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(an interoffice email)

On Thu, Jun 26, 2008 at 7:48 AM, Karim wrote:

Global Economic Integration and Decoupling

Vice Chairman Donald L. Kohn
At the International Research Forum on Monetary Policy, Frankfurt, Germany
June 26, 2008

For the moment, higher headline rates of inflation have shown only a few tentative signs of embedding themselves in core inflation or in longer-term inflation expectations.

>   -talking about u.s. here

However, policymakers around the world must monitor the situation carefully for signs that the increases in relative prices globally do not generate persistently higher inflation. Additionally, in those countries where strong commodity demands are associated with rapid growth in aggregate demand that outstrips potential supply, actions to contain inflation by restraining aggregate demand would contribute to global price stability.

>   -not describing/talking about u.s. here;
>   focusing on EM primarily.

right, gets back to bernankes testimony a while back that the falling dollar has been a good thing as it works to lower the trade gap via increasing US exports that sustain US demand. the old ‘beggar they neighbor’ policy from the 30’s.

unfortunately for us it’s actually a ‘beggar thyself’ policy on closer examination as most mainstream economists will attest. they all say you don’t ‘inflate your way to prosperity’ by weakening your currency. otherwise latin america and africa for example would be the most prosperous places in the world

seems they are still in the mercantalist mode where exports are good and imports bad, and this policy is making us look like a bananna republic at an increasing rate.

recall from previous emails the dollar decline has been triggered by paulson succeeding in keeping cb’s from buying $US, Bush keeping oil producing monetary authorities from accumulating $US, and Bernanke discouraging foreign portfolio managers from accumulating same.

(more later on how it’s actually not happening due to fed rate policy, but they think it is)

as suspected, the $US is most likely to take another major leg down as it adjusts to a level where the trade gap is in line with foreign desire to accumulate $US financial assets which is probably a lot lower than the current 55-60 billion per month.

the ‘cost push inflation’ is pouring in through the trade channel, and the fed is increasingly taking the heat from the mainstream (not me- i’m the only one who thinks inflation isn’t a function of rates the way they do) for its apparent weak $US/inflate your way out of debt approach.

furthermore, the mainstream (and the stock market) sees the low interest rate/weak dollar policy as taking away US domestic demand as higher price for food/fuel leave less domestic income for everything else, including debt service.

that is, they see the falling dollar hurting us domestic demand more than the low interest rates are helping it.

the reality is there’s foreign monopolist- the saudis (and maybe russians)- that’s milking us for all they can with price hikes, and keeping us alive buying our goods and service and thereby keeping US gdp muddling through.

the real standard of living for most working americans has dropped by perhaps 10% as they work, get paid enough to eat and drive to work, and the rest of their real output is exported.

and our policy makers, including bernanke and paulson who’ve ‘engineered it’ think this is all a good thing- they think imports are bad and exports good and we are paying the price in declining real terms of trade.

while in my book interest rates are not a factor, the mainstream thinks they are, and the response when the inflation gets bad enough will be higher interest rates. The ‘correct’ anti-inflation rate last August was 5.25 when the fed didn’t cut.

by Jan 08 it was probably at least 7% with headline moving through 3% to get a sufficient ‘real rate.’

today it’s probably moved up to 8%+ as cpi is forecast to go through 5% over the next few months and gdp muddles through around 1%.

the mainstream (not me) will say that by having a real rate that’s too low now the fed will need a rate that much higher down the road as inflation accelerates due to over accommodative fed policy.

by the time the cost push inflation works its way to core- probably over the two quarters- the fed will ‘suddenly’ feel itself way behind the inflation curve and recognize they made a horrible mistake and now the cost of bringing down inflation is far higher than it would have been early on- just like they’ve always said.

the mainstream knows this, and now sees a fed with its head in the sand regarding inflation. they also see this weak dollar policy as subversive as it undermines the currency and inflation accelerates.

i expect there will be a groundswell of mainstream economists calling for the replacement of bernanke, kohn and the entire fomc very soon.

ironically, in my book low rates have helped moderate inflation via cost channels and have helped moderate domestic demand via interest income channels.

rate hike will add to domestic demand as net interest income of the private sectors from higher government interest payments add to personal income and demand.

