Gold rose to its highest in a week on Monday before trimming gains as the dollar strengthened against the euro and oil prices eased, analysts said.

“It is mostly a story about the U.S. dollar, equity markets and inflation at the moment,” analyst Eugen Weinberg at Commerzbank said.

Gold had little incentive to move higher, with oil prices sliding, but firm buying once prices moved towards $800 an ounce created a floor, he said.

Gold rose as high as $845.55 an ounce, its highest level since Jan. 12, before trading at $831.85 an ounce by 1516 GMT, down 1.2 percent from $841.85 in New York late on Friday, as oil prices reversed course and slipped.

Demand from the jewelry industry was seen weak this year, accounting for 70 percent of total demand for gold, and falling inflation would also cap prices, Commerzbank’s Weinberg said.

Gold is traditionally bought as an inflation hedge and with inflationary pressures diminishing interest could fade.

“Whilst we recognize the likelihood of spikes above $1,000 an ounce during 2009, we believe that weaker physical demand limits the potential for a sustained rally in the metal,” Investec Securities said in a report.

The bank forecasts gold prices at $825 an ounce for 2009, falling to $800 in 2010 and $750 for 2011, the report said.

A firmer dollar weighed on gold as dollar-priced commodities tend to fall as the dollar strengthens because it makes them more expensive for holders of other currencies. The euro eased to $1.3139 against the dollar on worries about the health of the euro zone economy after a ratings downgrade on Spain and grim economic forecasts from the European Commission.

OIL WEIGHS

Oil edged lower to around $34 a barrel, having risen 3 percent in the previous session.

Sinking oil prices weigh on gold as the metal typically moves in line with crude, because it is often bought as an inflation hedge, and the direction of the oil market is an indicator of interest in commodities.

But dealers said record bullion holdings in SPDR Gold Shares supported sentiment. Gold holdings in the world’s largest gold exchange-traded fund jumped another 5 tonnes to 795.25 tonnes last week.

Platinum was trading at $946.50/951.50 an ounce, down from $946.50 late on Friday. More than 60 percent of platinum use goes to autocatalysts to clean exhaust fumes.

More bad news for automakers emerged on Friday as manufacturers in Japan, Europe and the United States all warned their businesses continue to struggle and outlooks remained uncertain.

“Given this negative dynamic, support for platinum metals prices from its most important demand sector is foreseeably going to be missing this year,” precious metals group Heraeus said in a report.

“Despite this, we do not expect a complete collapse in the platinum-metals prices. As we have been seeing for some months now, new production is going to slow down as well.”

Silver eased to $11.06/11.14 against $11.21 and palladium traded at $181/186 versus $183 late on Friday.

New York gold futures added $32.5 an ounce to $846.8.

Source: LONDON, Jan 19 (Reuters)

Gold surged on Monday, helped by higher oil prices, a lower dollar and investor concern about inflationary pressures given the large amounts of money being pumped into the global economy.

Autocatalyst material platinum jumped more than 6 percent to $840 an ounce, while palladium gained more than 11 percent to $178 on growing optimism about a rescue for the auto industry in the United States.

Spot gold rose nearly 3 percent to $776.70 an ounce and was up at $773.90/775.90 at 1030 GMT from $754.60 in New York late on Friday, when it fell to $740.40, the lowest since November 20 in a commodities-wide sell-off.

To some, talk of inflation is premature given the world is currently grappling with the prospect of deflation, but forward looking investors are adding to their holdings of the precious metal to preserve the value of their portfolios.

“We will see some deflation, but that will be short lived and the inflationary impact of substantial fiscal stimulus … will inevitably lead to inflation,” said John Meyer, analyst at investment bank Fairfax.

“Gold will be an important commodity in the protection of value,” he said. Fairfax expects gold to average $900 an ounce next year compared with a previous forecast at $550. Central banks have pumped cash into the world’s financial system and slashed interest rates in an attempt to ease the credit crunch and boost confidence.

Chinese and European leaders are due to plot their next steps on Monday to move the world economy back from a precipice, while stimulus measures presented, planned or pending injected optimism into stock markets.

