Thursday, June 17, 2004

What does the beginning of stagflation look like?

It might look something like this. (NY Post)

June 17, 2004 -- ALAN Greenspan is being told by an influential advisory group that he has relied upon in the past that the pace of economic growth in the U.S. is slowing and that "inflation measures remain elevated."
The bottom line: Interest rate hikes — while coming — are likely to be less severe than Greenspan himself implied they would be just a few weeks ago.

"There are clear signs that the pressures are moving from acceleration [of the economy] to the deceleration stage," says one of the advisers who has Greenspan's ear.

The betting now is clearly on a quarter-point hike — 25 basis points in banking lingo — in the federal funds rate at the end of this month.

Wall Street had been worrying about a half-point hike just a couple of days ago until Greenspan suddenly went before Congress and seemed to reverse himself on the pace of rate increases.

Before those comments to Congress, some experts had even been speculating about a 75 basis point rate hike after the June 29 and 30 meeting of the Fed's Open Market Committee.

Now we know at least one of the factors that changed Greenspan's mind.

The source believes gross domestic product growth will slow to between 2 percent and 3 percent in the third quarter that ends in September.

GDP growth in the first quarter now stands at 4.4 percent but will be revised later this month. Greenspan was also told that inflation is more of a problem than some people think.

"Most of the underlying measures of inflation are not temporary," was the other pertinent tip passed to Greenspan by the adviser, whose identity I can't reveal here.

Normally we would expect an economic downturn to lower inflation. However inflation is being propelled by excessive past monetary policy that is coming home to roost. They pushed the money out the door by the shovelful and now it's sloshing around the system. On the otherhand the economy is coming around for it's second dip just as the oldman predicted quite a while ago. However Greenspan will raise interest rates some.

With higher energy prices it'll set the stage for stagflation which requires three ingredients (1) Excessive monetary policy (2) A small interest rate hike (3) Commodity inflation.

All three primary conditions having met, Greenspan is about to usher in a period of stagflation. Welcome to the seventies. Don't be a fashion victim and start wearing plaid.

It's a bitter thing to be right sometimes.

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