Wednesday, February 27, 2008

A Stag(flation) Party

Much ado about yesterday's consumer price index report: according to those figures, prices across the board rose 7.4% over the past year. This figure far exceeds the "acceptable" range of 1-2% that the Fed regards to reflect "stable" prices. While the stock markets rose yesterday, the more important reactions were seen in the price of the dollar, gold, and oil. The dollar fell to an all-time low against the Euro; gold is now easily within striking distance of $1,000 an ounce, closing at about $950 (and today jumping to $960); and oil yesterday closed above $100 bbl., a figure that we are likely to regard as the new bottom. During the day oil broke the $102 bbl. level, nearly reaching the all-time inflation-adjusted high of $103.76, reached in 1980 in the wake of the Iranian revolution and the OPEC oil embargo. We should notice that our flirtation with this all time high takes place in the backdrop of relative stability and peace on the international front: there are no major disruptions in the major oil producing areas and the world is on course to produce its current all-time high level of 87 million barrels a year. Quite simply, worldwide demand is absorbing every spare drop of oil, and there is considerable evidence that the major suppliers are unable to produce at levels above the current output, while also intimating that a number of the major fields - such as Cantarell in Mexico - are going into rapid and irreversible decline. All told, Mr. Market was telling us that things are going to continue to get more expensive and that we will have less wealth to afford them.

The New York Times carries a front page story today telling of the pressures that gas prices are now exerting on household budgets. While the price of oil has been rising steadily, it has manifested itself only partially in the price of gas, given that existing inventories will allow for a lag in price increases. The article points to experts who suggest that gas prices will begin approaching $4 a gallon by this Spring, when driving demand typically rises. The article provides anecdotal evidence of the way in which average Americans are beginning to cut back on a range of economic activities - such as cutting back trips to the movies and other non-essential (and increasingly essential) "consumptive" activities. Multiply these sorts of instances by millions, and it's clear that an already reeling American economy is going to go into a severe tailspin.

Economists tell us that inflationary problems necessarily and rightfully result in recessions, and through recessions the price pressures are accordingly relieved. However, the Times story paints a somewhat different picture, not only concluding that high oil prices will almost certainly plunge the U.S. into a painful economic recession, but that oil prices will continue to rise in spite of the reduced economic activity. John B. Hess - appropriately enough, the Chairman of the Hess Corporation - revealed recently that we cannot solely "blame" China and India for wanting to live the same kind of profligate lives as we have enjoyed. "It's not a matter of demand. It's not a matter of supplies. It's both." The story cites a recent study by Barclay's Capital that sets an oil price target of $137 per barrel by 2015. While itself a hefty increase in seven years time, I think this target is laughably low (and I'm not alone - Matthew Simmons, oil man, is looking at $300 bbl in the next five years).

In response the growing evidence of economic recession and commodity inflation, the Washington Post today carries an article that raises concerns about the "specter of stagflation." Even as the price of commodities rises, the worth of our housing is plummeting (most recent data suggesting a remarkable decline of 8.9%, 9.4% in the D.C. area), effectively reversing the party of the 1990's and early 00's during which housing climbed inexorably and inflation was in check. It points to the bind in which the Fed finds itself: inflation levels such as these would normally demand a rise in interest rates to stem the damage entailed by the decreasing purchasing power of money and to dampen economic activity; however, given the slowdown in the economy, the decline in housing values, and above all the systemic threat to the econmomic system that the credit crisis poses (if banks cease lending, the whole house of cards tumbles), the Fed faces the unenviable choice whether to cut rates to stimulate the credit markets or to raise rates to dampen inflation. It's obvious to everyone that the Fed has decided on which side of the bed it will sleep on: it will cut rates, and continue to do so, as long as the credit system remains locked-up, but the result will be a further exacerbating of the loss of value of the dollar and the concomitant rise in the price of foreign goods - above all, oil. The very solution to one particular and vicious problem will only contribute to an increase in the cost of goods, meaning that we will all pay the price - and a hefty one - for the foolish lending practices of our "trusts" and profligate choices of our fellow "consumers."

Where will all this end? No one can say for certain, but my guess is that we are in the early stages of a wicked and wild roller-coaster ride in which inflation follows deflation and so on and so forth. The Fed will only act reactively to the worsening of each decline or bubble, always just enough behind the curve to exacerbate the condition that will follow upon the heels of the current crisis. Our "consumers" will not know what has hit them - indeed, they are already stunned and dizzy, wholly unawares of the structural conditions that are pinching their movie-going habits - and if we now think that what is taking place in the Ohio campaign constitutes "Populism," we have another thing coming. While our candidates fight over accusations of who promised to accept limits of public financing and whether someone supported NAFTA fifteen years ago, our economy threatens to spin out of control and not one candidate is willing to stand before the American public and tell them to buckle down for tough times ahead. It is the apotheosis of modern liberal democracy not to be able to call upon the citizenry to embrace self-governance.

As Aristotle told us long ago, democracy is properly understood as a form of self-rule, in which citizens rule and are ruled in turn. However, democracy easily devolves into a kind of contractual form of tyranny, in which - barring our opportunity to rule over everyone else - we rather embrace the notion that democracy is best defined as "doing as one likes." Democracy, that is, goes from being a demanding form of government calling for extensive civic virtues to a lax and tyrannically-inclined form of government in which what is desired above all is the absence of rule. We are now reaping the results of "doing as we like," and the paramount question of our time is whether liberal democracy will prove capable of surviving its own worst instincts.

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