IMMINENT BAILOUT

Adding to investor worries about inflation was oil , which leapt 6 percent to above $43 a barrel.

Gold often rises in line with oil, which can trigger inflation, while a weaker U.S. currency makes metals priced in dollars cheaper for holders of other currencies.

“The dollar and oil are doing their bit for gold, but we are seeing a lot of investor interest in gold,” a trader said.

The U.S. Senate will reconvene later on Monday as negotiators seek to draft legislation to provide the three largest automakers with $15 billion in short-term loans.

Expectations that the plan could be agreed were bolstered after U.S. President-elect Barack Obama said the auto industry could not be allowed to collapse.

The news boosted platinum and palladium, used to make auto catalysts that cut carbon emissions.

Palladium was at $178/185 an ounce from $159.50 on Friday and platinum at $839/859 from $788.

“Having sustained substantial price corrections between July-October, platinum is currently benefiting from a good degree of bargain hunting buying, mainly from those with longer-term outlooks,” TheBullionDesk.com said in a note.

“However, with more negative auto data expected and commodities generally under pressure the short-term view is still a little negative.”

Spot silver rose nearly 5 percent to $9.91 and was at $9.84/9.82 from $9.45 on Friday.

Pratima Desai , Peter Blackburn
LONDON, Dec 8

A tentative rebound in global stocks spluttered on Wednesday while euro zone government bond yields hit a three-year low as gloomy economic news highlighted the case for more aggressive interest rate cuts in Europe this week.

The euro stayed on the backfoot and oil held near a 3-1/2 year low a day before the European Central Bank, Bank of England and Sweden’s Riksbank are all widely expected to cut borrowing costs.

Supporting those expectations, economic reports on Wednesday showed the euro zone’s services economy fell deeper into recession in November than initially thought and inflationary pressures eased.

“This is a horrible survey across the board, showing that the euro zone service sector is being hit ever harder by the financial crisis, muted consumer spending and markedly weaker activity in key export markets,” said Howard Archer, economist at IHS Global Insight.

Australia’s economy grew at its slowest pace in eight years in the third quarter as gathering recession abroad and evaporating equity wealth at home curbed spending by consumers and businesses.

Central banks worldwide are cutting rates to fight recession. They are also considering more measures to stabilise financial markets and restore battered consumer and investor confidence, including help for struggling U.S. auto makers.

The FTSEurofirst 300 index of top European shares fell 1.5 percent in early trade with Britain’s FTSE 100 index down 0.9 percent and Germany’s DAX  shedding 1.7 percent.

MSCI world equity index eased 0.4 percent.

“The markets are still looking very tender,” said Justin Urquhart Stewart, investment director at Seven Investment Management.

“Markets are not focusing on any of the good news and the good news is rates are being cut, commodity pries are coming down, stimulus packages are being put together and banks are being supported. But the market’s feeling very depressed.”

Japan’s Nikkei managed to eke out a 1.8 percent gain following a rebound on Wall Street on Tuesday, but MSCI’s measure of other Asian stock markets put on just 0.2 percent.

EURO PRESSURED AS ECB CUT EYED

Also under pressure, the euro fell 0.7 percent against the dollar on the day to $1.2626 and was also weaker against the yen , while the dollar climbed 0.6 percent against a basket of major currencies.

But demand for less risky assets continued to mount, helping to push government bond yields lower.

The 10-year euro zone government bond yield plumbed a low of 3.004 percent — a level last seen in Sept. 2005, while the benchmark 10-year yield for U.S. Treasuries was at 2.727 percent, not far off a five-decade low of around 2.651 percent set on Monday.

“Economic indicators are plunging like there is no tomorrow and central banks are gearing up for significant easing,” said Elwin de Groot, a strategist at Rabobank, noting 100 basis point rate cuts from Australia and Thailand this week.

The ECB meets on Thursday and most economists expect an interest rate cut of 50 basis points, while the Bank of England is forecast to cut rates by an aggressive 100 basis points.

Sweden’s central bank is likely to slash rates by a record 100 basis points, or possibly more, on Thursday when it announces the result of its meeting, which it brought forward by almost two weeks.

