Thoughts on the Economy – Tag-teaming with One Salient Oversight

Here is One Salient Oversight (quoting himself in comments at Economist’s View):

I’m very unhappy with the rate cut. Like Fred, I think Higher interest rates are needed but the reason I have is the incipient inflationary pressure building up because of the low dollar.

Of course, there is the question of whether or not the deflationary effects of a potential recession will counteract the inflationary effects of a lower dollar. History has shown us that nations with plummeting currencies end up having both a recession and an outbreak of inflation at the same time. It happened in South America and it happened in Asia and it happened in Russia.

The difference between the regions just mentioned and the situation in America as its stands is that the devaluing of currencies was essentially what caused their recessions. In America’s case, however, a recession was already brewing. The plummeting dollar results from this problem, and will exacerbate it.

I’m not 100% in agreement with this last point… my opinion, having lived through a big part of the mess in South America, is that there was something of a feedback loop going on between inflation and devaluation. Recessions were sometimes part of the mix, sometimes not.

One Salient Oversight continues…

At some point in the next three months, inflation indicators will begin to get quite loud. At that point everyone will be confused and say “why do we have inflation AND a recession”? Of course Americans are not used to the inflationary effects of a plummeting currency, which means that analysis has been blinkered. American analysts and economists, unused to experiencing inflationary conditions, have completely factored out the inflationary effect of the Fed’s rate cut. When it is realised that America is actually no different to the rest of the world and that the basic laws of economic activity actually DO apply to America as well, there will be a clamour of activity arguing that higher inflation is justified in order to keep the markets running and people in jobs. A minority of economists and commentators will invoke Paul Volcker and the rate increases of the early 1980s as evidence that inflation needs to be conquered first, but then the pro-inflation majority will probably argue that the fundamental laws of economics has changed and blah blah blah.

A small quibble here too… the US still is different from the rest of the world, at least as long as the dollar is different from the rest of the world’s currencies. The dollar may be less different now, and perhaps may be becoming even less different as time goes on, but for various reasons, thre is still a difference. That said, when the dollar was much more, well, different, such as in the late 1960s and early 1970s, it wasn’t enough to prevent some inflation… even before the Oil Embargo. And years and years of cheap money plus the added cherry on top the other day have to show up somewhere sometime, and inflation is the somewhere. Hopefully the sometime won’t be any time soon.

He goes on:

A stimulus plan from congress will go ahead but will actually do little in stopping the recession and will have an inflationary effect. At some point after the election, Bernanke will either resign or be sacked.

I also predict that at some point the Fed will realise what is happening and increase rates to kill off inflation. This will cause a double-dip recession.

I don’t know about Bernanke suffering consequences, but I agree that whatever tax cut nonsense Congress and the Preznit cook up ain’t gonna do diddly to end the recession. And if inflation starts to rear its ugly head, I have to assume Bernanke and company are smart enough to realize it cut back on their monetary policy… belatedly. And yes… that could make it worse. Even methadone has its withdrawal symptoms.