Money and Metals

A pair of editorials on the economy, starting with the New York Times. "In the cool and quiet marble corridors of the Federal Reserve, the strategy for taming inflation sounds painless. Many economists, though suggest that the Fed is either too rosy about the looming slowdown or naïve about the difficulty of reaching its goal for inflation."

"This time, many analysts say that the Fed and its new chairman, Ben S. Bernanke, face considerably tougher challenges. Crude oil, at more than $70 a barrel, is selling at prices that would have been unthinkable in 1995. Productivity growth, which was accelerating in 1995, is slowing these days. The dollar, which was climbing against other major currencies in 1995, is declining against most of them now."

"'The economic slowdown has to be much more substantial than anybody in the Federal Reserve or on Wall Street is expecting,' said Robert J. Gordon, a professor of economics at Northwestern University. Mr. Gordon said the last few decades had shown a grim but consistent trade-off: to reduce inflation by one percentage point, the unemployment rate has to rise by about two percentage points for a full year."

"To reduce inflation to the upper limits of what Mr. Bernanke and other Fed officials consider acceptable, more than three million jobs would be lost, a bigger drop than in the recession of 2001."

"And that is Mr. Gordon’s relatively upbeat hypothesis, which assumes no other shocks to the economy, no additional increases in energy prices, no collapse in the dollar’s value, no collapse in housing. 'I think the Fed is facing an absolutely classic case of stagflation,' Mr. Gordon said, 'a situation in which they cannot win.'"

"He is not alone. Many other economists contend that inflation is more entrenched and will be more painful to reverse than the Fed thinks. Others predict that inflation will indeed subside, but only because the economy will weaken much more than the Fed is expecting."

"Economist Nouriel Roubini predicted that the economy would fall into a recession early in 2007 as a result of high energy prices, higher interest rates and a housing collapse. 'Either the Fed does not believe its own inflation forecast, which I don’t think is the case,' Mr. Roubini said, 'or the slowdown is going to be greater than what they have been saying. They can’t have it both ways.'"

"Specialists like Mr. Gordon at Northwestern maintain that the labor market is already very tight and predict that wages will soon start to push up inflation. But others disagree, arguing that wages over the last five years have lagged behind increases in productivity and have barely kept up with inflation. The bigger risk, according to that school of thought, is to make the situation worse by driving up unemployment."

"'We have no clue about labor market tightness right now,' said J. Bradford De Long, a professor of economics at the University of California, Berkeley, who argues that workers still have little bargaining power. Depending on one’s perspective, Mr. De Long said, the Fed’s attempt at a soft landing is either a display of cool-headed technocracy or murky witchcraft. 'Right now, he said, 'this is on the witchcraft side.'"

From Paul Krugman. "These are the dog days of summer, but there’s a chill in the air. Goldman Sachs recently reported that the confidence of chief executives has plunged. The key point is that the forces that caused a recession five years ago never went away."

"Business spending hasn’t really recovered from the slump it went into after the technology bubble burst. Also, the trade deficit has doubled since 2000."

"Nonetheless, the economy grew fairly fast over the last three years, mainly thanks to a gigantic housing boom. But the conventional wisdom was that housing would have a 'soft landing.' You might say that the theory was that investment and exports would stand up as housing stood down. The latest numbers suggest, however, that this theory isn’t working."

"Now maybe we’ll still manage that soft landing. But based on what we know now, there’s an economic slowdown coming. And what will policymakers do about a slump, if it happens? A snarky but accurate description of monetary policy over the past five years is that the Federal Reserve successfully replaced the technology bubble with a housing bubble. But where will the Fed find another bubble?"