Meanwhile, U.S. crude edged up 41 cents to $47.37 but was within striking distance of Tuesday’s trough of $46.82 — a low last seen in May 2005.

Gold slipped to $774.80 an ounce, down $6.70 from New York’s notional close on the back of a broadly firmer dollar.

By Ian Chua
LONDON, Dec 3 (Reuters)

This past Friday with King Juan Carlos, the Spanish economy seems to have faltered again and this has occurred several times in recent months. There are already some who are speaking of reforms, hoping this slip will not be transformed into a fall, one that will leave more than a bruise.

What is happening with the Spanish economy?

The Spanish economy is facing several negative situations at the same time. One of them is linked to what it is happening with the value of the euro. The appreciation of the euro is playing a very dirty trick on Spain. Spain’s current account reached record deficit levels the first quarter of this year, constituting nothing less than 12.1% of the GNP.

How has this happened? The main blow to the Spanish’s current account was the significant deterioration of the trade balance. The level of imports has grown to a rate of 10.5% year-on-year, which represents a rate of growth of more than double that of the level of exports, which has only grown at the rate of 5.1%.

However, one of the factors explaining the increase in the level of imports is the increase in the price of the energy. These higher energy costs generated a rise of inflationary pressures. In fact, the preliminary economic data shows that in the month of May, inflation was sitting at 4.7%, its highest level in more than eleven years.

This situation, created by major inflationary pressures, is occurring in the context of economic deceleration (a situation many are already calling “recession”). In the case of the real estate market, Spain was one of the countries affected the worst in continental Europe. The data shows that in March there was a 38% drop in mortgages over that of March of 2007. The sale of houses also fell a dramatic 38.55%. In April, a large deceleration in construction was observed (as well as a slowing down of other economic activity). This lack of new construction has tested the rest of Spain’s economy by, in effect, spilling over into the rest of its activities.

So it is in this context of frustration, confronting Spaniards, that they find themselves not speaking of “consumer confidence” but rather what I would call the “distrust of consumers”. And this level of “confidence by Spanish consumers” hit its lowest level in fourteen years this April.

What will the Spanish government do in the face of this situation?

For Rodrigo Rato, the former Managing Director of the International Monetary Fund, it is in his expert opinion that Spain is facing a situation requiring that it consider the possibility of undertaking its first program of structural reforms since the country entered the Eurozone. It is these measures that are going to need to be more than Spain would ordinarily have considered since joining that union.

It is true that Spain has had past success with the implementation of reforms, especially when the various sectors of the Spanish economy agreed to the necessity of those measures. According to Rato, Spain also enjoys many benefits of membership in the Eurozone such as: “the advantage of stability, without currency exchange or monetary policies”. In his opinion, situations like the present one adequately demonstrate that the Spanish economy will be difficult to control without the enactment of some sort of monetary policy.

Rato goes on to note that one thing is certain: the government of Spain must react to the current situation quickly before time runs out. Spain must accept the fact that it must effectuate urgent changes, and now. Ex-president Felipe Gonzalez has already predicted there could be a serious energy crisis facing Spain by 2012. As one can see, the situation is complex.

Beyond all the debate that is generated by this situation confronting Spain, we will have to hope that within a month the Cabinet will approve a package of measures that will devise to stabilize the economy. Some of the things that they are contemplating are tax reductions for industry and the elimination of many administrative regulations to increase openness in the marketplace.

The Spanish government promises an ambitious package… Will its aims be realized? We will meet again tomorrow,

Horacio Pozzo

Editor’s Note: The economic figures in Spain have deteriorated. Rato proposes reforms, and hopes that the government approves a package of economic measures soon. Send your comments to me at: paola@latinforme.com

In that ad hoc comment, we wrote: “The crux of the thesis of our latest book, The End is Not Nigh, is simple and goes something like this: a) Asian central banks continue to manipulate their currencies and prevent them from finding a fair value against either the US$ or the Euro b) this manipulation triggers an accumulation in central bank reserves which, in turn, leads to low real rates around the world c) the combination of low global real rates and low Asian exchange rates amounts to a subsidy for Asian production and Western consumption d) in the US, the subsidy has by and large been captured by individual consumers e) meanwhile, in Europe, the subsidy has been cashed in by governments whose debt has skyrocketed f) we see little reason why, in the near future, the subsidy should be removed but g) if it were removed, the US would most likely encounter a consumer recession (not the end of the world) while h) Europe could go through a debt crisis (far more problematic).”

