Weekend's Featured: Stagflation In The US, Anyone?

Suddenly U.S. stagflation doesn't seem so far fetched anymore.

The Federal Reserve's rate cut last week has been interpreted by the markets - bond yields up, equity and commodity prices up - as being reflationary. But the dollar's coincident fall suggests further rate cuts as the Fed tries and fails to stave off economic downturn. A word of caution here, however. Break even inflation rates suggest that although the market is discounting a slightly higher inflation rate in the future, the operative word is "slightly" here. Inflation here is seen at only around 2.3%. And although the dollar (and a multitude of economists' forecasts) suggest slower economic growth, the market consensus is far from calling recession. Indeed, the economy is broadly expected to bottom out in the region of 2% year on year GDP growth. So why worry about stagflation? After all these sort of numbers suggest, at the very worst, stagflation-lite. The reason to worry is that the market seems a bit too complacent. The balance of risks is towards higher inflation and slower growth. Greg Jensen and Fred Post at Bridgewater Associates, a large asset management firm, paint the picture in a recent research note. Both rising inflation and falling growth are features of the end of a reserve currency's dominance, they argue. The flows of cheap capital slow and ultimately the central bank has to recourse to printing money to pay debts. That, arguably, is the dollar's position. Ever more countries are looking to cut their reserve weightings in the dollar as their pegs against the weakening U.S. currency force up domestic inflation. Saudi Arabia is just the latest in a growing list. That just points to further dollar weakness and rising imported inflation into the U.S. (crude prices north of $80, rising Chinese import prices, rising commodity prices etc.) But investors are still largely wedded to the notion that inflation is dead - thanks to its steady decline during the past 25 years or so. As inflation starts to pick up, they'll be in for a nasty shock. What's more, this dollar depreciation is unlikely to spur the economy into revival as long as the U.S. housing market keeps collapsing. Robert Shiller, the Yale professor and housing expert, figures that there's still a very long way to run in this downturn. What's more, recent research suggests that housing market weakness is a more significant cause of recessions than shifts in business investment. Which is to say rising inflation will be met by slowing growth. Stagflation, in other words.