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Blogger’s Take: Slowing Growth, or Inflation?

Posted By Barry Ritholtz On December 13, 2006 @ 7:00 pm In Blog Spotlight | Comments Disabled

Today’s’ topic for the Blogger’s take is this:  Given the concerns raised by the Fed, what is really the bigger threat to the economy: Slowing Growth or Inflation? 

Does the risk of a decellerating macro environment present a bad option (My pal Kudlow thinks we see 2% GDP all next year, whch certainly ain’t recessionary). Others think a mid-cycle slow down will lead to a re-acceleration of inflation.

Which presents the greater threat to the economy? The blogger’s take:

I think slowing growth would do more to harm the economy right now.  Investors
around the world put their money where they can get the best return, and
frequently that means they invest in the United States.  Slowing growth limits
the opportunities to attract capital, and filters through the economy in a
negative way.

-Rob May, Businesspundit.com [1]


As the Fed stays on pause here it is natural to debate the
trade-off between inflation and economic activity. While important in the short run, the bigger
question is what should the Fed focus on in the long run? On that question the answer is quite
clear. Inflation.

If we think for a moment behind what drives real economic
activity, absent a horrible policy mistake, monetary policy is not all that
important. However the ability to
maintain inflation within a reasonable range and keep inflationary expectations
from entering into real economic decision-making is important. In addition, that goal remains within the
policy reach of the Fed.
We would point you to a Federal Reserve paper [2]
and an interview
with the author
by James Picerno of the Capital
. In it they
explore the determinants of behind stock market booms on a global basis. The paper finds that low inflation, kept under
control, was by far and away the key factor underlying stock market booms. Enough said.


I find it amazing that people think that a blunt instrument like interest rates
can cure rising energy prices or utility bills.

CPI is a lagging
Wages are a lagging indicator.
Energy demand is relatively

The Fed being enormously wrong at major turns is legendary. I
think the question is not how fast they hike next year but when the downturn
gets going how fast they start cutting.

We are not going to have either growth or
inflation as I see it.

-Mike Shedlock, Mish’s Global Economic Trend Analysis


growth is more important, by far. Through its history, the Fed has basically
perfected the art of killing off growth. Stopping inflation? Eh…not so
much. In fact, I would say that slowing growth is itself an inflation threat. Personally,
I’d like to see the Federal Reserve much less federal, and far more
reserved. Monetary policy is always and everywhere a human phenomenon.

As a
general rule, $13 trillion economies don’t start or stop on a dime. Since
1990, when one quarter of GDP growth is above trend (3%), there’s a 60%
chance that the following quarter will also be above trend. Conversely, when
growth falls below trend, there’s a 64% chance that the following quarter
will also be below trend.  

other words, once you’re stuck in slow growth, it’s hard to break
out. During the last recession, we had 11 straight below-trend quarters. We
finally broke out, but now the outlook is looking shaky. The last two quarters,
and three of the last four, have been below trend.

on the other hand, is—and has been—well contained. The 12-month
core CPI has bounced between 1% and 3% for ten straight years. Not once has it
left that range. And it’s been over 15 years since it hit 4%, which was during
a period of below-trend growth. That’s not a coincidence.

-Eddy Elfenbein, Crossing Wall Street [4]


has a new report out on the consumer crunch. It is an important
read. The gist of it: they estimate that in 2006, consumers used new debt to
provide 90% of their cash flow for investing (mostly residential property), and
debt service. In other words, it’s Minsky’s definition of a Ponzi finance
scheme. They go on to suggest that in 2007 new liquidity will be nigh
impossible, and will lead to a large drop in both consumption and household
investment. Perhaps more signs of the times, is this bomb from Best
this morning. Canary in coal mine Dell cuts [5]30%
of monitor panels orders. Nucor [6]
reports a slowdown. Which pretty much leaves Pig Man Goldman
and their bonus
to carry (pun intended) the economy. Or have they slashed, burned and
gamed enough already?

Significant new consumer liquidity is impossible for two reasons. Nearly
three-fourths of the total, or $7.75 trillion in US mortgage financing took
place in 2004-2006. I would argue that the 2004 mortgage vintage of $2.773
trillion now has collateral at levels roughly where it started, or soon will be.
Any collateral appreciation that remains is dissolving, especially in light of
the developments in the subprime market, which I expect to spread to the Alt A
markets. I don’t see the prime market as immune at all either, especially if a
contagion breaks out in the financial sphere. The 2005 vintage of $3.027
trillion is break even at best on appreciation, and really down more like 10% as
a rule. And 2006 vintage mortgages of an estimated $2.5 trillion, are almost all
showing depreciation

-Russ Winter, Winter (Economic & Market) Watch [7]


Good stuff, thanks guys.

Article printed from The Big Picture: http://www.ritholtz.com/blog

URL to article: http://www.ritholtz.com/blog/2006/12/bloggers-take-slowing-growth-or-inflation/

URLs in this post:

[1] Businesspundit.com: http://www.businesspundit.com/

[2] Federal Reserve paper: http://research.stlouisfed.org/wp/more/2006-051

[3] Abnormal Returns: http://abnormalreturns.com/

[4] Crossing Wall Street: http://www.crossingwallstreet.com

[5] Dell cuts : http://www.digitimes.com/displays/a20061212PB202.html

[6] Nucor: http://www.marketwatch.com/News/Story/Story.aspx?guid=%7B1E101521%2D6E51%2D41B1%2DB09A%2D2DAE464D75FE%7D

[7] Winter (Economic & Market) Watch: http://wallstreetexaminer.com/blogs/winter/?p=184#more-184

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