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Posted by warren mosler (208.49.176.241) on 19:48:55 10/31/07
Subject: major theme review
My two major themes have been gradual weakness due to lagging demand
due to the deficit being too small, and higher prices due to the
saudis setting ever higher prices.
I had thought the higher prices would keep the Fed from cutting and
instead trigger hikes, even as the economy drifts weaker.
Instead, the Fed has now cut twice even in the face of the strongest
possible warning signals for inflation. The cuts were due to fear of
systemic failure via the 'credit crunch' with the caveat, as in 98,
that they would be quick to 'take them back' as 'liquidity' recovers
and inflation remains threatening. Clearly the inflation has
deteriorated substantially since the August meeting when the Fed did
not cut due to inflation concerns. The way they put it is they don't
want to 'turn a relative value story into an inflation story' by
'adding to demand and monetizing the price increases.'
This latest 25 cut was out of fear that since the markets were fully
pricing in 25 cut not to cut might have been disruptive to the point
of triggering a 'liquidity relapse.' And to make sure the Fed
wouldn't face that set of circumstances again in December their
statement made it clear their posture was now 'neutral.'
It is still my position that 'inflation' is putting an upward bias on
Fed policy, and that over the next few weeks this will likely
intensify. cpi is released Oct 15 and with the run up in gasoline
could go from 2.8 to perhaps 4% year over year and up a similar amount
year to date, with the forecast for 07 over 4% as well. While core is
expected to rise .2, it too could move higher. Note that owner equiv.
rent rose .3 last month and tends to trend.
Along with higher cpi, crude could easily be higher and, as in the
previous quarters, exports could move q4 gdp estimates higher.
While 'trade flow' and the low US budget deficit are working in favor
of the $US, world portfolio flows ('inventory adjustments') are
working against it, and can be the stronger force for as long as it
continues. At least some of these global portfolio adjustments are in
reaction to Fed activity and US foreign policy, including the recent
sanctions on Iran, which are also giving cover to the Saudis (and
perhaps Russians) as they raise price.
Given the above, before the December Fed meeting an increasing number
of mainstream economists could be estimating the 'right' fed funds
rate at 7-8%. The 'forward looking' inflation rate will be north of
4%, so the 'neutral' ff rate will be 6-7%, and some premium over that
is considered necessary to 'lean against the wind' of higher
inflation. And the Fed will probably agree and be formulating a way
to get ahead of the inflation curve, economic weakness not
withstanding, as they firmly believe that price stability is a
necessity for optimal long term growth and employment.
It is also not impossible for Congress to become critical over the
escalating rate of inflation as they believe it hurts the purchasing
power of their constituency and that inflation is robbing working
people of their savings.
comments welcome
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