You're invited to a STAG party...
As an older brother and the best man, I have been given the honor of organizing my brother's long awaited bachelor aka stag party in Washington DC. We're going to have a great time, hitting a fancy steak house, enjoying some cigars, and hitting some bars (a few of them that have some interesting entertainment). Don't feel too left out though, you're all invited to a different sort of stag party. Unfortunately, this one doesn't involve beer, good food, and dancing ladies...it is a STAGFLATION party. That is exactly where I think that the U.S. is headed The dollar has been dropping and U.S. growth has been slowing. Few can dispute these facts. The question is will these things continue and if so, for how long.
Perhaps a prolonged downturn in the U.S. economy will help to slow the prices of commodities like oil, gas, and food. Many people are placing this bet right now and we have seen a dramatic drop in the prices of commodities over the past week or two. People seem to be forgetting that the Fed is coming out with both guns blazing during this election year doing everything in its power to prevent the U.S. from slipping into a deep recession. The two 75 basis point cuts that the Fed has made in the Federal Funds rate in recent months are the largest moves that it has made in over two decades. Plus the Fed has been singing the ABCs introducing all sorts of TSLFs, TAFS, and other ways to add liquidity to the U.S. banking system. It is now accepting collateral that it has never welcomed in the past and it even invoked section 13.3 of the Federal Reserve Act to provide loans to “primary dealers” aka investment banks for the first time since the Great Depression.
Whether or not Ben Bernenke and his friends will be successful at averting a massive U.S. slowdown can be debated, but the amount of liquidity that they have pumped into the system is unprecedented. Not surprisingly the Fed’s moves have taken their toll on the dollar. I find if funny that the dollar actually rallied when the Fed cut 75 basis points last week, which in the past would have been an unthinkable move. I highly doubt that the Fed is done cutting rates either. The Fed Fund Futures are currently pricing in a 25 basis point cut at the Fed’s April meeting. They may end up taking a breather after that, but if the credit markets don’t improve or the economy takes a turn for the worse I have no doubt that Helicopter Ben will not hesitate to begin easing again.
There’s definitely a good chance that the economy will continue to slow. According to the numbers that the Conference Board released today, Consumer Confidence is at its lowest level in five years. Furthermore, the Board’s expectations index (a measure of where consumers see the economy headed) is at its lowest level since 1973 during the oil embargo. Why are consumers so down? Perhaps it is because the percentage of their disposable income that consumers now spend on food, energy, and medicine has skyrocketed to 36%, the highest level that it has been at since Merrill Lynch started tracking it in 1960. Guess what fuels the U.S. economy? That’s right, consumer spending. It currently accounts for approximately two-thirds of the GDP.
Let’s say that America is somehow able to miraculously shake off the credit crunch, rising unemployment, falling consumer confidence, falling home prices, an ethanol-fueled rise in the price of food caused in large part by the government ethanol boondoggle, a massive federal deficit caused in large part by an unnecessary war, etc… That’s good because it gets rid of the stag part of the stagflation. What we’ll be left with is just massive inflation caused by increasing demand for oil, food, and metals here in the U.S. and in rapidly growing developing countries like Brazil, China, and India. Either way the prices of “things” are going to increase. I don’t see any other possibility.
To sum this long (and once again negative…I’ve really got to work on that) post up, one of two things is going to happen:
A) The U.S. is going to fall into a recession and the Fed is going to destroy the dollar trying to get us out of it in an election year, causing the price of dollar-priced commodities like oil and grains to rise.
B) The economy will be fine and the prices of commodities will continue to rise as they have been for the past several years, fueled by increased demand from the U.S. and emerging markets.
Pick your poison, but either way this is a temporary dip in the price of commodities. Long term they’re headed for the moon.