One of the things that I do to rationalize positions is take the opposite side and create my own debate. I often do this when my head says one thing, but my gut feeling is saying something else. So for this blog entry I am going to spill my guts and hope somebody wants to add their own two cents.

Ok, here is my problem that my gut keeps telling me, and its from from a comment Greenspan made.

Alan Greenspan said the housing downturn is more of a problem than credit quality and said the lending worries would be fixed if house prices rose 10 per cent.

Greenspan has been saying quite a few things lately with some things being that we may have a recession in the fall. I was reading in Business Week Greenspan is behaving the way he is because Bernake can’t tell the truth.


So let’s assume there is this Greenspan and Bernake tag team, what would they be hiding? Well, it seems Greenspan is pre-occupied with real-estate and a recession in the fall. I cannot seem to find any comments where Greenspan is concerned about inflation, and that has me raising an eyebrow. Is Bernake privately concerned about the same things? What if Bernake is giving lip service to inflation, but more concerned about real-estate and the recession? I think, and this is the part that my gut is telling me, Bernake will in the next few  months lower interest rates regardless of what inflation is doing.

My concern right now is inflation, and the inflation data is bad regardless how you look at it. I am a burnt child, what can I say. Yet Greenspan is not saying much about inflation. Of course Bernake has said in the past he wants to fight inflation, but that is the official party line of the Fed.

Let’s say Bernake becomes an inflation dove and talks about lowering the interest rate is that bad? Here is what I think will happen if the interest rate is dropped.

  • The real estate market will begin moving again with prices increasing.
  • The stock market will go up.
  • People will be feeling good about everything and consumers will buy again.

This is good, right? Wrong, because while it might seem like a good idea to drop interest rates people like the linked reference will also get a reprieve. The other and greater problem I see is the lack of attention to inflation.

Inflation is bad because you begin a cycle what I call “competing with the Jonses.” While inflation in some instances can be good for an economy, disregarding it can be devastating for an economy. Prices will increase and people can do one of two things; ask for a wage increase or consume less. People usually ask for higher wages, especially if the labor market is tight like it is now. Thus as people ask for higher wages the company can do one of two things; increase prices, or swallow the costs. If the company swallows the costs they can do one of two things; cut profits or find a way to increase productivity. If companies increase prices we are back in square one with the employee asking for more money.

There it is, my guts are spilled. My head says that I am wrong, and that Bernake will be an inflation hawk, but I wonder… Comments?

NOTE: Bernake is giving some comments this coming week and we shall find out if this blog entry is dumb thinking…

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Actually it is a bit more complicated than that.

What Greenspan is saying is that if we enter a recession under current conditions, we will still have inflation. This is stagflation and is far worse than just a recession. The housing recession should not be allowed to pull the entire economy into a recession and this is avoidable by carefully monitoring the fallout effects from the sector. Subprime is an issue today but is not enough on its own to cause a recession.

There is ample liquidity in the world markets today and there is still growth both in the U.S. and overseas. It would take a major market crash to wipe out the excess liquidity in order to facilitate a recession. A recession may be inevitable. The timing of the recession is crucial. Once inflation is totally under control, then and only then, can the U.S. enter a controlled recession as part of the cycle. Beforehand, the Federal Reserve will not let it happen.

So your ‘head and guts’ are actually in sync with each other!

Disclosure: Comment written by a CrossProfit analyst and may not reflect the opinion of CrossProfit.com
http://www.crossprofit.com

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