith's honor.

We met Snow again last August, shortly before he left his post as White House press secretary. He was speaking in New York to the Hudson Institute about the Iraq war. We chatted with him briefly after the speech, and he seemed to have aged much more than the six years that had passed since our last meeting. The cancer and its treatment had obviously taken their toll.

In our brief experience, everything they're saying about Snow was true--he was gracious, earnest, good-natured and had a genuine interest in and command of ideas. We're glad to have known him and wish we'd known him better.

Vertigo and Obsolescence
Jack White, a former columnist for Time magazine, has an interesting perspective on last week's Jesse Jackson kerfuffle. White notes that Jackson's comment was "the sort of talk we'd expect from a lynch mob," a point we made last week. White, who is black, attributes Jackson's rage to confusion:

His stunningly inappropriate comments symbolize the social, political and psychological vertigo that all of us, and especially black Americans, are experiencing because of Obama's success. We are all, including Obama, in a place we never really thought we would be, and it has knocked us off our feet. We don't know how to act. We don't have a plan. We're searching for our equilibrium. And until we regain our footing, we can expect all sorts of bizarre behavior from people who ought to know better. Hold on to your hat. . . .

For the most part, we, like Jackson Sr., have seen ourselves as outsiders battling for justice and a seat at the table. Our default has been to protest. And while that mindset has served us well, it has, in a flash, been made damn near obsolete by the prospect, even the likelihood, that one of us may soon become the most powerful man in the world. If that happens, how can we seriously argue that we're being held back by anything but the limits we place on ourselves? . . .

We're not really ready for the day when The Man becomes a black man.

It's a dizzying idea that is going to take some getting used to. And until we do, we'll stumble about, like Jesse Jackson Sr., saying all kinds of crazy things as we slip and slide on the new paradigm.

It also must be noted, however, that Jackson has self-interested reasons to dread an Obama presidency. This is a man who has made a career--and a highly remunerative one--of black grievance and white guilt. And Jackson isn't alone, as this Associated Press story illustrates:

Racial disparity will remain an issue in America, regardless of whether Barack Obama is elected as the nation's first black president, the chairman of the NAACP told the organization's national convention Sunday night.

Julian Bond, a veteran civil rights leader, said Obama's candidacy doesn't "herald a post-civil rights America, any more than his victory in November will mean that race as an issue has been vanquished in America."

Whether racial disparity "remains an issue," whether we are in "a post-civil-rights America," whether "race as an issue has been vanquished" are all questions of definition and degree. One could make a case either way. It is indisputable, however, that Obama's political success is a tangible sign of the diminution of racial division in America. If "civil rights leaders" are not obsolete, their skills are a lot less urgently needed than when Bond and Jackson were young.

Metaphor Alert
"Top Bush hands are starting to get sweaty about where they left their fingerprints. Scapegoating the rotten apples at the bottom of the military's barrel may not be a slam-dunk escape route from accountability anymore."--Frank Rich, New York Times, July 13

God Bites Man
"A man says he was so consumed by the spirit of God that he fell and hit his head while worshipping," the Associated Press reports from Knoxville, Tenn.:

Now he wants Lakewind Church to pay $2.5 million for medical bills, lost income, and pain and suffering.

Matt Lincoln says he is suing after the church's insurance company denied his claim for medical bills. . . .

Lincoln says he has fallen from the force of the spirit before but has always been caught by someone.

Presumably the church's defense will be that it was an act of God.

It's Just Ice Cream
We've never seen the 1971 film "Mr. Forbush and the Penguins." We don't think we've even heard of it. But a reader calls our attention to this description of it on The Spinning Image, a British "cult movie database":

Mr Forbush (John Hurt) is a wealthy university student who cares more for the ladies than he does his studies. . . .

Forbush realises that his shallow manner is not going to make a good impression on Tara, which is the main reason he agrees to spend most of the year alone with the penguins. He bids farewell to his disinterested parents, tells his friend Star (Dudley Sutton), who is also headed down that way, that he'll see him at Christmas, and is given a St Christopher's medal by a now sympathetic Tara who he plans to see when he gets back, and will send tape recordings of his thoughts to her. And so it's off to the Antarctic. . . .

Around two thousand birds follow and Forbush has company at last, the study becoming his all-consuming obsession as he tags and observes the creatures going about their daily business of making more penguins. . . . In fact, so obsessed with the penguins does Mr Forbush become that he actually turns into a penguin. Well, not exactly, but he feels like a protective father to the animals.

Could this be where Gail Collins got the idea?

