Malmgren: The Social Fabric in Emerging Markets is Being Ripped Apart by Inflation

Serious players I talk to on a regular basis are deeply concerned about the economic prospects for the United States and the world. Most won't go on the record.

One serious player, who is willing to publicly voice her concerns, is Phillipa Malmgren. You don't get insider credentials much better than hers. She was Special Assistant to the President for Economic Policy on the National Economic Council. She was also a member of the President's Working Group on Financial Markets, aka, the Plunge Protection Team. Her client list includes every elite corporate firm in the world.

During a speech recently delivered in Zurich, Switzerland to hedge fund managers, she laid out the problems she sees ahead.

In part, she said, as reported by Opalesque:

Malmgren, a well-known policy and markets analyst, made the following remark on the hedge fund world: “I find it is an industry where people have become accustomed to a certain way of thinking… they have to put a number to things.” However, she said, politics, policy, geopolitics are not quantifiable.

The hedge fund world has no understanding of the social function of inflation that is going on in the emerging markets at the moment, she said. They believe there should not be any great unrest, and the environment is not likely to be as unstable as it was in the 70s because of the economic growth that started in the 80s.

But “the social fabric is being ripped apart by inflation,” she said....Inflation is a big problem, which we cannot handle, said Malmgren. Standards of living are falling everywhere (e.g. by 10% in Spain), and in emerging markets too. GDP may be rising in the emerging markets but higher inflation is eroding the standard of living. That’s why we have so many strikes, riots, and now coups there. The minimum wage is not enough given food inflation. All this will affect the Western world, which will have to pay 8% more for imported textiles and clothing this year simply because the Bangladeshi workers’ wage demands are rising. We are for example seeing the first textile price hikes since 1984: Levis Strauss is set to hike its prices.


Malmgren believes that these inflation pressures will set civil unrest in motion.

Chinese authorities, for example, are very nervous these days; they have curfews in some compounds. 50 million workers in China have left factories and gone back to farms and some workers did not receive their wages. China also has to deal with a shortage of water. The country must keep growth rate above 8% if it wants to avoid civil unrest. But inflation has moved from 2.75% to 3.6% in recent time, and some argue that it is already really above 10%. Therefore, China will reach for food, energy and raw material assets around the world more aggressively than in the past.

Events in Asia are not black swans, she said. But the increased competition for critical assets like gas fields, food and raw materials and shipping lanes could bring about another form of civil unrest and instability, of a kind not seen in the last 25 years: conflict between states.

She also expects sovereign defaults. Here's Opalesque, again:

“We are absolutely going to see a sovereign default,” she declared. According to her calculations, in Ireland, 3.8% of GDP will go to paying interest alone, which is more than Germany was asked to pay in war reparations for World War One, when they paid only 2.5%. Even that was too high in terms of “human pain” and Germany defaulted five years later. So the chances that Greece will repay its debts all the way until 2060 are not very good, and the willingness to pay is low.

However, “we always survive defaults and even benefit from them,” Malmgren stated.

She listed five kinds of defaults:
1. State does not pay back at all (e.g. Argentina)
2. State pays back a little less and more later (e.g. haircuts) – although it is quasi-default with extended payments.
3. State defaults on citizens, as now in Western Europe and the U.S. This means a great amount of human pain and a re-negotiation of the social contract.
4. Inflation
5. Devaluation

On the regulatory front, “don’t focus on the U.S.’ Frank-Dodd Bill,” she argued, “look at where the action is, and at what is not being addressed, i.e. higher and more hidden taxation. We are heading there; in the end all defaults are the same.”...In answer to a question from the audience about her favourite commodities, she replied: "At Principalis, we are currently keen two ideas in the commodity category: rubber and diamonds, both of which reflect the pressures I have described.”

There you have it. Thing across the globe from an economic perspective are dire. Debt will not be repaid, inflation will escalate and more civil unrest is ahead. How this will impact the United States, and whether civil unrest will hit here, is unknown. As Malmgren correctly puts it, politics, policy, geopolitics are not quantifiable.

A word to the wise, though, be prepared.