My Gloomy Thesis On the U.S. Economy Is Playing Out

by: Roger Ehrenberg

I've been one of those on the stagflation bandwagon, deeply concerned about the weakness of the dollar, the likelihood of the Fed continuing to reduce rates in the face of locked-up credit markets, rising food and energy prices and persistent and rising deficits. This is a toxic macroeconomic cocktail I've written about and which has been the source of much worry. And to add insult to injury, a rash of economic statistics were released last week that generated articles this weekend that only served to reinforce my Droopy Dog attitude towards the US economic landscape. So I'm here to share the pain.

First, CPI shot up 0.8% in November, the largest jump since Hurricane Katrina in 2005. From Saturday's New York Times:

Higher prices, however, have begun to bubble up at the consumer and producer levels, government reports showed this week, complicating the policy calculus of the Federal Reserve as it tries to bolster the struggling economy.


“This is the first time we really have seen these energy costs and food costs starting to get passed through into finished- goods pricing,” an investment strategist, Edward Yardeni, said. “It’s the first glimpse that it’s starting to spread more broadly.”

A rise in inflation leaves the Federal Reserve policy makers “walking a tightrope,” Mr. Yardeni said. Analysts said they expected the Fed to be more reluctant to cut rates as it tries to balance problems in the credit and housing market with the need to maintain price stability.

Bottom line, the Fed has precious little room for error given the confluence of rising prices and troubled credit markets. Continue to pump liquidity into the system by reducing rates, and run the risk of unleashing inflation after a two-decade hiatus. Hold the line on rates to stave off incipient upward price pressures, and face the threat of recession due to a heavily indebted consumer and a scared and unfriendly credit market. Choose your poison.

Next, even in the face of rising prices we have signs of an economic slowdown within export/import data. Also from Saturday's NYT:

The rate of increase in imports has begun to decline, and is now at its lowest level since 2002, when the economy was only slowly emerging from a recession. At the same time, export growth has remained strong, thanks to a buoyant world economy and a weaker dollar that has made American goods seem cheaper to overseas buyers.


...the last time import volumes declined was in 2001 and 2002, which was also the most recent recession. The time before that, in 1990 and 1991, was another recession. In each of those cases, the figures fell into negative territory only after the recessions began.

After the 2001 recession ended, imports rose even faster than exports, leading to a rapid rise in the American trade deficit. But import growth peaked in August 2004 and has come down significantly since then.

Whether by coincidence or not, that was one month after the Standard & Poor’s/Case-Shiller home price index peaked. Americans who used their homes as piggy banks to finance consumption were less able to do so once home prices began to slip.

It seems pretty logical. A weak dollar makes domestic goods look cheap to foreigners, foreign goods expensive to those in the US, and even more expensive when a major source of US consumer purchasing power - home equity - is taking a big hit. This is a pattern that has been played out in the past and is being played out now. The question is when things will begin to turn. But between the weak fundamentals for the dollar and only being at the beginning of a great housing unwind, I can't see the current outlook changing markedly in the near term.

Finally, just to rub it in, overseas shoppers are engaging in a feeding frenzy over comparatively cheap US goods. From the Saturday NYT once again:

With the dollar near its lowest rate against the pound in 26 years, and its lowest rate against the euro ever, many Europeans are looking at the United States the way some Americans have long viewed Latin America and the Caribbean and, once upon a time, Europe — a cheap place to flex their strong currency.

The situation is more than a potential blow to Americans’ self-image, it could be a blow to the world economy as some central bankers worry about “currency tension,” and many countries move trillions of dollars out of their reserves and buy euros instead.


But monetary authorities are not laughing. The dollar has been so low for so long, Europeans are worrying about how expensive their exports are becoming for American consumers when priced in dollars, and how much that hurts European growth.

Last month, Mervyn King, the governor of the Bank of England, warned that an appreciating pound and euro, combined with most oil-producing countries and China linking their currencies to the dollar, creates “great currency tension.”

Such tension could hurt the dollar further as countries like China, which holds the largest reserves of American currency outside the United States, see their dollar reserves sink in value and hurry to move them to other currencies. A Chinese official threatened to do that last month, though other leaders contradicted him.


“The current currency system is quite fragile and will break down as it leads to imbalances and capital losses” among countries with dollar reserves, said Nouriel Roubini, a professor at the Stern School of Business at New York University.

It is still less clear whether one or several currencies will replace the dollar as the main reserve currency. “With the euro, the world has gained an alternative reserve currency but other currencies have also won in strength,” said Chris Munns, a lecturer at the London School of Economics.

Can you believe this? This totally sucks. The article did a pretty good job highlighting some of the big issues of the day and some of the very real concerns I have over the prospects for the US given its current spending patterns and economic policies. And it doesn't even begin to describe how the vibe in the US is beginning to feel a bit circa 1975-79, with sky-high rates, rising prices, a massive rise in Middle Eastern petro-wealth, tensions with the Muslim world and a US asset base essentially for sale. Sound familiar? We're not there yet, but do we want to be? I'd say not.

Whether it was real estate, companies or art, it felt like the Middle East was taking over the US. The only difference today is that it is not only the Middle East who is buying but China and Russia as well. We've got to get it together, and quick. We incurred a lot of pain in the early 1980s to get us back on track, but get us back on track it did. We need to take some pretty bad-tasting medicine. But let's get it over with. Some fiscal responsibility, international diplomacy and common-sense immigration policies would be good places to start.