Tuesday, January 22, 2008

Say Hello to the 1970s

I was hoping that Ben Bernanke would be a good Fed chief, but the longer he's in the more I'm convinced he's a disaster. He came in with some good ideas, having a target inflation range and being more transparent than the Greenspan Fed, but he's worked on propping up the stock market instead of keeping inflation in check. See if you can follow the dominoes here. The dollar has been weak against the Euro and Pound in large part not because of market fundamentals but because of the perception that interest rates in the US were not high enough to protect against inflation. That in turn has increased oil prices. That in turn has increased inflation. It's a vicious cycle that won't stop until the dollar gets some confidence behind it. As long as we keep interest rates low though it won't help with that. Instead, he should cowboy up, take the hit, and move on. Of course, looking at his academic history, we shouldn't be surprised. He believes that the recessions are due to high oil prices + high interest rates. The conundrum that he currently has is lowering interest rates could increase oil prices, creating more pressure on him to lower rates, creating a weaker dollar, increasing oil prices, and so on. The problem we have is that because of the weak dollar commodity prices are extraordinarily high...$900/oz for gold, $90-$100/barrel for oil, and so on. On top of this we have Washington compounding the problem with their jones for ethanol that is raising feed prices for animals and impacting consumer prices for everything we get from corn (gas [the ethanol] to soda [high fructose corn syrup], shampoo [the bottles use corn in them], all animal products, and the list goes on). So we have higher prices across the board and wages aren't going to keep up with them. As a result, we get to see stagflation up close for the first time since Paul Volcker banished it in the early 80s. If we want to avoid an encore, the proper prescription is higher interest rates despite the recession and attendant unemployment we will see. The housing crisis will get worse, but right now we're just postponing the inevitable. Let's get the pain over with now to avoid more in the future.

1 comment:

Rob said...

Amen, it is time to let creative destruction do its work. And I think most of the fiscal stimulus packages being proposed are band-aid fixes too (except for reducing the corporate tax rate and taxes on personal savings interest, capital gains & dividends for families earning under $200,000 of course).