We went on and wrote: “Last week, and against most observers’ expectations, the Indian central bank did not raise rates at its meeting. Instead, it seems that the authorities are allowing the currency to rise and hopefully thereby absorb some of the country’s inflationary pressures (linked to energy and higher food prices). In recent weeks, the rupee has shot higher and now stands at a post-Asian crisis high. And interestingly, the local market is loving it. While Indian stocks had been sucking wind year to date, the central bank’s apparent policy shift (from higher interest rates to higher exchange rates) has triggered a very sharp rally.

This of course is an interesting turn of events and we would not be surprised if Asian central banks were to study developments in India carefully over the coming quarters. After all, India is blazing a path that a number of Asian countries may yet decide to follow.

One could argue that a change in monetary policy in Asia could end up being a “triple whammy” for Western economies. It would mean that:

• Asian central banks would export less capital into our bond markets and this would likely lead to a drift higher in real rates around the world.
• Asian exchange rates would move sharply higher, which in turn would likely mean higher import prices in the US and Europe.
• As Asian exchange rates start to move higher, Asia’s private savers would likely start repatriating capital, further amplifying exchange rate and interest rate movements. This would also likely lead to collapses in monetary aggregates in the Europe and the US.

Finally, we concluded the paper by saying: As we highlighted in Part 1: Why We Remain Bullish, we are not worried about valuations. And we are also not worried about “excess leverage” in the system, or the threat of a “private equity bubble”. We also do not fear an “economic meltdown” or a brutal end to the “Yen carry-trade” (which we did fear in the Spring of 2006). Instead, if we had to have one concern, it would have to be a possible change of monetary policy across Asia and the impact that this would have on real rates around the world. As we view things, the only reason Asian central banks would change their policies is if food prices continued to increase (in that respect, owning some soft commodities — a hedge against rising real rates — makes sense to us – as does owning Asian currencies). Interestingly, such a turn of events seems to be unfolding in India, yet no one seems to care. Monitoring changes in Asian inflation, monetary policies and exchange rates could prove more important than ever.

Nine months after that paper, we have indeed just gone through a period of a) rapidly rising food prices which have led to b) faster inflation rates across Asia, which have triggered c) a change in Asian monetary policy, notably a willingness to let the currencies appreciate faster than they have in the past. And if Asian central banks are now finally allowing their currencies to rise, then one thing is sure: Asian central banks will no longer need to print large amounts of their own currencies and accumulate US$ and Euros. They will thus also no longer need to buy US Treasuries and European bonds to the extent that they have.

Is it a co-incidence that, as Asia starts to allow its currencies to rise, US mortgages have been hitting the wall and spreads amongst European sovereigns have started to widen? The subsidy that Asian central banks have been giving to consumption in the US and governments in Europe (see The End is Not Nigh) is now disappearing.

Indeed, for the past five years, spreads of Italian ten-year government bonds to German bonds have hovered between 15bp and 25bp. But recently, spreads have started to break out on the upside.

And, of course, Italy is not alone. All across Europe, we have seen a widening of spreads between the “stronger” signatures (Germany, Holland, Austria, Finland, Ireland) and the “weaker” signatures (Portugal, Italy, Greece, Spain, Belgium, France) including those of Eastern Europe (Latvia, Romania, Hungary, Poland…).

Oil Shortages Within 5 Years

The Financial Times wrote: “Fears of a shortage within five years propelled long-term oil futures prices well above $130 yesterday, further stoking inflationary pressures in the global economy. Investors rushed to buy oil futures contracts as far forward as December 2016, pushing prices as high as $139.50 per barrel, up $9 on the day.”

Wow. The price rises $9 in just one day? People are rushing to trade out eight years. I had to e-mail Kevin Kerr to find out if that really happens in trader land (yes). Oil traders are saying that they have never seen such a jump.

