Like its soccer team at the World Cup, US stocks were pummelled yesterday. From Reuters:
Stocks dropped on Monday amid persistent worries about rising interest rates and slower economic growth after the latest warnings on inflation from Federal Reserve officials...
The Dow Jones industrial average closed down 99.34 points, or 0.91 percent, at 10,792.58. The Standard & Poor's 500 Index was down 15.90 points, or 1.27 percent, at 1,236.40. The Nasdaq Composite Index was down 43.74 points, or 2.05 percent, at 2,091.32...
Sandra Pianalto, president of the Federal Reserve Bank of Cleveland, said a sustained rise in core consumer prices would exceed her comfort level.
Federal Reserve Board Governor Susan Schmidt Bies said the Fed is very data-dependent now, and that the economy is at a turning point which makes it difficult to know when the Fed will stop raising interest rates after two years of increases.
And prices are rising in the UK too -- house prices as well as producer prices.
British factory gate inflation picked up more than expected in May to its fastest rate in eight months as the cost of petrol hit a record high, official statistics showed on Monday.
The Office for National Statistics said that output prices rose 0.3 percent on the month in May, taking the annual rate up to 3.0 percent from 2.5 percent. Analysts had predicted 2.8 percent.
Maybe that is why Bank of England Governor Mervyn King says that "global interest rates may have been too low for too long".
"During the fastest three-year period of world economic growth for a generation, monetary policy around the world may have simply been too accommodative," said King in a speech to business leaders in Edinburgh. "Even though the monetary stimulus around the world is now being withdrawn, its effects are still being felt."
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Bernanke's Recession and Economics 101
The Fed chairman's poor handling of federal policy has sparked a worldwide dip -- teetering on recession. Bernanke's folly has surpassed the Greenspan market crash at the start of his term, and he does not appear to be done.
There are four serious flaws in the current Fed thinking on inflation.
1. The blind faith in the economic truism that increases in interest rates fend off inflation, no matter what the interest rate level, is foolish and, as have seen before, a dangerous oversimplification. At some point, the additional costs associated with interest rate increases put tremendous pressure on borrowers to raise prices. Once past the inflection point, instead of limiting inflation, rate increases DRIVE inflation. We have not learned the stagflation lessons of the Carter era. We are seeing stagflation now, driven by the last couple of rate increases.
2. By raising rates too high and doing so unnecessarily, the fed has ruined their tool for fending off inflation. The impact of rate hikes on inflation versus interest rates looks something like a bell curve (before the infection point). At somewhere around 3% to 3.5% interest rate changes appeared to have optimal impact. Greenspan endangered the economy by driving interest rates so low that the county no longer could use them as a vehicle for stimulating the economy. This irresponsible policy was "fixed" by the recent long series of rate hikes. The only good news was that because the increases were regular, at least we could plan accordingly. As we know, the impact of rate hikes is a delayed response. So we really don't know how badly the current rates will hit the economy. It will soon be clear that the damage done by further rate hikes make rate hikes no longer viable as a tool to combat inflation. Assuming they are capable, the fed will need to "let the air out of the balloon" to moderate interest rates over the next year so that they may, again, reclaim this tool.
3. The models used by the Fed are untested in interest rate extremes. It is likely that these models will break down at some point and we appear to be there. Still, the feds blindly continue to rely solely on their models.
4. The fed is discounting the impact on the housing market. The booming housing market has disguised many of the problems with the US economy and has been the key driver in the 5 years of growth in the economy. If the housing market were to collapse, and we are getting close, the impact on the economy would be truly disastrous and a major danger to the banking industry.
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