Fri, 04 Feb 2011


By William Pesek
Feb. 3 (Bloomberg) -- It’s hot in Indonesia these days, and I don’t just mean the equatorial weather.

We’re talking about two things that rarely fuse together: Chili peppers and hot money. Try chatting up a local without both topics coming up. The reason: Record prices for the fiery spice Indonesians eat at breakfast, lunch and dinner are partly due to Federal Reserve Chairman Ben Bernanke.

La Nina weather patterns also are to blame. Yet near-zero interest rates set by central bankers in Washington, Tokyo and Frankfurt are sending torrents of cash to Asia in destabilizing ways. Inflation in Indonesia almost doubled to 7 percent last month from a year earlier.

Indonesians will put up with all kinds of indignities. Rising rents? Dismal infrastructure? Endemic corruption? Public inefficiency? Such is life. But a four- or five-fold surge in chili prices? An outrage!

The message is clear: Policy makers must intensify their inflation battle immediately and interest rates aren’t enough.

This is more than an exercise in avoiding ugly consumer- price-index readings. It’s about social stability in emerging economies that suffer from an underappreciated vulnerability. East Asia is home to a critical mass of those surviving on less than $2 a day. For families, surging costs for chili peppers, rice and cooking oils are a desperate issue.

Chili Crisis

That hasn’t been missed by President Susilo Bambang Yudhoyono. Unable to control the weather or ultralow interest rates in bigger economies, he is urging Indonesians to grow their own chili plants in pots. When a busy Asian leader is offering advice about spices, you know we have problems.

Inflation is a real danger, of which the fast-unfolding events in Egypt serve as a reminder. While 30 years of autocratic rule are what’s forcing President Hosni Mubarak from office, 10 percent-plus inflation isn’t helping.

What can Asia do? Recently, I had an interesting debate with a group of economists and businesspeople in Jakarta that reminded me of the extent to which policy makers are in uncharted territory and that conventional thinking is losing its clout in our financial world.

It went something like this: Food costs and wages are surging. So are oil and gold prices. Telltale signs of inflation are bubbling up everywhere. What’s a responsible Asian central banker to do? Cut rates, of course. Huh?

Overheating Risks

The missing link to explain why smart, worldly individuals would so blatantly forsake their Milton Friedman is hot money. It’s creating havoc in Asia and adding to overheating risks. Now, none of this is going to happen. Friedman’s views on excess money fueling inflation remain persuasive. In Asia’s case, it means massive asset bubbles that could lead to another crisis.

Yet the fact such ideas are bouncing about speaks to the extreme uncertainties of our times. Higher rates will make Asia even more attractive to overseas investors, adding to already considerable inflation risks.

Governments must be more creative and interventionist. Here’s where Asia tosses aside Friedman’s faith in the self- disciplining magic of markets. The free-markets crowd will take exception, but scant few of its members are on the ground in Bangkok, Jakarta or Kuala Lumpur. These places are on the front lines of liquidity washing Asia’s way.

The Real Menace

Economists are prodding China, India, Indonesia, the Philippines, South Korea and Vietnam to boost rates. Governments also must step up efforts to avoid social instability from Mumbai to Manila, where rising food costs are the real menace.

“Markets are becoming increasingly impatient,” says Fauzi Ichsan, Jakarta-based senior economist at Standard Chartered Plc.

When investors worry about runaway Asian economies, they’re often thinking about China, now the second biggest in the world. Fast-rising wages there mean the biggest export from the globe’s factory floor this year may be inflation. Shopping at Wal-Mart may never, ever be the same.

It’s now becoming a generalized, regional risk, though. Asia may face a “hard landing” if authorities don’t act faster, International Monetary Fund Managing Director Dominique Strauss- Kahn said in Singapore on Feb. 1. In all likelihood, that means capital controls to limit fund inflows.

Watch the Leverage

Expect more tweaks to what economists call “macro- prudential policies,” including steps to slow the rise of property prices and tighten standards for exposure to foreign currency borrowing. Leverage is the real worry here. While everyone agrees too much liquidity is dangerous, the key is locating where those excesses exist. Policy makers should be paying close attention to leverage ratios.

Asia, with the exception of Japan, is booming. Any cursory look at data on gross domestic product and stock performance shows that. The trouble is, the region has too much of a good thing on its hands. Too many investors are seeking higher returns at the same time Europe is quaking and America’s outlook is shaky.

As economies here get too hot for their own good, policy makers must reassert themselves. If they have any doubts, the proof is in those red-hot spices sitting on the dinner table.

(William Pesek is a Bloomberg News columnist. The opinions expressed are his own.)