We now are caught between the forces of inflation – food and
fuel – and deflation – homes and other assets: irresistible
force meeting immovable object. The Federal Reserve’s Open
Market Committee April meeting minutes released recently
gave indication the central bankers indeed now are worried
about the effects of inflation, namely higher prices
(inflation technically being an economist’s term denoting a
period of increasing money supply, as in “too much money
chasing a finite quantity of goods”).
But Fed officials also acknowledge they are fighting a
difficult, two-front war against slow economic growth and
soaring commodity prices – “stagflation” – an economic
phenomenon whose last known whereabouts were sometime in the
1970s during the last substantial period of vast amounts of
money in hot pursuit of agricultural, mineral and
hydrocarbon goods.
Since the early 1970s, dollars have been created at will,
not only by the Federal Reserve, which creates money by
buying Treasury obligations from banks on the open market
(hence Fed “Open Market” Committee) and deposits the
proceeds into their accounts at the central bank. In our
fraction-reserve banking system, banks then lend out excess
reserves. When all is said and done, for every $100 created
by the Fed, another $800 or so is created within the banking
system.
And since the late 1970s our central bank has had plenty of
government bonds from which to choose as a generation of
deficit spending has resulted in the issuance of trillions
of dollars of new treasury obligations (now exceeding $5.3
trillion of “public” debt).
All this money has been swirling around the world for years,
building modern factories in faraway countries where labor
costs to staff those factories are a fraction of those in
the U.S. or building the world’s tallest buildings in the
Middle East and Asia, enabling us to buy inexpensive
imported merchandise and, at least until this new decade,
inexpensive oil to fuel our American lifestyle.
Now – again - we are seeing the impact of “cost-push”
inflation as higher input (raw material/labor) costs drive
up finished goods prices, including, for the first time in a
while, imported goods as input costs rise in China and other
previously low-cost producers.
Money, unlike matter which can neither be created or
destroyed Einstein and others postulated, is being destroyed
at a copious clip at the margins of the nation, where
cratering real estate prices – with no sign yet of
stabilization – are translating to all manner of
domino-falling – layoffs, retail sales, commercial real
estate, state-government budget shortfalls, and so on - as
DEflation marches through, as Sherman to the sea, wide
swaths of our economy. Irresistible force meets immovable
object: the result is stagflation.
Keenly watched money supply numbers bear out this epic
struggle as massive increases in credit (money) creation in
parts of the economy are being offset by wholesale
write-offs, short-sales, liquidations and bankruptcies in
other segments.
The worst IS over credit-crunch-wise according to some very
knowledgeable people including the Secretary of the
Treasury, who, confidently, have pronounced a bottoming of
negative economic conditions. But is it “the” bottom?
The worst is NOT
over, according to other, presumably equally knowledgeable
people, including Warren Buffett, who says “don’t bet
against America,” but is buying big chunks of assets outside
the country and predicts a “long and deep” U.S. economic
downturn.
Clearly a lot of people are “talking their book,” promoting
views most beneficial to their own particular, current
investment strategy, including many of those appearing on
business-cable-TV urging expensive, taxpayer-funded bailout
plans of every stripe.
Presidential candidates are proposing federal gasoline tax
rollbacks and the House of Representatives, all 435 of whom
also campaigning for re-election, has voted to sue
OPEC for electing to allow insufficient quantities of
petroleum to seep from the earth, preferring, instead, to
let its value appreciate in situ (much as bags of
flour have gained value in our pantries the last year).
Consumer confidence fell below 60 in May, level not seen
since Jimmy Carter wore cardigans in the White House, and,
more concernedly, down from the upper 90s only a year ago,
even though preliminary First Quarter 2008 GDP was reported
as +0.6%.
It’s not a recession, however, until the National Bureau for
Economic Research says it is, and it doesn’t pay much
attention to GDP.
NBER monitors four factors: employment, real personal
income, industrial production and real manufacturing/trade
sales. All four factors peaked between September 2007
(personal income) and January 2008 (industrial production).
Ultimately, as NBER will soon confirm, the recession likely
began sometime in the Fourth Quarter of 2007. It’s called
stagflation - but you knew that already.
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