There Would be an Inflation Rebound in USA

Is it possible that in the United States the inflation rise again?. In september 2008, Kenneth Rogoff compared the economic problem in the United States with an emerging market country crisis which at the end will suffer of an inflation problem.

Let's try to think about this possibility.

First of all, let's check historically what happened with the inflation in a recession period. We can observe that most of this time the year-over-year price variation increased in each economic slowdown period. This outcome would be the product of the reduction of the interest rate that usually was applied as a policy monetary tool.

In this moment, the inflation, which was very high as a consequence of a strong leveraged demand, is now decreasing by the financial crisis. The financial crisis makes this recession special, because in my opinion it would multiply the common recession effects.

In my analysis I want to focus in one economic indicator, the money supply. Why do I care this variable?. Because the inflation is a monetary concept and has positive correlation with money supply. What has been happening with this indicator?. The monetary base (B) has been increasing rapidly to help the financial institutions, and although monetary supply (M2) does not show a big movement, this apparent discrepancy between B and M2 is due to M2 show the deleveraging process of the current crisis. The inflation problem will occur when present-day crisis impacts will disappear, and M2 will reflect the increased monetary base effects.

Monetary supply will increase in the near future and will impact over the inflation. I know that today there are other problems to deal, but we need to start thinking how to counter this new problem.

The USA Low Personal Saving Rate Would Make the Perfect Storm

Many important economists have been saying that The United States is a liquidity trap. I can summarize the concept of liquidity trap as a situation where a monetary policy has no effect in the economy. It happens when the interest rate is so low that any change in it does not make any difference.

What do we need to the monetary policy work?. The reduced interest rate helps companies to invest more money because of the reduced money price, and the increased investment impacts positively in the gross domestic product and so on. We can see how the monetary policy usually helps to reactive the economy by the supply hand. On the demand hand, the reduction of credit interest rate and the money abundance push consumers to buy more in a normal situation.

What is now wrong in the equation?.

Many things happens to arrive to the current situation, but I can sum up in only one indicator that in my opinion expresses the real problem, and it is the very low saving rate. Never historically was this macroeconomic variable so low, inclusive getting in september 2005 a negative value. The historic mean of the variable is around 7%, and in this new century the ratio is around 1.5% now recovering to a level of 2%.

Now The United States is in a recession, and the Federal Reserve has been reducing the target interest rate. The question is whether the monetary policy will be effective enough. My answer is not because the demand hand won't work. My response is based on the idea that the consumers are now leading with many problems. First of all, they are losing their main revenues, losing their jobs and looking how their main actives value are falling. Second ,many of them have debts to pay, and finally because they have very small savings. I think the present monetary policy won't help the economy, and the consumers will have to shield themselves through increasing savings and reducing consumption.

Finally, I agree with many economist's opinion that the economy recovery would take long, and a fiscal policy is necessary to help pass through this difficult moment.

Tough Time For the OPEC Countries

The OPEC has been having a very good time since 1999 because the oil price had a positive trend and reached its maximum level of US$ 145 the barrel in july 2008. Their macroeconomic indicators show this fact. For example, in the period 1999-2008 the OPEC gross domestic product has been growing 5% in average, its current account has been adding up 120% of its GDP, and its per-capita GDP has been increasing three times. Now the price is around US$ 50 the barrel since it plummeted from its highest level. The OPEC is not ready for this event because many countries have been increasing their expenditures with the expectative that the price will remain high or get the US$ 200 the barrel. In this way, they are facing a future big reduction in their revenues and perhaps the future of the cartel continuity.

In my opinion the real problem of the OPEC countries is an unexpected deep oil price fall because of a demand drop. This fact nobody forecasted makes these countries to vary their strategies. For example, they must cut their oil production, reduce their outlays, increase their investment to reduce production costs, change the cartel goals and wait until a rebound of the price. Although the present-day price is more or less the third part of its peak, this price is higher than the historic price of US$ 20 the barrel, so they still have a gap to benefit and to make the necessary improvements to not be affected by the low price.

United States Current Account

I used the WEO database Oct-08 to extract information of the current account of the United States and other important countries. One can easily see how the United States has been financed mainly by China, Japan and other Asian countries since 1990. I have some questions in my head. First, is it possible that a country can live forever with a current account deficit?. Second, what will happen if this situation continues?. My teacher of International Economics told me that in an economy of flexible exchange rates and free flow of capitals a current account deficit is compensated by capital flows.

I always thought that USA was one of the best places to invest money, and this is not only by its zero exchange rate risk but also by its financial system soundness. But now the present crisis makes me doubt about this believe. In this difficult moment funds in this difficult moment bought treasury bonds in USA because nowhere could they find a safe place to invest. For example, all commodities, that were used as reserve value after technological burst, have been going down with the present-day crisis. I think when the water makes calm, investors will have serious problems to evaluate where to put their money. The United States must work hard to improve its macroeconomic indicators.

The Stock Market Big Falls

It is difficult to predict how much time the stock market will continue its down trend. The great crash of 30's was not only the biggest in fall but also the longest in time. It took three years to reach its bottom level.