Stagflation – Tackle The Flation First

We all know the catch-22 situation facing the Federal Reserve… stagflation . A stagnant economy coupled with rocketing inflation. At the rate oil is increasing, we can expect our daily products to double in prices within the next 2-3 years.

I believe the Fed is aware of the impact of low interest rates on the US Dollar and that every time oil and gas prices scaled new heights, the stock market gets punished with panic sell-offs.

However, jacking the rates drastically will aggravate the burdens of those suffering from the housing crisis and credit crunch and push them into defaults. Banks already teetering on the brink of collapse will again report massive write-offs. The Fed has no choice but to bail them out to preserve confidence in the financial sector.

Isn’t this script familiar? All this melodrama has being played out before in previous speculative bubbles. Who pick up the tab in the end for the excesses of a few irresponsible and greedy speculators? The old lessons are never learned and risk managements, even in place, are never enforced.

The European Central Bank is expected to raises interest rates this Thursday. As I mentioned, this is equivalent of a rate cut in America and further pressure will be wrought on the anemic dollar. Oil and commodity prices are poised to go even higher. If you are still holding onto stocks, psych yourself for another round of bloodshed.

Though the Federal Reserve is likely to raise rates in early 2009, I am hoping that they will take action sooner than later. Pause for a while and ask this question: Where is all the money going to at the moment?

Cheap credit is not benefiting businesses or the stock market in this economic climate. Purchasing sentiment is weak as consumers deal with stagnant payrise, unemployment prospects, inflation and declining assets.

Oil speculators do welcome the low interest rates and weak dollar. They are pumping whatever they have (beg, steal, or borrow) into the oil and commodities market. In fact, trading in commodities now account for a major part of the profits for investment banks and mutual funds.

With oil prices pushed sky-high and stock market declining, we will see analyst reports that the economy is in bad shape and needs more help. The Fed, not one to take tough action, will be forced to inflate the money supply and lower interest rates which the speculators will then use to pump back into the oil market, stock market gets worse, and the moolah continues to flow for these traders.

Tightening the credit supply is important to stop this vicious cycle. The critical question for the Fed is whether to accept short term pain and get the economy up and running faster or embark on the road to long-term decline. I rest my case for now and we shall see what is the Fed’s decision in the coming months.

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Filed under Economy, Inflation, Oil, Properties, Stocks

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