Living Room Economist

Discussion in 'Economics' started by ElectricSavant, Dec 13, 2003.

  1. I have a question for the more experienced.

    If our (USA) rate that banks borrow from each other is so low coupled with low inflation and a weak dollar, what will greenspan do when we get inflation?

    Michael B.
  2. WinSum


    He will start to raise the Fed Fund rate to combat inflation. You might want to read up on Paul Volcker, Greenspan's predecessor, on how he fought inflation.
  3. With this combination that we have....

    low fed funds rate
    weak dollar
    low inflation

    Historically what happens to the stock market when inflation arrives? Does this combo above historically indicate the onset of the NATURAL cycle of inflation that Greenspan will tinker with?

    Michael B.

  4. pspr


    Here is a very simplified explanation.

    Usually, the market continues to move up even as inflation begins and the Fed starts to tighten (they have several methods available to them of tightening or raising short term rates). This is because the economy is surging and corporate profits are increasing despite the beginning of inflation and slightly higher interest rates and corporate profits can keep increasing into this for some time.

    However, at some point, interest rate increases start to slow the economy because of the increasing costs to both consumers and corporations which cuts into corporate earnings which eventually will slow and/or reverse the inflation tendencies as demand drops and corporations begin cutting costs and lowering prices to move product.

    The most friendly way inflation rates start rising is when manufacturing capacity utilization reaches near capacity and manufacturers start raising prices to increase profits. This happens because corporations can no longer increase profits by manufacturing more product without making large expenditures for plant and equipment. So they naturally begin raising prices more frequently because demand is there.

    The more harmful way inflation rates start increasing is from one or more widely used (needed) commodities start experiencing rapid price increases.

    A good example of the latter was the oil crisis caused by OPEC in the 1970's. Rapidly increasing oil prices created rapidly increasing costs in almost every sector of the economy resulting in price increase spirals. Only after new Fed Chairman Volker increased rates to astronomical levels was he able to reign in economic growth and put the clamp on increased oil usage and the resulting inflationary spiral we were in.

    Of course, this created a deep recession and cost Jimmy Carter the White House but there was no other way out of the double digit inflation we were experiencing by the time Paul Volker was hired to do the job.

    We could talk about why a little inflation is good but hyper inflation is bad but that is another book entirely.
  5. read "secrets of the temple"

  6. Pabst


    Nice post Wally. The present environment is much like you describe. A year ago the U.S. stock market feared 1930's deflation. Hence inflation, i.e higher CPI data ect., has been a BULL item. Last quarter's surge in GDP was IMO not systematic of expansion in activity but indicative of the higher prices that are being fed through the economy. But as you say, at some point those higher prices show up as corporate profits. However inflation has been historically accompanied by rising unemployment. Labor is a commodity afterall. So voila' inflation is almost always stagflation. No matter how the economist's cut it, the purchasing power of many, will be left out in the cold. During that non consumer led cycle is when equities usually suffer dire consequences.
  7. Thank you so much for speaking in a way I can understand....I am a trader and feel a responsibility to understand in my feeble way some things discussed over here in the economics wing of ET.

    Michael B.

    P.S. In every sense of the word....I am a living room economist...(electric typing this on his notebook while he is sitting on the couch in his living room watching Bloombeg TV)

  8. This action in the dollar....does anybody have time to enlighten me in my living room?

    Michael B.
  9. pspr


    Well, I'm certainly no expert when it comes to Dollar moves but it looks like the Bush Admin. has decided that a weak dollar is going to help our exports (makes prices of our goods cheaper in other countries) and help stem imports (makes foreign goods more expensive for us). But some raw materials we use are priced in Dollars so they aren't increasing at the same rate for us.

    However, since the Chinese Yuan (is that spelled right?) is currently tied to the Dollar (by China) it has no effect on the costs to us of Chinese products. But... It does drag the Yuan down vs. other currencies as the Dollar falls so if the fall continues the Chinese products get even cheaper for the rest of the world but the raw materials they are importing from countries other than the U.S. are skyrockting.

    Floating currency moves are primarily tied to interest rates in one country vs interest rates in the other. The country with the higher interest rates pulls money into their currency raising their currencies value. Of course, a stability crisis in any country will cause investors to get out and that drives the currency down regardless of interest rates.

    Beyond these thoughts, the analysis becomes much more complicated than most of us understand -- especially me! :)
  10. Rumor has it that when China gets finalized in the WTO they will float their currency.....perhaps within 2 years? any validity to this line of thinking?

    Michael B.

    #10     Dec 13, 2003