Apparently, investors are betting that oil production will soon peak due to geopolitical and geological constraints. According to Robert Hirsch, who wrote a major energy study for the U.S. Department of Energy in 2005, we are more likely to see a several-year-long plateau than an actual “peak.” Still, the Peak Oil viewpoint is establishing a beachhead in the futures markets and supporting high prices. Greed and fear are just plain hitting the fan on this one.

Veteran oilman T. Boone Pickens has been beating the drum on this topic for quite a while. In Houston last October, Mr. Pickens told me, “All the world can produce is 85 million barrels of oil per day. But the world demand is nearer 87 million. Something has to give. It’s the price.” And Mr. Pickens has repeated that comment many times since then.

Apparently, the markets are listening to Mr. Pickens. On a large scale, investors are shifting their energy focus from the short to the medium term. Beyond the medium term, fears for future oil supply dominate the thinking. Since January 2008, long-term futures oil contracts, such as those for delivery in 2016, have jumped almost 60%. Near-term prices have gone up 35%.

I just hope that you have been following the Outstanding Investments energy recommendations over the past year or so. My goal has always been to align the portfolio with the energy-scarce future. I want you to benefit from these macro trends.

The View From Chevron

I had the recent opportunity to interview Peter Robertson, vice chairman of the giant oil company Chevron Corp. The American Petroleum Institute arranged the call. Mr. Robertson was in Washington, D.C., to testify before the U.S. Congress on — you guessed it — energy issues. Mr. Robertson made some time available to talk about the oil business with your humble editor.

Mr. Robertson focused on the oil markets from the perspective of what he knows best. That is, what does he see every day as he runs Chevron? “The U.S. market is well supplied” with oil and refined products, he said. In fact, “gasoline demand is down” in the U.S. That is, Chevron has seen a 1.5% decrease in gasoline demand. (Exxon has reported as much as 4% demand drop in some parts of the country.)

“What is causing angst is crude prices,” Mr. Robertson added. But Chevron has no control over the world price of oil. Chevron just accepts whatever price the world marketplace sets. With 9,800 gas stations nestled among the 160,000 total in the U.S., Chevron is hardly in a position to move the U.S. market for motor fuel one way or the other. Chevron just reacts to demand trends. Chevron does not cause them.

Chevron buys and sells about 2 million barrels of oil per day, according to Mr. Robertson. But these are “real” barrels, as opposed to trading futures. That is, Chevron either takes delivery or releases crude from inventory. So the company gets its hands dirty in the old-fashioned oil business. It does not speculate in the futures markets.

According to Mr. Robertson, in the first quarter of 2008, Chevron “made no money in the downstream business,” referring to the refining and marketing of refined products. He characterized it this way: “Downstream operations are not taking money out of the market. It’s all the cost of crude oil and taxes.”

This made me wonder how much higher fuel prices would be if refining DID take money out of the market. From what I know, gasoline at $3.75 per gallon reflects oil at $110-115 per barrel. At $140? The price of gasoline has more to go on the upside. Time to stop driving that SUV down to the strip mall to buy a box of Kleenex, right?

As an aside to Mr. Robertson’s comment on taxes, let me note that one recent study reviewed the total taxes paid by the top 27 energy-producing companies in the U.S. In 2006, the 27 largest energy companies paid more than $81 billion in income taxes, resulting in a 37% overall effective tax rate. That figure is higher than the top U.S. corporate tax rate of 35%.

Mr. Robertson notes that over the past six years, Chevron has earned about $72 billion total in after-tax profits. And it has invested over $73 billion in new energy and energy-related projects. So Chevron is investing more into its future asset base than it earns.

Interestingly, Chevron is the largest private producer of geothermal power in the world. Chevron sees a solid investment climate and return for geothermal in the U.S. This is of interest to me because I have five much smaller geothermal companies listed in my Energy & Scarcity Investor publication. All five aspire to be the Chevrons of the geothermal future. I won’t list the five names here, but I have recommended geothermal player Ormat (ORA: NYSE) for Outstanding Investments.

