Inflation - the next whammee to the slowing economy arrives

The New York Times reports on the rapid increase in inflation during June.

A crucial measure of inflation rose at its fastest rate in 17 years, the government said on Wednesday, just a day after the chairman of the Federal Reserve warned that inflation poses a significant risk to the nation’s economic outlook.

The Consumer Price Index, which measures prices of a batch of common household products, rose 1.1 percent in June, the Labor Department said. That means inflation accelerated at nearly twice the rate in May, when the index grew 0.6 percent.

It was the biggest monthly gain in the closely watched inflation indicator since September 2005.

The increase in June caps a year where inflation has risen to proportions seen by some as threatening the stability of the American economy. In the last 12 months, the price index has risen 5 percent, the biggest year-over-year jump since 1991. Core inflation is up 2.4 percent compared to June 2007. [Snip]

A large part of the increase in the index stemmed from the record high price of crude oil, which has sharply raised gasoline prices. Stripping out food and energy products, the so-called core index rose 0.3 percent last month, slightly more than economists had predicted. Energy prices advanced 6.6 percent, reflecting the surge in gasoline prices.

The Fed has warned about higher inflation for months, although Ben S. Bernanke, the Fed chairman, has repeatedly said the nation does not face the runaway price gains of the 1970s.

But this week’s economic reports speak to the difficult situation faced by policy makers going forward. A measure of retail sales, released on Tuesday, showed that consumer spending has nearly stagnated, a sign that economic growth is slowing. But the Fed cannot lower interest rates without risking more inflation problems ahead.
[Highlighting mine - Editor WTF-o]

So inflation is hitting while the economy is slowing. The fed cannot pump the economy by lowering interest rates without increasing inflation and also causing the dollar to drop more in international markets.

The drop in the dollar has caused some of the run up in crude oil prices, but not by any means all of it. Here is today's report from Kevin Drum.

This week, in a piece called — you guessed it — "Crude Awakening," Business Week claims to have gotten access to a super-secret internal Saudi document with a field-by-field breakdown of estimated Saudi oil production from 2009 through 2013. Its conclusion? 15 million barrels is a pipe dream:

The detailed document, obtained from a person with access to Saudi oil officials, suggests that Saudi Aramco will be limited to sustained production of just 12 million barrels a day in 2010, and will be able to maintain that volume only for short, temporary periods such as emergencies. Then it will scale back to a sustainable production level of about 10.4 million barrels a day, according to the data.

....One dramatic part of the data concerns a site called Ghawar, which has been the kingdom's workhorse field for decades. It shows the field producing 5.4 million barrels a day next year, but the volume then falling off rapidly, to 4.475 million daily barrels in 2013.

The Fed's only cure for inflation is higher interest rates that result in slowing the economy. If Saudi Arabia can no longer act as the swing producer that sets the price for OPEC (which is what the limitation on their production means, then oil prices will continue to rise, with a resulting further wave of inflation through the American economy - and probably the economies of the rest of the industrialized world.

This isn't going to help the already weak banks that Jim Cramer considers threatened:

We all know that Citigroup (NYSE: C) (Cramer's Take), Wachovia (NYSE: WB) (Cramer's Take), Washington Mutual (NYSE: WM) (Cramer's Take) and National City (NYSE: NCC) (Cramer's Take) are in trouble. Bank of America (NYSE: BAC) (Cramer's Take) says it isn't in trouble, but obviously the market doesn't believe management because the stock failed to rally when it said its dividend was safe.

Further bank failures are going to further stress the already stressed American economy.

The next time someone claims all this will be over by 2009, laugh at them.

As for who caused all this - the housing bubble and the credit crunch are all entirely financial mismanagement brought on by deregulation of the financial sector of the economy as a result of the Reagan Revolution and the conservative movement with its strong Libertarian free market element that catered to Wall Street Bankers. That's caused most of the drop in the value of the dollar. It was entirely the fault of conservative policies since Reagan was elected in 1980.

But the rapid increase in price of oil is different. It is the natural effect of running out of a key economic resource. Still, it was known and predictable, even if the exact numbers were not known for sure. Yet in spite of that foreknowledge, no one has prepared for it by encouraging greater efficiency in oil use. The conservatives have fought increasing the CAFE standards tooth and nail for two decades. They have also fought government economic planning, claiming that it meant the government would be choosing economic winners and losers, and that twas a function that should be left to the free market. Unfortunately for that idea, the free market is congenitally incapable of looking past the next quarterly earnings report.

Planning for the far future requires collecting information from a lot of different and widely separated sources and analyzing that data without being too concerned with the results of the cost of data collection on the next quarterly report. Only a monopoly or government can do that, and monopolies charge monopoly-level prices to do it. Government is more efficient at system-wide regulation and long-term planning than private enterprise.

