Published on the Malta Independent¸ issue 13th February 2011

Global financial markets appear to be remarkably relaxed about a cautious recovery. Share prices are roaring away on the back of optimism about the growth prospects of the world’s two biggest economies¸ China and the US. With Dow Jones hitting the highest peak for a record number of years now averaging 12¸300 mark. Financial markets are rallying¸ perhaps influenced by waves of over-confidence interspersed with bursts of panic.

The good news for Asia is that most of the region’s monetary authorities are¸ in fact¸ tightening policy and China is typically raising interest rates to calm down inflationary pressures. The bad news is that leaders have been generally slow to act. The markets appear to expect a good deal more monetary tightening in Asia – at least that’s the message coming from sharply appreciating Asian currencies¸ which seem to be responding to prospective moves in policy interest rates. Asia¸ with its export-led economies¸ can’t take currency appreciation lightly – it undermines competitiveness and risks eroding the country’s share of the global market. It is true that the Western world is currently in a confident mood.

At present¸ the mood is one of supreme optimism¸ marked not just by a willingness to shrug off events in Egypt but also to downplay evidence of overheating in Asia and the intense commodity price speculation encouraged by the cheap money policy. Ironically¸ this will lead to even higher oil prices and even dearer food¸ increasing the chances of an eventual hard landing.

In Malta we are seeing a constant increase in energy costs¸ milk¸ bread prices and other essentials. It is well known that imported commodities such as cereals are more expensive and this alone will result in higher food prices. Really and truly¸ the true cause behind the hike in oil prices is not the social unrest in the Middles East but what is going on in China and the US. Surely we should still be concerned because we cannot bear facing a double dip recession due to run away inflation. Should history repeat itself¸ the result will initially be higher inflation as companies mark up prices resulting in dearer food and energy¸ coupled with claims from workers for compensation.

This will be followed by deflation caused by a squeeze on corporate profitability and tightening of monetary policy as central banks seek to bring inflation down again. For example¸ emerging markets¸ particularly Asia¸ find themselves in a classic policy trap¸ dragging their feet on monetary tightening while risking the negative impact of stronger currencies¸ in contrast to the dwindling value of the dollar. Asia aside¸ we cannot ignore the unprecedented events that are currently unsettling the people of the Middle East. Can we ignore the unrest in the Middle East as this adds fuel to the fire that is leading to more volatility in oil prices particularly if this will lead to a slow down in tanker traffic via the Suez Canal?

All is rather confusing and contrasts with the positive trend in advanced economies such as that of US and Germany. This optimistic view of a quiet revival of the export market however¸ is based on a series of assumptions¸ some more plausible than others. The first is that there will be a peaceful transition to democracy in Egypt. The second is that there will be no ripple effect across the oil-producing states of the Middle East. The third is that¸ even if the protests do