A One-Man Crime Wave

• "Naked Man Breaks In, Flees in Woman's Clothes"--headline, Associated Press (dateline Stuart, Fla.), July 1

• "Naked Man Arrested in City Park for Drugs"--headline, Palestine (Texas) Herald, July 3

• "Police: Naked Man Harasses Female Patron at Sheetz"--headline, York (Pa.) Daily Record, July 8

• "Naked Man Arrested after Hijacking Las Vegas Bus"--headline, Associated Press, July 9

• "Naked Man Breaks In, Trashes Neighbor's Home"--headline, Grand Rapids (Mich.) Press, July 10

We Prefer It Poached
"Minmet Investors Set to Roast Top Brass at EGM"--headline, Independent (Ireland), July 13

We Prefer Them Simmered
"US Bank Poaches Top Treasury Official"--headline, BBC Web site, July 10

We Prefer It Roasted
"Unrest Simmers in Diamond Industry"--headline, Gulf Times (Doha, Qatar), July 9

'You're Chevy Chase, and I'm Not'
"Chevy Chase Bank Closing 54 Branches"--headline, Fairfax County (Va.) Times, July 10

It's Always in the Last Place You Look
"Shark Found in Australian Pool"--headline, Agence France-Presse, July 11

Don't Tell Her Husband
"Publicist: Ethan Hawke Has Married Girlfriend"--headline, Associated Press, July 10

Just Leave It in the Front Yard, and It'll Be Stolen in No Time
"Special Needs Tricycle Stolen"--headline, Associated Press, July 14

Help Wanted
"Windham Police Search for Naked Man"--headline, Eagle-Tribune (North Andover, Mass.), July 10

Everything Seemingly Is Spinning Out of Control

• "Antarctic Ice Shelf 'Hanging by Thread': European Scientists"--headline, Agence France-Presse, July 10

• "Six-Year-Old Hit by Flying Sofa"--headline, Local (Berlin), July 11

• "Desk Rage Spoils Workplace for Many Americans"--headline, Reuters, July 10

• "Seattle-Area Children Falling From Windows With Alarming Frequency"--headline, Seattle Times, July 11

• "What's Next in the Law? The Unalienable Rights of Chimps"--headline, New York Times, July 14

• "AP IMPACT: An American Life Is Worth Less Today"--headline, Associated Press, July 10

Breaking News From 1962
"Police Seek Information on Monroe Break-In"--headline, Morning Call (Allentown, Pa.), July 10

News of the Tautological
"World's Oldest Blogger Dies at 108, After Posting Final Message"--headline, Asian News International (India), July 14

News You Can Use

• "Warning: Habits May Be Good for You"--headline, New York Times, July 13

• "Serious Fear of Laughter? Could Be Gelotophobia"--headline, Associated Press, July 9

• "Want to Fly? Don't Copy the Birds and the Bees"--headline, Society for Experimental Biology press release, July 9

Bottom Stories of the Day

• "Pineapples Not Banned in City, Host Panel Says"--headline, Rocky Mountain News (Denver), July 9

• "Talk of Manoogian Mansion Bash Is Still Just a Rumor"--headline, Detroit Free Press, July 13

• "M.L. Walker Born in 1864, Not 1867"--headline, Richmond Times-Dispatch, July 11

• "No Bomb Found at Lantana Bingo Hall This Morning"--headline, Palm Beach (Fla.) Post, July 10

• "VRU Has Got Agenda for Today!!!"--headline, For-UA.com, July 11

Mystery Solved
Freud famously asked: What do women want? The Associated Press reports that one young man believes he has discovered the answer:

Nick Epperson, a 24-year-old grad student, spent the night outside an AT&T store in Atlanta, keeping his cheer up with bags of Doritos, three games of Scrabble and two packs of cigarettes. Asked why he was waiting in line, he responded simply "Chicks dig the iPhone."

The jury is still out as to whether chicks dig Dorito-munching, chain-smoking, Scrabble-playing grad students.

There Is No Reason to Panic

By PETER J. WALLISON

If Fannie Mae and Freddie Mac were ordinary corporations, the sudden collapse of investor confidence last week would have set them to work on their bankruptcy applications. But they are not ordinary corporations -- and they are likely to survive because their debt securities have been viewed for decades as ultimately backed by the U.S. government. Barring the unlikely event of a credit market loss of confidence in the U.S. government itself, they should be able to attract the necessary financing for continued operations.