and rate hikes will add to the cost push inflation via higher interest costs for firms.

it’ all going down hill fast, with policy makers both going the wrong way on key issues as they have the fundamentals backwards.

the only near term ‘solutions’ are near term crude oil supply responses like 30 mph speed limits which isn’t even under consideration in any form, nor are any other crude supply responses. most other alternative energy sources don’t replace crude.

medium term supply responses include pluggable hybrids that only start being produced in late 2010.

longer term supply responses include nuclear which might come on line 15 years down the road.

a collapse in world demand is possible if china/india let up on their deficit spending and growth, but so far that doesn’t seem in the cards. all their ‘tightebning’ seems to be on the ‘monetary’ side which does nothing of consequence apart from further increase inflation.

so with no supply responses on the horizon expect the saudis to keep hiking prices, and keep spending the new revenues to keep world gdp muddling through, cb’s hiking interest rates that will bring results that will cause them to hike further, and continuously declining real terms of trade for oil importers.

what to do?

cds on germany- it’s one go all go over there, and germany is the least expensive insurance.

forward muni bmas over 80 with no interest rate hedge as markets should discount the obama lead and long move up with inflation.


9 Responses

  1. Very provoking.

    One question though, assuming we did adopt a 30MPG policy and reaped an average fuel efficiency of, say, 10%, what would stop the saudi’s from raising prices to gobble this up, too? Would we be sheltered by some force of global demand?

  2. With respect to fuel efficieny, I would just much rather see us make a concerted push into alternative fuels.

    Honda’s Civic-GX NGV (http://automobiles.honda.com/civic-gx/) runs on compressed natural gas, and can be refueled at home using the NG connection already provided in most homes. At current NG prices, it can go about 25 miles on US $1.47 worth of NG, and it is very nearly zero emission. Proven reserves of natural gas dwarf proven reserves of oil; the US alone has 204 trillion cubic feet of proven NG reserve, and the world-wide total is 6,182,000 trillion cubic feet – almost 6 times the total world-wide reserves of oil.

    Wider adoptance of these sorts of technologies for transportation, further pushes into the use of plug-in hybrids and full electric “city cars”… could in my opinion considerably reduce our reliance on oil. The big confounds to this in the past have been the relatively cheap cost of oil. Why build infrastructure to support alternative fuels when the mainstay fuel is cheap and plentiful?

  3. I think 30 mph would cut a lot deeper than that as it would curtail driving and cause a shift towards public transportation.

    but yes, even a few million barrels a day won’t dislodge the saudis. more is needed.

    this gets to the second comment- alternative fuels that replace crude products are needed to further change the net supply of crude and dislodge the saudis. like pluggable hybrids

    but again, something could take take a large chunk out of crude demand like a 30 mph limit aren’t part of any discussion that i’ve seen.

  4. Well, with the precipitous rises in oil we could soon be in a place where the drastic starts to show up on our collective radar, and maybe some resurgance of energy sensitive speed limits will show up again. I have a deep seated skepticism that the political reality will ever get to 30mph… but chaos has a way of changing the political reality. I just deeply hope we don’t get to that place because the chaos I personally feel would need to ensue for our “leadership” to get that desperate would, I expect… be byond the experience of anyone alive today, and is not at all something I personally wish to suffer through.

    I will say that if I had the means, I would be out right now getting my hands on some form of alternative fuel vehicle before the stinky stuff really hits the fan. Unfortunately, not only do the vast majority of Americans not have the means to act proactively to protect themselves and their families, most don’t see the risks.

    Then again, perhaps I am overly pessimistic?

  5. how about living close enough to work to walk, or something like that?

    seems the right locations capture some of the value of higher fuel costs, though this is probably well underway

  6. cds on germany- it’s one go all go over there, and germany is the least expensive isurance.
    W, not sure what this means?

  7. germany credit default risk is less expensive than say italy as it’s perceived that italy is more likely to default.

    i’m thinking that if any one national govt gets hit with a ‘liquidity crisis’ maybe due to a major bank issue, all the nat govts will get hit by the same crisis within 24 hours.

    so i bought german cds because it was less expensive than the others and i think it has a near equal chance of paying off

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