Mr. Robertson discussed Chevron’s efforts to assure future supplies of oil and natural gas. In the Gulf of Mexico alone, Chevron is the lead player or interest-holding partner to 40 different projects. Each project represents a commitment in excess of $1 billion by Chevron. The major constraint for Chevron to invest more hinges on its ability to obtain skilled personnel and to find vendors that can supply equipment and services.

According to Mr. Robertson, “Our personnel constraints are not just within Chevron, but with our contractors. The contracting community shrank in the days of cheap oil. Now the contractor community needs to grow.”

Of interest, about two-thirds of the total Chevron investment of $73 billion over the past six years has been outside the U.S. This is because of the level of restrictions on investing in energy projects domestically. Chevron would like to invest more in the U.S., but the national (and some state) investment policies discourage it.

For example, Chevron has struggled for several years just to obtain permits to upgrade its refinery at Richmond, Calif. Chevron is still waiting for approvals, but meanwhile, it’s operating one of the oldest refineries on the West Coast.

During this same time, India’s Reliance Industries Ltd. has constructed a new, state-of-the-art 600,000 barrel per day refinery in India. That refinery exports product to the U.S. West Coast market. So instead of having a more efficient Chevron refinery near San Francisco, drivers in California are buying fuel imported from India.

“If inflationary developments and, more important, inflation expectations continue to worsen, I would expect a change of course in monetary policy to occur sooner rather than later, even in the face of an anemic” U.S. economy, Fisher said during a Wednesday speech in San Francisco.

In a financial commentary titled, “With Oil Speculators Blitzing, the Fed Needs to Call an Interest-Rate Reverse Play,” Money Morning Contributing Editor Martin Hutchinson predicted that escalating inflationary pressures will force central bank policymakers to start increasing the benchmark Federal Funds rate – perhaps as soon as the two-day Federal Open Market Committee (FOMC) meeting that’s scheduled for June 24-25.

Although the article was datelined Wednesday, Money Morning’s articles are typically posted to the Web site the night before. And Hutchinson actually filed the article on May 21 – a full week before Fisher made his comments. Even before that, however, Hutchinson has repeatedly warned that inflation was becoming problematic: Back in early April, he even predicted that gold prices are headed for the $1,500-an-ounce level – again, due to inflationary pressures [Check out several of Hutchinson’s recent inflation-related research reports - one detailing profit plays stemming from higher oil prices, and the other looking at gold plays. Both reports are free of charge].

A move to boost interest rates would be a major story as well as a major turnabout for the U.S. central bank. After all, for nearly eight months the Federal Reserve has been engaged in one of the most aggressive rate-cutting campaigns in its history, having slashed short-term interest rates from the 5.25% level in mid-September down to 2.0% today.

The Fed Funds rate is the interest rate Fed-member banks charge for overnight loans to other institutions needing the cash to meet reserve requirements. Changes in that rate quickly affect borrowing costs throughout the U.S. economy, since commercial lenders are quick to adjust the so-called “Prime Rate” – and rates on other types of loans – in lockstep with changes in the Fed Funds rate.

Hutchinson, a longtime international banker and an expert on emerging-markets finance, said that as soon as he read the minutes from the April 29-30 FOMC meeting, he knew a near-term rate increase was likely. The two key reasons:

• The central bank had reduced its 2008 economic growth outlook from the range of 1.3% to 2.0% it issued back in January down to a new, lower 2008 growth estimate of 0.3% to 1.2%.
• At the same time, FOMC policymakers boosted their estimates for inflation – excluding food and energy prices – to a range of 2.2% to 2.4% this year, up from an earlier range of 2.0% to 2.2%.

According to Hutchinson, that double-whammy of lower growth and higher inflation leads to only one conclusion: Interest rates must head higher.

“Obviously, the Fed’s outlook on growth and inflation both changed,” Hutchinson said in a telephone interview from his Washington-area home yesterday. “There’s a lot of straw in the wind at this point.”

The April FOMC meeting minutes were released May 21; Hutchinson wrote his analysis and made his predictions later that same day. Prior to the release of the Fed minutes, there was almost no marketplace expectation of a near-term increase in interest rates.

