2008 February 21 Thursday
Mild Stagflation Makes A Return

The Federal Reserve has put fighting the credit crisis and threat of recession ahead of fighting inflation.

With the credit markets in disarray from the collapse of the housing bubble, Bernanke is cutting rates in a headlong rush to blunt the risks of recession.

But in putting its emphasis above all on reviving growth, America's central bank may face a bigger inflation problem down the road, according to some economists and even a few Fed officials.

"They are cutting rates with a bill to be paid later," said John Ryding, chief U.S. economist at Bear Stearns. "The question is not, will we get inflation, but how much will it cost to stuff the genie back in the bottle. This has the feel of 1970s stagflation."

Is the Federal Reserve making the right decision? I'm thinking the inflation problem is going to worsen because oil production is going to stay flat or decline. Plus, the US trade deficit is still too large and so the US dollar will drop further, raising the costs of imports and the foreign demand for US products (and hence their prices).

Amidst lowering forecasts for economic growth inflation is up.

Even as Fed officials ratchet down their forecasts, acknowledging that growth will be almost stagnant in the first six months of this year, investors are pushing up long-term interest rates and mortgage rates out of fears about bad debt and rising inflation.

On Wednesday, the central bank disclosed that Fed policy makers now expect the United States economy to expand between 1.3 percent and 2 percent in 2008. That would be the slowest growth in five years.

Making matters more difficult, the Labor Department reported on Wednesday that consumer prices are rising faster than analysts had expected and faster than the central bank’s unofficial comfort zone.

Consumer prices jumped 4.3 percent in January, compared to one year earlier, the fastest year-over-year jump since September 2005.

US inflation over the last 3 months has risen at an annualized rate of 6.8%. How big was your last raise?

The consumer price index rose 0.4 percent in January from the previous month, topping economists' expectations of a 0.3 percent increase. Over the past 12 months, the index has risen an unsettling 4.3 percent, and the pace is increasing: Over the past three months, it has been increasing at an annualized rate of 6.8 percent.

Even more disconcertingly, the "core" index, which excludes volatile food and energy costs and is generally a more restrained measure, also topped expectations in January with a 0.3 percent month-over-month increase, rather than the 0.2 percent advance economists had been anticipating.

But inflation was much higher in the 1970s.

However, some inflation watchers were also quick to point that the current situation is a long way from the stagflation seen in the 1970's, when interest rates and inflation both climbed into the teens. To put that in perspective, the federal funds rate is now at 3%.

What are good investments for protecting your assets against inflation? Any suggestions?

But Zimbabwe is worse.

The Zimbabwean dollar collapsed Thursday in parallel market dealings following the announcement that the official inflation rate has topped 100,000%. The country's Central Statistical Office said 12-month inflation in January was 100,580%.

Share |      By Randall Parker at 2008 February 21 09:46 PM  Economics Business Cycle


Comments
Kenelm Digby said at February 22, 2008 2:55 AM:

The madness is this:
Money borrowed from the far East, (America generates absolutely no capital as savings), is somehow being used to 'correct' a crisis caused by over-borrowing from the far East!
Perhaps I'm profoundly ignorant of 'economics' but the words 'tautology' and 'double negative' spring to mind.

Audacious Epigone said at February 22, 2008 10:34 AM:

What are good investments for protecting your assets against inflation? Any suggestions?

Gold is still probably a good bet. I-bonds are another option. For equities, I just moved some into big food. I'm in farm country, though, so things are still looking pretty good. I hope others provide their takes on the question, too.

Randall Parker said at February 22, 2008 6:14 PM:

Kenelm,

Yes, it is madness.

My sense of it is that the Fed has decided a massive cascade of financial failures will cause more damage than inflation. So the Fed has opted for inflation.

Audacious,

I do not see gold as the best metal long term hedge. I think platinum is a better bet since decay in South Africa could cut platinum production. Platinum has a bigger African vulnerability than gold does.

I'm thinking more along the lines of capital assets that will rise in value with inflation because they will retain their wealth creating value.

Bob Badour said at February 22, 2008 7:02 PM:

Capital assets depreciate and tend to lose value over time. Look for high returns on assets and pricing flexibility. Pricing flexibility requires monopolistic attributes or what Buffet would call a franchise.

Coca Cola's franchise is its brand.
Geico and Walmart are both the lost-cost supplier in their respective markets.
Microsoft's franchise is Dos -- OEM sales of Dos and now Windows for new computers specifically.
Google's franchise is better search.

Audacious EPigone said at February 23, 2008 8:26 AM:

Randall,

I'm not familiar enough with platinum to be comfortable with it. Is there any chance its production increases in the future, either through locations of additional stores or progress in chemical processes? It seems so 'inefficient' in terms of how much ore must be mined to produce so little actual platinum. But that's a fear of ignorance on my part.

Palladium is another commodity that is mined primarily in Russia and South Africa. Better or worse than plantinum?


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