Friday, November 11, 2005


To Beat Inflation, Fed Risks Deflation

This editorial suggests the Fed is in a trap. "The Fed has a major problem on its hands. In order to prevent soaring energy prices from creeping into the general economy it must continue to raise the fed funds rate until it hurts. A number of corporations have already begun tacking surcharges onto their prices in the hope that consumers will perceive them as temporary, while others are attempting to hike prices directly."

"In the meantime, Wall Street is assuming that core prices will remain under control and that the Fed is near the end of its tightening cycle, seemingly without realizing that these potential outcomes are contradictory."

"As long as the rate hikes have no effect and consumers continue spending, the Fed cannot stop tightening. They realize that if they stop tightening too soon, and inflation takes off, it will eventually be that much harder to bring it back down. The only way to stop higher prices from spreading to core prices is to keep raising the funds rate until consumer demand softens to the point where business finds that they can no longer pass along the increased cost of energy."

"The problem is that the Fed will only know that their policy has worked when it sees the actual signs of the slowdown, and by that time they will have instituted two or three more rate hikes than they needed. The result, as usual, is likely to be a recession."

"With household debt at record highs; consumer savings at record lows; housing prices at the top of a bubble; the trade imbalance at record levels; and the federal budget already in serious deficit, a recession could easily feed on itself and become a damaging deflationary downturn at a time when the market is highly overvalued."

"The Fed is therefore facing the difficult problem of both a near-term inflationary threat and an eventual undesirable deflationary outcome at the same time that it is undergoing a change in leadership. We believe the current complacency and downright optimism in the stock market will prove to be yet another example of the majority being wrong at the turning point."

This writer has summed up my general attitude about the Fed's situation. In spite of massive credit creation, the economy sputters and assets take on an artificial value.

Now that energy prices took off, the Fed is forced to back down and a recessionary deflation seems likely.
I agree, and seems like the whole equalibrium is so skewed at this point that when it finally corrects the stress back will cause some form of catastophic failure..
Ben, Do you have any favorite links especially to metals?
I look at safehaven, silver-investor etc, but thought you may have some more informative sites as well...Ok thanks

I bet several co-workers that oil is going to drop like a rock in the next year. The bet is that oil is around $40/barrel this time next year. Check the historical value of oil and you will see on several occasions oil has peaked when housing has peaked and dropped when housing has dropped (because of the recessionary pressures due to housing deflation). Case in point, what was the value of oil after 1991?
It went down to something like $20/barrel.

When I see Exxon/Mobil talking about peak oil I start looking for the head fake. It's like a realtor telling you if you don't buy now you'll be forever priced out.

While oil is a scarce commodity it is still dependent on demand. And this demand will dry up in Asia and US as the housing bubble deflates. When the US gets the sniffles China will get pneumonia.
No more ATM cash-outs to buy China made shiny things.

Are you currently leaning towards or aways from gold/silver?
I usually use I don't link to it because all the graphs cause some dial-up users to lock up.

I want to own more gold and silver, but I am in the deflationist camp and think better prices will be had in the future.
Also, I will believe in the long term prospects for oil when Texas, Louisiana, New Mexico and Colorado start drilling like crazy ala the 70's and 80's. Good luck on that bet.
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