Two Paths to One Outcome: Slower Growth

The jig appears to be up. Many factors have brought us to this point, but it seems that there are two paths left. One or the other will out, eventually.

On the one hand, the Fed may raise interest rates, and thereby support the dollar, which in turn will put downward pressure on oil, which is priced mainly in greenbacks. The alternative path is keeping rates unchanged and so allowing the oil bull market to run skyward unencumbered by any monetary policy braking.

In time, the outcome will be the same: slower growth, perhaps recession, with the possibility of a deep, long recession. Shifting the odds in favor of something tamer, it seems to this observer, requires a proactive monetary policy in the form of hawkish behavior from here on out. Yes, that will incur economic pain. But economic pain is now inevitable. The only question is how it's administered.

If the Fed does nothing, and effectively allows the bear market in the buck to roll on, the threat of higher oil prices rises as well. In that case, an untethered increase in oil prices from this point will generate more demand destruction to push the U.S. economy, and perhaps the global economy, into recession. In time, that will pare oil prices to reflect the new, albeit temporarily adjusted supply/demand equation.

Alternatively, the Fed could engineer a similar outcome but with a higher possibility of imposing demand destruction gradually, with a kinder, gentler hand compared to the blowback from a runaway bull market in energy. There's no guarantee, but if Bernanke and company take the lead and steadily tighten monetary policy, and speak forthrightly to the markets about their intentions, there's a chance that the Fed can minimize the pain.

But let's be clear about what's possible, and what's not. To the extent the higher energy prices reflect higher demand and a growing struggle to find new supplies, monetary policy, enlightened or otherwise, can't change geologic reality. At the same time, some degree of higher energy prices are a function of the weak dollar. Exactly what degree is unknown. Whatever the degree, it's almost certainly a small influence on oil prices. Still, the Fed should use its influence, limited though it is.

Rest assured that if the Fed doesn't act, or doesn't act with sufficient speed or authority, the markets will eventually do the central bank's job. In that case, the damage may be greater than if the Fed acted pre-emptively and prudently.
 

Comments

[Peter Sterling]

Poll: 74 percent support offshore oil drilling in U.S.

Zogby International
11:42 a.m., Thursday, June 26, 2008

Three in four likely voters – 74 percent – support offshore drilling for oil in U.S. coastal waters and more than half (59 percent) also favor drilling for oil in the Alaska National Wildlife Refuge, a new Zogby International telephone poll shows.

SEE:

www.strategicnine.com/...

[blink0404]

not sure what Peter Sterling comment has to do with this article.. but ok.
I read an intresting optimistic article here today:www.greenfaucet.com/th....
The main point was that we are a lot closer to reaching the bottom of this mess than we are to dealing with it more.

[bertil]

I support this, especially since the professional drillers believe results in deep waters can be achieved in relatively short time. Which seems contrary to media buzz. But how will the decision to go ahead eventually be decided? And by whom??

[winslow]

First, the Fed's head is in a noose due to the Greenspan era. Second, the current administration has a laissez faire attitude on business activities in this country, thus the current problem. These problems are not going away anytime soon. I don't remember the current admistration ever talking about "problems" in this country. Just 2 weeks ago, Paulsen stated "the worse is over". The lack of leadership is appalling. Remember the scene when the president was in the classroom when 9/11 occurred....here we are again (and again, and again).
The lack of response with a well-thought out plan-of -attack is beyond reproach.

[iThinkBig]

I June 2007 I crunched the numbers and had an 'oh shit' moment and prepared. In March 2007 I submitted a five point plan to the President that subsidizing domestic energy including drilling and alternatives such as nuclear and biodiesel, to not drop rates below 2.25% and that the U.S. was exporting inflation to other nations while we refused to even acknowledge the problem.

The President gets credit for keeping his boots strapped on right up until the day he leaves office on these issues (which he also preached on energy after 911 as well). Now, the real issue is Congress and the Senate. Dick Cheney and President Bush despite best efforts need legislative support to get these things done. Speculators simply had a safe bet Democrats would do nothing. I don't blame them, I love sure bets as much as the next guy does.

As of March, I further prepared for not just deep recession but potentially depression and social chaos if our financial system collapses (my numbers in March were -20 GDP by 2011 without a $300 B subsidy into energy). Now, with this recent run-up in energy and the resulting shocks, black swan event is now a PROBABILITY, not just a 35% possibility. Fear mongering aside, much money can be made in any business environment. But what's the solution?

Change our government: How? Create funds for guys who feel $130k a year is great money to run for Congress and want to be public servants to our country. If the problem is our elected leaders are on the dime, then funding is needed to support candidates that can take six months off from work, have an education and will not accept RNC or DNC contributions/sponsors...

Guys, the problem is political and I have a feeling I am not the only one to have figured this out. So, those of us fundamentalists can either help get mature adults get into office or we can grab pitchforks later and throw the spoiled adults out of office the physical way. I vote for the former method.

Note to Republicans: Start FUNDING media people and use the Internet to connect your vision of conservatism to the masses. You have failed in your pride thinking you have grown powerful enough to go at it alone without the American people, but your heart was in the right place.

Note to Democrats: Your 1D thinking that conservatism and demand destruction has no other dimensions. This thought process is selfish and lazy. Change your attitude or your attitude will be changed the hard way, and people like me that run databases don't forget your policy votes. That means you will not get a pass for being totally self-centered, thinking you'll leave office doing nothing but making yourself richer.

To All: rich or poor, the easy days (for now) are at an end. The next decade to two decades we must all act as public servants, to our families and to each other. We may not have time to create enough energy assets to stave off the worst, but we sure can make sure those responsible don't stay in office.

[Dr. Duru]

I expect the market to exact the discipline that has been lacking to-date. Fed action for a long-time has focused on avoiding the process of cleansing excess and cleaning out the books. The Fed has not enacted pro-active pain since Volker wrestled inflation to the ground by sending the economy into a prolonged recession with higher rates. And if the Fed is indeed finally contemplating being pro-active about taking the medicine sooner than later, I think they will be VERY hesitant about doing it before the Presidential elections.

[iThinkBig]

Winslow, you are correct but 49% GDP which is small business is what is being ignored. 51% government and megacorporations have adequate hedges, liquidity etc. This leads into deeper discussions that new innovation is slowing meaning we have less to sell the global consumer. We could talk about it all day, but what are your ideas?

[skeptical_investor]

Huh? "...is now a PROBABILITY, not just a 35% possibility". OK, I now know how much credibility to put into to iThinkBig. iThinkNot.