Over the past few weeks, several other Fed bank presidents – including Thomas Hoenig of Kansas City and Gary Stern of Minneapolis – have displayed an escalating concern about spiraling pricing pressures. But Fisher, 59, is the only FOMC policymaker to “dissent” three times from decisions to lower the Fed Funds rate, Bloomberg News reported.

Buenos Aires, Argentina May 28, 2008

Frequently I ask my macroeconomics students: “Why is it so bad to have an inflationary economy”? I can assure you that the answers I get are quite varied, at times even funny. In my opinion, if I had to choose two reasons why inflation is bad for an economy I would have to say, unquestionably, that first – it generates negative effects for an economy’s growth because it increases uncertainty for investment. Second, and possibly more important, inflation has an aggressive nature in that it adversely affects the poor – for in times of high inflation they often cannot afford the things they need.

Inflation tends to hit the poor people the hardest because they have fewer mechanisms in place protecting them against its effects. Also, due to inflationary pressures occurring in the region the effect on the poor is even greater because the increase in the cost of living typically affects essential items such as food and energy.

In the past, Latin American countries typically resorted to increasing interest rates in inflationary times. Also a very basic and widely known policy used to cool down the economy is to remove inflationary pressures on prices through lowering the aggregate demand.

But are these kinds of policies really useful when it comes to controlling inflation? I have already commented in past articles in my opinion that if inflation is caused by internal factors, then the policies that are most effective at controlling this inflation must be internal as well. But if the reason for price increases is external to the economy, then implementing more restrictive monetary policies tends to do very little to assist. Recently in Latin America, we have found instances of the effects of both internal and external pressures (i.e. domestic demand is strong while at the same time “imported inflation” is creating the most damage).

So the operative question is what can governments do when facing the impossibility of applying a restrictive monetary policy to effectively control inflation rates? One alternative could be the implementation of policies following the lead of other countries in the region, such as Mexico.

Currently, the Mexican government is implementing policies to fight the increases in basic food items. Instead of setting up price controls, a policy that ends up creating the opposite effect, Mexico is eliminating the importation duty on these items and creating a situation where the levels of supply are increased.

In keeping with this method, Mexico has decided to eliminate import tariffs on several food items such as corn, wheat, rice, and soy paste. This way, it fights inflation directly at its origin and at the same time it protects the population of the poor. This policy is complemented by a farmer support policy to increase production (a $1.9 billion package has been adopted to finance farm machinery), the elimination of tax on fertilizer and manure, and stronger aid to disadvantaged families.

Speaking about this policy, Calderón, Mexico’s president, noted: “In order to alleviate the effect of this international phenomenon in our country and to insure that it does not spread and effect those that are less fortunate, my government will implement several policies, starting today, to supplement the income of families in the face of the current international food price increases.”

These measures must be stressed because they are the ones that are most likely to have the greatest effect on containing external inflation without creating distortions in the economy. The significance of this policy is that it promotes the additional production of domestic food supplies, which in turn will decrease the dependency on external food supplies, which currently are experiencing great volatility in prices.

But maybe these are not the only benefits created by these types of measures to fight the causes of inflation…. Are there, in fact, any additional benefits to this type of economic policy?

In relation to this question, I believe that in this way, easing the monetary policy through much lower interest rate increases will benefit economic activity. And the final cost of the support for agricultural production and the elimination of import tariffs will be offset by the creation of a stronger level of economic activity.

We will meet again tomorrow,

Horacio Pozzo

Editor’s Note: Imported inflation is generating the greatest damage in Latin America, even when domestic demand remains strong. When it comes to economic policy, México is doing the opposite of some populist Latin American governments. Send your comments to me at: paola@latinforme.com

The day’s economic numbers were pretty grim.

The Conference Board reported that its May consumer confidence index fell to 57.2 from a reading in April that had been revised up to 62.8 from a prior estimate of 62.3. That represents a 16-year low, and was far below economists’ expectations for a reading of 59.5. Confidence is off by nearly 50% since last July.

“With home price deflation deepening, the unemployment rate rising, and food & energy costs climbing, there’s little to buoy consumers’ outlook,” wrote Benjamin Reitzes, an economist at BMO Capital Markets. Yet the stock market rose and gold fell. Go figure.

