Fears that new liquidity cycle will stoke inflation

Financial Times ^ | March 16 2008 | Chris Flood

[Aristotelian]

Efforts by the Federal Reserve to restore order to financial markets are about to enter a new and potentially dangerous phase.

The Fed is expected to cut US interest rates by 75 basis points to 2.25 per cent, following its recent, more aggressive policy moves to improve liquidity conditions. There re-mains a clear possibility that interest rates will only be reduced by 50 basis points as policymakers attempt to evaluate the impact of their earlier efforts to restore confidence to financial markets.

Joachim Fels of Morgan Stanley says the Fed is about to enter a new phase in the easing of monetary policy that will take real interest rates below zero. This would be achieved with a 75 basis point cut. Morgan Stanley forecasts a further 50 basis points reduction to 1.75 per cent in April and rates to then remain on hold for the remainder of 2008.

Mr Fels says this marks the start of a new global liquidity cycle in which the combined but not necessarily co-ordinated efforts of central banks should lift growth and asset prices in 2009. However, the clear danger is that easier monetary policies will cement a new regime of higher global inflation, undoing years of hard work by policymakers to anchor price stability and inflation expectations.

[TheBattman]

What I suggested is inflation with a purpose—to stop a recession. That means it has to be strictly managed, or it will turn into stagflation, like during Carter, or worsen the recession.

don't forget that the government buys a bunch of grain too... Gotta have something to bribe North Korea and their ilk with... That helps boost the price of commodities as well.

But I agree- a wage cut is better than no job!

[TheBattman]

I just made the point the other day to some friends - When you borrow to pay your bills, the bills just get bigger. Sooner or later, they come due in full. Our government along with consumers have ignored this truth for years. Well, the bills are now coming due - and the money has to come from somewhere. Printing more isn’t helping pay them - it just makes the situation worse.

Something drastic is going to happen - it can either be controlled (will be quite painful to most), or it can just be allowed to happen - and will be a total disaster for the US. Right now, it appears that the Fed and the Congress has chosen the second option...

[yefragetuwrabrumuy]

There is the possibility, if things turn utterly disastrous, the the US could do what it has never done before: abrogate its foreign debt.

The reason to do this would be to protect ourselves from a massive international depression.

Granted, it would ruin international trade, both exports and imports. But it would put the US above the catastrophe with the idea of using its position to restore the international economic order.

To emerge from the mess, the US would have to do several things: a fairly airtight balanced budget amendment to its constitution, and the re-assumption of some of its debt, paid for exclusively with grain.

That is, we continue to feed the world, receiving no other imports, in exchange for reducing our foreign debt. Any critical items we had to have from other nations would be by ad hoc, non-monetary trading arrangements.

The value of the dollar around the world would drop to zero for a time, except for cash reserves backed with commodities other than specie.

There would have to be a ton of other things, but this would be a start. Oddly enough, it could curtail the international depression while preventing mass starvation, and the US could come out of it not looking too bad.

[count-your-change]

HUH? Would the term “barking mad” be adequate to describe such an idea or can someone think of a better one.
Go ahead, ask “why” and confirm our worst suspicions.

[yefragetuwrabrumuy]

Simple answer: desperation. The assumption would be that the international economy is collapsing, and the US has to separate itself from it immediately.

But until that happens, it is moot. This brings up two important questions. The first is could an international collapse happen?, and is the US already insulated enough to evade joining it, without resorting to extreme measures?

[P.O.E.]

Rhodium? Isn't that the stuff they use to make a Rody?

[TheBattman]

Problem - we declare “bankruptcy” which is basically what you are advocating, thus cutting off our suppliers - where will we get our fuel (traded in dollars which would then be worthless), and all the stuff we now import because we no longer make it here? While we would be worthless to the rest of the world, we would have mega-hyper inflation here as good would become extremely scarce. No capital to restart old mothballed factories, no money to pay for our domestic obligations.

[yefragetuwrabrumuy]

Remember, as an axiom to all of this, the world economy must be collapsing, so dire predictions of what would happen to the US would be true no matter what the US did.

This would reduce all of world trade to essentially barter on a grand scale, providing critical items in exchange for critical items. Most currencies and non critical items, such as specie, would have little or no value compared with food and oil.

Any temporary currency would have to be redeemable for critical items on demand.

The US could not “take charge” of the situation by just suspending its foreign debt. It would have to abrogate it entirely, with the slim chance that some percentage of it would be returned to foreign creditors once the recovery was underway. The difference between Chapter 11 and Chapter 7.

Debt would have to be eliminated, not carried over, and thus creditors would have to be fractionally repaid. The US is singularly able to do this, in agreement with Canada most likely, by radically increasing their production of export grain.

OPEC, along with the US, Russia and Canada again, would be in a similar situation to radically increase oil production as the flip side of the coin. Their imports are tiny compared to their exports.

The end result is that for a time, all currency is backed with either grain or oil or both. From this point, more and more products and services can return to the market, as countries jump in with deep backlogs of products and services.

World markets in credit and futures would take decades to recover, and then only under very tight restrictions against speculation and imbalance.