Thursday, April 10, 2008

Inflation CW

I just love conventional wisdom.

The inflationary CW is that as the U.S. economy slows, inflation will back off due to lessening demand. And in the past (like most CW), this has been true. But what about now?:

Third, the US is no longer the world's only leading consumer of raw materials. As such, a slowdown in US demand won't be the world-wide cure all for spiking inflation. We have to rely on India and China to deal with their respective inflationary levels.
That's right. The U.S. isn't the only player on the block. Our overwhelming economy is becoming less and less the guiding force internationally.

Back in the 1970's, inflation got out of control. The main reason for that was that non-market, exogenous forces, were working on the economy. The price of oil was not being guided by market forces but by political forces. When oil prices skyrocketed and rippled throughout the economy, they did so regardless of the market forces which actually were indicating lower oil prices. Thus you had inflationary pressure occurring at the same time the economy was slowing .... stagflation. Between the Iraq war and international competition for commodities (the "decoupling"), the U.S. is facing international pricing pressure while suffering from domestic slowdown. In a word .... stagflation. And frankly, I'm not sure the Fed will do much about it until inflation is much worse than today.

Added: Right on cue, a classic example:
During the first half of 2007, motor gasoline consumption was up by 0.9 percent compared with the same period the previous year. But, during the second half of 2007, gasoline consumption declined by 0.1 percent from the year before. In fact, fourth-quarter consumption fell by 0.4 percent. The drop in gasoline consumption, the first since the recession of 2000, should come as no surprise with the slowing economy and soaring gasoline prices.
That's right. Gasoline consumption is down considerably. Yet prices look pretty firm to me!

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