Inflation and the coming trade war.

            It has been well established that China is purposely undervaluing its national currency, the Renminbi, with the Yuan as its principal unit. China's reason for doing so is quite simple. By undervaluing its currency, China keeps the cost of its goods and cost of labor artificially low giving it an extreme competitive advantage over those countries with a free floating currency. World governments, especially those of the U.S. and Japan, have been trying to persuade China to allow its currency to rise with market forces for years now, with hardly any luck. Well it now seems these governments have taken the philosophy; if you can't beat them, join them.

            The Japanese government has taken unilateral action to hold down rising appreciation of the yen and has promised future action if needed. Both the U.K with its pound and the Swiss with the franc, have taken aggressive measures to devalue their currency in hopes of competitive advantage. The United States Federal Reserve, already after one round of quantitative easing, has stated that it would be willing to purchase another $1 to $2 trillion more of government debt, if the economy remains on shaky ground. The argument for such action is populist in nature, make our exports more affordable while creating and holding manufacuring jobs, but like all government intervention, unintended consequences abound.

             With the major economies debasing their currencies, the first hints of inflation to come are starting to be seen in the commodities market. Precious metals, cotton, coffee are all at multi-year highs, while most other commodities are up over 20% for the year. As the cost of these raw materials increases, that added cost will be felt and magnified at every step in the process chain. From the price of a cup of coffee at Starbucks to a box of cereal at the supermarket, prices are going up. With unemployment still near 10%, any increase in the price of staples would be felt much more quickly than in times of prosperity.

              Which brings me to the ratcheting up of trade tension between the U.S., China, and Japan. China and Japan have recently clashed of islands in the South China Sea, to which both lay claim. Japan detained a Chinese boat captain accused of ramming into two Japanese coast guard boats. In retaliation, China cut off high-level diplomatic talks, discouraged Chinese tourism to Japan, detained 4 Japanese nationals, and supposedly cut off all export of rare earth metals to Japan. These rare earth metals are crucial to the battery and cell phone industry, industries heavily relied upon in Japan. The U.S. has also gotten tangled up in rising tensions with  China. In retaliation to China's unwillingness to allow its currency to appreciate, the U.S. House of Represenatives is considering to impose tariffs on Chinese exports deemed to have unfair competitive advantage as a result of the devalued yuan. Earlier this year the U.S. imposed tariffs on imported tires from China, they recently retaliated by imposing steep tariffs on U.S. poultry exports.

               Not only does this tit for tat retaliation step up tensions with our largest trading partner, these escalating tariffs are another add cost that will eventually be past down to a consumer who is ill equipped to handle rising prices. It is clear that the debasing of world currencies and the imposing of tariffs will raise the cost of production when the global recovery is anemic at best. Economists continue to rally against deflation for fear there is not enough demand to ensure stable prices, this is certainly true in the very short term, but do we really trust the Fed and other world governments to quickly cut the money supply and find an efficient exit strategy for all this loose monetary policy, their track record leaves alot to question. We've, also, come along way from the passage of the Smoot-Hawley tariff act of 1930, but with extreme nationalism on the rise in China, Japan, and the U.S., will cooler heads prevail?