The deflation was confirmed by Standard & Poor’s 20-city Case-Shiller home price index, which fell 2.2% from February to March, for a 16th consecutive decline in prices. Home prices in the 20 major U.S. metropolitan areas have now plunged by a record 14.1% in the past quarter.

Meanwhile, the euro got no lift from comments by European Central Bank Governing Council member Axel Weber. Weber said in an interview that rate cut speculation this year is “wishful thinking,” given high inflationary pressures and robust economic growth.

Source: Dollar Gains Against Euro

How does one control the inflationary trends that are happening worldwide? Surely, this is not a simple question to answer, even for specialists. Every time my colleagues and I meet, we cannot reach an agreement regarding how to control inflation, particularly in a context where international energy and food prices keep increasing.

One of the conclusions we can reach without much discussion is that strong food and energy price increases are striking all world economies, and that net commodities exporters are benefiting from these price spikes.

The second conclusion that we are able to gather from this situation is that countries having great natural resources, that are not yet net commodities exporters, now have a great opportunity to gain from the current economic situation.

This is exactly the circumstance that Brazil finds itself in currently. For two decades now they have had an effective policy regarding oil (fossil fuels), but now they are looking to expand their interests in biofuels and in developing policies to promote the cultivation of grains. In this way, Brazil is demonstrating a way not only to limit dependence on imported commodities, but also how to benefit from the current high international prices of commodities.

Thinking now of Mexico, the first thing I ask myself is: to which extent are these high energy and food prices affecting the Mexican economy?

Due to inflationary concerns, on the 16th of May, the Bank of Mexico decided not to modify interest rates. Inflationary pressures keep mounting along with concerns regarding a potential recession in the US: “Inflationary pressures in the world and in Mexico keep increasing and it is a growing concern.”

The Bank of Mexico’s governor, Guillermo Ortiz Martínez, noted a few days later: “There are still inflationary pressures because processed food prices could still go up, even though there is a more stable grain price.”

Inflation is worrying Mexico and there are concerns about a potential economic slowdown there as well… But there is also another situation that worries Mexico and this one is related to the development of energy reform there.

Reform within Pemex, the nation’s oil company, is at the center of this debate. Pemex plays a vital role in Mexico’s economy due to the huge profits that it generates. These profits, in turn, are used to fund areas within the infrastructure of Mexico such as education, security and other social programs.

For the first quarter of the year, 45% of the country’s income came from Pemex. This contribution by Pemex to the state treasury is particularly significant because oil production is decreasing and the known reserves have diminished significantly in recent years.

Pemex’s production peaked back in 2004, but ever since then it has consistently declined. Its oil production has fallen 1.3% in 2006, another 5.3% in 2007, and during the first quarter of this year it fell 7.8% below production levels during the same period last year.

However, it is most worrisome that between 2000 and 2007 the proven oil reserves in Mexico fell 54%, according to data from Pemex’s own annual stock report.

And while oil prices keep on skyrocketing (breaking the $130 barrier) Mexico is losing a great opportunity. With these high prices, now is the time for Mexico to begin looking towards investing in its future. However, the bad economic policies of the Mexican government are leading to a lack of any such investments at the current time.

But there is still time to change history by changing these policies; and to accomplish this Mexico needs massive amounts of capital for investing in its future. Thus the key issue for Mexico to resolve, and quickly, is how to find this necessary funding.

And one cannot forget that Mexico is not the only country in the region that is squandering its future growth opportunities. Argentina is as well and I will talk to you more in depth about this matter tomorrow. Today I have an opportunity to hear several renowned Argentine economists speak at an interesting conference at the Sheraton Hotel. Tomorrow I will specify their ideas and forecasts regarding Argentina, for you, our Latinforme readers.

We will meet again tomorrow,

Horacio Pozzo

Editor’s note: With oil prices climbing to higher than $133, to what extent does Mexico benefit from this? Is it taking advantage of this special time? Enjoy the following article and send your comments to: paola@latinforme.com or on our website at www.latinforme.com