 Up Against the Wall
Politics causes inflation. How? T. Wall explains:
by Terrence Wall
Business people around the community have been asking where I think the economy is headed, and as you may have guessed, national politics has made a
bad situation even worse - impacting the economy and, in turn, impacting our businesses.
As discussed with my shareholders in May 2007, I predicted that the housing market and subprime markets would soon crash and we should prepare for a slow down and possible recession in 2008. And in fact, had the Fed not intervened, the economy would have entered a recession early this year. However, the Fed's actions in reducing interest rates in the fall of 2007 has started to have its desired effect, keeping a general nationwide recession slightly at bay, although certain sectors certainly are in a recession — a depression in a few cases — and the values of homes and mortgage pools have both declined.
Likewise, the Fed's action of pumping huge amounts of liquidity into the economy this spring will have its desired effect this fall (there's about a six month or so lag effect).
The Fed's actions, combined with a number of political factors that are "baked in" for the next few years, will lead to significantly higher inflation.
The first factor is the end of Fast Track trade approval. Congress did not renew the President's unilateral right to approve trade pacts without Congressional approval, which will result in trade barriers remaining in place. Likewise, more trade tariffs are already being threatened by Europe in response to increasing U.S. tariffs. Higher tariffs and more trade barriers lead to higher prices.
The second factor is the weaker dollar, which won't recover as long as the Fed holds interest rates down. After many years of pushing for a lower dollar, the Bush administration now has what it wanted ... but the only problem is that the weaker dollar has significantly added to the cost of imported goods.
The third factor is taxation. Higher taxes are also "baked in", given Congress' refusal to renew the Bush tax cuts. The capital gains tax rate automatically jumps 33% in 2010 and — given that the estate tax drops to zero in 2010 — you can count on Congress passing a new tax bill in 2009 to alter that situation that will undoubtedly be loaded up with all kinds of tax increases. In fact, both Clinton and Obama have pledged to raise taxes significantly and McCain has avoided promising to reduce them.
The probability of the capital gains tax also being increased in 2009 is almost guaranteed.
The fourth factor is commodity pricing, which is a result of supply and demand, but is also influenced by the factors above, which then feeds back on itself. Sure, a slow down in economic activity could result in a temporary pull back of commodity prices, but two factors will work against that.
First, the federal ethanol legislation has baked in higher demand and therefore higher prices for corn, and — since corn is in just about everything — higher food inflation will continue. Second, once the Olympics in China are over, the Chinese government will "release" a large number of projects waiting in the pipeline driving upward pressure on materials.
Likewise with oil, if you apply U.S. per capita oil consumption to China's population, China would be consuming over 90 million bbl/day, which compares to the U.S. daily consumption of 20.7 million bbl/day; that's 3.5 times the U.S.
consumption. (By the way, there's only a supply of about 85 bbl/day worldwide.) Even if China's population doesn't consume at the same rate as the U.S., the Chinese would only have to consume at a rate one-fourth of the U.S. per capita rate.
What surprises me is that CNBC is already speculating that the Fed may raise interest rates this summer to address inflation — but don't count on it. The Fed has a policy of avoiding raising rates leading into an election, and the Fed just cut rates, so it's not likely to raise rates before the lag effect has taken hold. The result will be that the Fed will not act to cut off higher inflation until late 2008, which means we are guaranteed higher prices going into 2009.
What the public and the media are missing, however, is the false impression of moderate inflation today. The "core" rate excludes food and fuel (a ridiculous notion), and the trailing 12-month average rate is adversely influenced by prices rated nine to 12 months ago, when it was lower.
If you look only at the CPI over the last six months instead of 12, inflation is running over 12 percent, significantly higher than that being reported. So, come 2009 be prepared for a strong Fed response — increasing interest rates in 2009 with much higher inflation during 2009, and expect these conditions to continue into 2010.
Business Tip of the Month: Don't wait to make your company green; doing so may reduce your energy costs by one-third or more during a time of raising energy prices.
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