Behind the Global Curve

Global interest rates are rising in anticipation of inflationary pressures ahead. There are two major non-participants in this story. The first is Japan, which is adding liquidity to counter the economic devastation in the wake of last month’s earthquake/tsunami/nuclear event. Strong aftershocks are still occurring and the nuclear situation is far from being contained. The natural disaster, compounded by a man made disaster will probably end up costing in excess of $400 billion before all is said and done, and that does not count the hundreds of billions in lost GDP. This will be by far the most expensive non-military disaster ever. The Japanese have reason not to raise rates, regardless of what is happening. They can’t.

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The United States is the second non-participant. The US can raise rates but it won’t. There is a difference. It signals that the economic recovery of the past couple of years is fragile at best. We see prices going up all around us, commodities, education, healthcare – these are obvious signs of inflation. Yet the Fed is powerless to act. What we are seeing develop is the ugliest of all scenarios – stagflation. Stagflation is the fancy term coined by a politician, Ian McLeod in 1965 in a speech to Parliament in Britain. Essentially stagflation refers to increasing inflation and decreasing economic growth, both occurring at the same time. We are getting pretty close to that now.

Stagflation is perhaps the hardest type of economic malady, short of depression, to come out of. By it’s very nature stagflation slows the economy more as inflation increases. But, this inflationary increase should end at some point when supply and demand are back in sync…unless there is a situation where prices continue to increase and the price of commodities is priced in a currency which has an ever increasing supply. The situation developing now is much more serious than the past. In the past stagflation occurred in the US due to a short-term oil shock, which sent prices higher and dampened economic growth. To counter inflation, the Fed raised interest rates to a point where the economy’s growth was choked off completely.

That is not the case today. The Fed cannot jump-start the economy because rates are already at zero – there is nothing to cut to stimulate growth. The only way is to hold rates at zero, which means printing more dollars. These dollars are now worth less and the commodities bought by these dollars become more expensive. If the Fed steps up and raises rates, the economy will falter severely. If they do nothing, the standard of living will plunge. This is the price one pays for forestalling the medicine that should have been taken two years ago.

Remember when the market was crashing in March of 09. The S&P and Dow were down by more than 60% because of the financial and home crisis. We had a choice then. The tough choice would have been to clean house and let the market sort out the casualties. It would have meant unemployment over 20%, severe economic contraction and a full-blown depression. But, it would have cleansed the plate for growth in the future, growth unaided by the Fed. It would have been painful yes, and it would have lasted for many years. But, the end result would have been an economy that was sound, a place where smart money bought assets on the cheap, really cheap. And, it would have meant that irresponsible investors, homeowners who over leveraged to satiate their greed, and municipalities that misunderstood economic theory would have failed.

By today, we would be two years closer to a real recovery, one with teeth and one that was based on free market capitalism. Instead, we are facing the prospect of becoming the largest banana republic on the planet.

There are rumblings out of Washington that NOW is the time to act. NOW is the time to cut spending and deficits. Somehow it rings hollow. I have little doubt that we will cut spending, raise taxes and face a potentially grim period in the years ahead IF we indeed do not act now. You might be doing well personally, but your future depends in the long term on the future of the country you live in. And, that country is about to sink into a hole that it can only get out of by printing wheelbarrow cash. If you, like me, are not adept at pushing wheelbarrows down sidewalks for long distances, then I would urge you to contact your local and national elected representative and give them an earful if they decided to procrastinate on these issues. Or, it really will be NOW or never.

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One Response

  1. Any OD

    I completely agree with you.


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