Better in their words…

Agenda: Rest of the World Must Act now – WSJ.com.

A rather interesting analysis. What do you think?
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As the world waits for Egyptian President Hosni Mubarak to succumb to the outgoing dictator’s traditional helicopter moment, Jordanian King Abdullah hastily thrashes out a reform program with his newly appointed prime minister and former Tunisian President Ben-Ali settles into his new life in Saudi Arabia, it’s worth pondering the global causes of this regional crisis—and what might be its global economic consequences. These go far beyond the immediate risks of political and economic contagion already manifest in volatility across many world markets and pose a risk to the global financial order.

The political turmoil in the Middle East may have revealed an overwhelming pent-up desire to overthrow years of oppressive dictatorships, but it has its origins in the vast global economic imbalances that have built up over the past decade and that continue to destabilize the global economy—in this case reflected in the form of high and rising food prices across the world. If world leaders take one message from these protests, it must be they can no longer afford to delay the agreement of a grand bargain to tackle these imbalances, following up on their G-20 commitments last year. If they fail, I fear we will see a lot more political unrest this year—and see it spread well beyond the Middle East.

It is hardly surprising the Egyptian people are angry: the country is one of the world’s most vulnerable to rising food prices. Food constitutes more than 40% of Egypt’s total final consumption—one of the highest levels among all emerging markets, according to data compiled by Absolute Strategy Research. The same is true of Tunisia, Algeria and Morocco. Worryingly, other countries where food is more than 40% of consumption include Pakistan and Ukraine, both nuclear states. The sharp rise in food prices in these countries has inevitably a much greater impact on living standards than the U.S., U.K. or Japan, where food is just 7.2%, 8.7% and 14.3% respectively.

High food and commodity prices are partly a consequence of pressures of rising demand but also reflect the vast amounts of liquidity sloshing around the global financial system. Indeed, there has been a remarkable correlation over the past 50 years between three-year growth in global liquidity and rises in industrial and food commodities, analysis by ASR shows.

The vast amounts of liquidity pumped into markets in response to the global economic crisis, most notably the U.S. Federal Reserve, has weakened the dollar while at the same time driving up the price of dollar-denominated assets, including agricultural commodities such as corn and wheat which have doubled in seven months.

Does that mean we should blame the Middle East crisis on Ben Bernanke? Many people already implicitly do exactly that, accusing the Fed chairman of embarking on the last round of quantitative easing in a deliberate attempt to weaken the dollar, thereby fuelling inflation around the world. But that is far too simplistic: Mr. Bernanke sets U.S monetary policy in response to U.S. financial conditions—but those conditions inevitably reflect policy decisions made elsewhere in the world.

The U.S, like many other highly-indebted Western countries, desperately needs to rebalance its economy away from consumer spending towards exports. But it is being prevented from doing so by a combination of the refusal by some emerging market countries to allow their exchange rates to appreciate to boost their own domestic demand and a host of bureaucratic, legal and political constraints that make it very hard for developed market investors to deploy capital in many emerging economies.

The result is that domestic growth in many developed markets for much of past year did not appear strong enough to offset the risk that economies tipped into deflation, while at the same time global excess liquidity was driven by the lack of alternatives into resuming the same desperate search for yield that lay at the heart of the global financial crisis. The effects of this search for yield are already showing up across the markets, for example, in the surge of funds into emerging markets, in falling developed market sovereign and corporate bond yields, in the huge flows into London commercial real estate.

These problems are likely to become even greater as the global recovery picks up pace. The latest data on both sides of the Atlantic suggest inflationary pressures are picking up everywhere, but central banks won’t start withdrawing liquidity while there is still so much spare capacity. At the same time, faster growth in the emerging markets means these countries will continue to accumulate reserves far beyond what their domestic markets can absorb. Add in the risk that the current political instability in the Middle East leads to funds flowing back into developed market assets, and there is a risk of a further round of destabilizing asset bubbles, laying the ground for the next crisis.

From an economic perspective, the best outcome from in the Middle East would be the emergence of open, democratic governments committed to the creation of free and open markets that can provide investment opportunities to absorb some of this global capital. But that is not going to happen overnight.

Meanwhile, the rest of the world cannot afford to delay addressing the underlying causes of the crisis before it engulfs other regions. That means action on exchange rates to rebalance developed market economies and it must mean opening up emerging market economies to wider foreign investment through structural reforms. Above all, it must include action on both scores by China, which accounts for 25% of emerging market GDP. After all, the lesson from Egypt is that China has as much at stake in resolving these issues as any country: it is very far from being a democracy—and food accounts for 30% of household spending.