Ignoring the strengths of government is a major reason why the current economic problems are now worse than they should have been.

The government is saving the mortgage industry by nationalizing the loses and handing the later profits to the bankers

Daniel Gross at Newsweek has now published a mainstream article that tells much of the unspoken the truth about the mortgage mess. He points out that the continued announcements over the last nine months that the latest gimmick to save the mortgage industry had solved the problem, only to be followed by new and larger problems, has made it very difficult to get investors to step in and refinance Freddy Mac and Sallie Mae.

The result is that the only remaining solution is for the government to take over those two agencies. Since Freddy Mac and Sallie Mae have been responsible for 70 of all mortgages sold in 2008, that means that the mortgage industry has already been nationalized. It belongs to the government. The only question is how explicit the ownership documentation actually is.

That means that the conservatives in government are directly responsible for subsidizing the losses while giving away all the profits in the mortgage industry since Alan Greenspan created the housing bubble by lowering interest rates to avoid a recession that would defeat Bush in 2004. [See Economics and politics of the Fed fund rate.]

The unregulated free market dreamed of by conservatives and pushed for by the Reagan Revolution has failed disastrously. The result is going to be more government subsidy, handing out taxpayer funds. The only question is whether the conservatives will obstruct efforts by the government to recover gains to pay the taxpayers back instead of just handing future profits to the bankers who created this mess.

Oh, wait. I forgot. Phil Gramm has told us all the Truth (as viewed by conservatives and Libertarians.) This is "this is a mental recession. .... We have sort of become a nation of whiners." Right. Phil Gramm and John McCain have theirs already in hand and to Hell with the rest of us.

Go read the Newsweek article. Then prepare for the lengthy period of stagflation that has already started.

Recession in 2008 - more from Roubini

Nouriel Roubini is now reasonably certain that we can anticipate a recession in 2008. His two question s now are whether the recession will be a mild one ("soft landing) or a bad one (hard landing), and whether the American recession will be isolated to the U.S. only (decoupled from the global economy) or whether it will trigger a worldwide recession (recoupling.)

First Richard Berner of Morgan Stanley started to talk about a "mild" recession in 2008; then yesterday Bill Gross of Pimco also argued that the US is likely to experience a "mild" recession in 2008.

Then today Larry Summers spoke of the high risk of a recession in 2008 and the possible risk that such a recession would be more severe than just mild unless the monetary and fiscal policy response to the current economic slowdown is not more forceful.

Add to the list Alan Greenspan that now believes that the odds of a recession are now about 50%; and Marty Feldstein (professor at Harvard, former CEA Chairman and head of the prestigious NBER) who thinks that a 2008 recession is certainly likely. And add to the list Rosenberg of Merrill Lynch who has effectively made a recession call, as well as Jan Hatzius who is one step short of formally calling for a US recession in 2008.

Also, while the consensus had been arguing until now that the rest of the world would "decouple" from the US the consensus has also recently shifted towards the "recoupling" view. Both Goldman Sachs and now Morgan Stanley are now referring to the 2008 as the "year of recoupling". This is not surprising; the decoupling view was always predicated on the view that the US would experience a soft landing. Now that a hard landing is becoming the more likely scenarios analysts are considering that trade, currency, financial, confidence, common shocks and other channels of interdependence will lead to a significant slowdown of global growth following the expected US hard landing, i.e. "recoupling".

Thus, at this point the debate is less on whether the US will experience a soft landing or hard landing but rather on how hard the landing will be, i.e. whether the coming recession will be "mild" or "severe".

Roubini is the professional. I'm not. But I still suspect that the Federal Reserve Board under Bernanke is going to try to delay the recession, which will lead to greater inflation. But back to Roubini:

As Summers pointed out today how severe the downturn will be will depend on how sensible the macro policy response - monetary, fiscal and regulatory - will be. So far it is not clear that US policy makers and other G7 policy makers are fully aware of the significant downward risks to growth. There is still the view among them that this is a soft patch of growth and that growth closer to potential will resume in the second half of 2008. That view increasingly looks like wishful thinking.

The problem that I see is that 2008 will be both the year the recession starts and also the Presidential election year - one in which the Republican Party is going got take a drubbing by an increasingly populist Democratic Party.

Right now that populism seems to frighten Wall Street more than what they think is going to be a mild recession. If the fed, reacting to the concerns of Wall Street, remains more concerned about the political threat against Wall Street than they do the economic threat, then we will see both stagflation by the time of the election and an even harder landing for the recession after the election.

I suggest that anyone reading this consider my opinions on political actions separate from Nouriel Roubini's economic opinion, and give his greater weight.