The key judgment about their financial condition will not be made by the equity markets, but by their regulator, the Office of Federal Housing Enterprise Oversight (OFHEO). As long as OFHEO believes they are adequately capitalized -- as James Lockhart, the director of the agency, affirmed in a public statement last week -- they will continue to operate: buying, holding and securitizing mortgages as they have for decades. And last night the Treasury and the Federal Reserve announced they would take steps to prop up the two corporations if and as needed.

David Klein

So there is no reason for stock market panic, nor for handwringing in the credit markets about an imminent default. Indeed, with the Senate finally -- after months of dithering -- passing legislation on Friday for a strong new Fannie and Freddie regulator, there is hope that the government will finally be able to rein in the excesses of these enterprises.

Yet there is little evidence the real lessons have sunk in. Just as the grave risks Fannie and Freddie create for taxpayers are finally being recognized, Fed Chairman Ben Bernanke and Treasury Secretary Henry Paulson were asking a seemingly compliant Congress to involve the Fed in supervising the largest investment banks -- which will only create similar risks elsewhere in the economy. (More on this later.)

Although they are owned by shareholders, Fannie and Freddie are government sponsored enterprises, or GSEs, chartered by Congress to perform a government mission: providing a national market for mortgages and enhancing the availability of affordable housing. This, together with a brace of special statutory exemptions and the fact that the U.S. government has always bailed out its GSEs, has led the capital markets to believe, correctly, that the U.S. government will never allow Fannie and Freddie to fail.

The result has been a complete loss of market discipline, uncontrolled growth, and the development of two giant companies whose deteriorated financial condition now threatens the stability of both the U.S. and the world economy. The story of Fannie and Freddie is a cautionary tale about the moral hazard created by government support for private institutions -- a tale we saw played out in the S&L debacle less than 20 years ago, and one we may be about to inflict on ourselves again.

There might have been a time when it was possible to believe that the feds would not stand behind Fannie and Freddie's obligations, but today, the possibility that any holder of their senior debt (or their mortgage-backed securities) would be allowed to suffer a loss is simply unimaginable.

First, because of unprecedented conditions in the capital markets, they are now virtually the only consistent buyers and securitizers of U.S. mortgages. If they could no longer raise the necessary funds to continue this activity, housing finance -- already very weak -- would come to a halt. The consequences for the housing market in the United States would be dire.

The result of a GSE default for the financial markets and the world economy would, if anything, be even worse. Fannie and Freddie's debt securities are held by thousands of U.S. banks -- often in amounts in excess of their capital -- and in large amounts by financial institutions around the world. Many of the world's most important central banks also hold huge inventories of these securities.

If there were ever the slightest doubt that the U.S. would stand behind these obligations, there would be a rush for the exits that would make what occurred in the equity markets last week look like a stately minuet. The value of GSE debt securities would plummet, and with it the capital of virtually all the world's major banks and other financial intermediaries. With weakened capital, lending would decline and further damage already weak economies, perhaps with truly disastrous results.

Thus, because the U.S. government will not allow Fannie and Freddie to default, they should be able to survive. If housing prices turn up again and their losses are stanched (or if they can raise more capital to cover the losses they will suffer in the future), these two companies will get through this period. This is by far the most likely outcome of the current period of stress.

But their survival will not be unalloyed good news. It will chase the wolf from the door only temporarily. Their embedded losses -- made worse by the risky commitments they are probably now making in order to recover their profitability or hide their losses -- will, as in the case of the S&Ls, eventually have to be paid. And of course, if Fannie and Freddie actually become insolvent, the U.S. government is now ready to step up. Considering that these two companies now have something like $5.3 trillion in liabilities, this is no small step.

This is a bad state of affairs; the U.S. government has lost any room to maneuver. Worse still are indications that no lessons have been learned. In the same week when it became apparent that implicit government backing has made the U.S. hostage to the health of two companies that grew out of control, Messrs. Bernanke and Paulson told Congress that they wanted a new regulatory structure for investment banks like Bear Stearns.

In this plan, the Fed would have supervisory authority over these companies and oversee a formal system for their "orderly liquidation." The only reason the Fed might want to regulate the investment banks is that it believes itself to be somehow at risk. The markets, ever clear-eyed, will read this for what it is -- potential Fed backing if the big investment banks get into trouble. In other words, we are now proposing to introduce a government-created moral hazard into investment banking. The resulting loss of market discipline will replicate the experience with the S&Ls and Fannie and Freddie.

According to reports, not an eye blinked in the House Financial Services Committee when the Fed's bid for more power was laid on the table last Thursday. This is fully consistent with the past willingness of Congress to condone -- and even encourage -- unimpeded growth at Fannie and Freddie.

If Congress actually believes that the Fed can assume responsibility for supervising and liquidating the large investment banks -- and yet not become responsible for bailing them out when their enhanced access to capital results in massive losses -- they deserve to wrestle with the future crisis they are now setting in train. But the American people do not.

Mr. Wallison is a senior fellow at the American Enterprise Institute.

The Fed to Latin America: Slow Down

For decades Latin America has been plagued by currency devaluations, inflation and lackluster growth. But just as some key countries have gotten serious about price stability and begun to reap the benefits through higher growth, the region is facing a new economic menace: the Federal Reserve.

The Fed is exporting inflation to the rest of the world as dollar-denominated commodity prices soar. The Latin American countries that keyed their currencies to an unofficial dollar standard are now finding that the standard is collapsing.

The Federal Reserve is exporting inflation to Latin American countries, inhibiting the growth and stability of these emerging markets, says Mary Anastasia O'Grady, writer of "The Americas" column. (July 14)

It hasn't been easy, but in recent years most Latin American central banks, excluding Venezuela and Argentina, have diligently battled inflation despite the higher-than-ideal interest rates required. To further tighten credit, Chile on Friday hiked its bank rate by 50 basis points to 7.25%, and Mexico is expected to take its rate to 8% before year's end. Brazil has raised its equivalent rate by 100 basis points in recent months to 12.25%. Peru and Colombia have also adopted hawkish stances.

These unpopular measures, however, have little effect on imported inflation. With oil and commodities priced in dollars and the dollar sinking in value, there is nowhere for prices of these globally traded goods to go but up, and no way for central bankers to avoid the effects on prices at home.

Two weeks ago, the world learned that the Fed is unlikely to take responsibility for dollar inflation any time soon. Worse, it now wants to blame the victims -- the emerging economies -- for the problem of rising food and energy prices. The finger pointing occurred on June 26 in Frankfurt, Germany. The finger pointer was the vice chairman of the Fed's Board of Governors, Don Kohn.

In a speech to the International Research Forum on Monetary Policy, Mr. Kohn laid out how he sees the problem: "It is clear," he said, "that the sharp increase in many commodity prices has given rise to highly coincident increases in inflation rates around the world."

AP

Brazil is booming thanks to currency stabilization. Here workers build a new bridge in Sao Paulo, April 16, 2008.

Coincidental? Well, maybe not. He continued: "In industrialized economies, such as the United States, rising inflation has chiefly reflected the surge in energy prices, whereas in developing countries, for which food takes up more of household budgets, rising food costs have been a more important culprit." In other words, Americans driving SUVs and the masses in the rest of the world trying to feed themselves are the cause of inflation. The Fed's feckless dollar husbandry is not to be blamed.

Why inflation persists even when the global economy is no longer booming is apparently a mystery over at the Fed. Or as a puzzled Mr. Kohn put it: "The reasons for the trajectory and persistence of increases in prices of food and energy this year, as global growth has moderated, are not entirely clear."

Nonetheless, the vice chairman put forth a hypothesis. "The upward trend in prices of food and energy over the past several years importantly reflects the pressures posed by rapidly growing demand in developing economies against relatively inelastic global supplies of commodities." Translation: Developing countries are consuming too much and there is not enough to go around. Mr. Kohn did not mention another American blunder on top of the dollar: the massive corn-ethanol program, which has put additional pressure on grain supplies.

"For the moment," Mr. Kohn continued, "higher headline rates of inflation have shown only a few tentative signs of embedding themselves in core inflation or in longer-term inflation expectations." In other words, he doesn't think we have a problem. On the other hand, just to be on the safe side, he's happy to let someone else solve it. "In those countries where strong commodity demands are associated with rapid growth in aggregate demand that outstrips potential supply, actions to contain inflation by restraining aggregate demand would contribute to global price stability."

I thought that the "Phillips Curve" -- which alleges that inflation is a byproduct of growth -- had been discredited 30 years ago. Apparently not at the Fed. But it sure has been in Brazil, where expanding investment and growth have been byproducts of Brazil's success in currency stabilization.

It is not encouraging to learn that a Fed official thinks global inflation is caused by growth and has nothing to do with the weak dollar. The world knows better. It knows that the Fed is responding once more to a crisis in the American financial sector that it had a great deal to do with creating through its overly accommodative policies.

The world also knows that the Fed has given pressures from Wall Street and Congress priority over its responsibilities in managing the world's most important currency. If central bankers in Latin America resent the shifting of blame by a top Fed official, they are fully justified.