Blogs & Comment

Double-dips and fear of inflation

It appears the global economy may be moving ever closer to the the dreaded double-dip recession.The premier leading economic indicator in the U.S., the ECRI Weekly Leading Indicator (WLI), now stands at a level that foreshadowed the past 7 downturns, observes David Rosenberg, chief economist with Glushkin Sheff + Associates.
So, we are likely heading for “a 2002-style growth relapse or an outright double-dip recession.” Either way, Rosenberg suggests, you might not want to be overly exposed, at this time, to risky assets like stocks.
The fear of inflation was, in my opinion,one of the main contributors to the prolonged slump of the 1930s. That fear kept policy makers from meting out as much stimulus as they should have perhaps done. I wonder if a similar dynamic is at work in 2010.
There is a popular notion the Federal Reserve of today has gone wild with the printing press — thanks to buying up all the dodgy assets of the financial sector. True, but it has largely sterilized that massive stimulus.
It has done this by offering attractive interest rates on banks’ reserves held at the Fed, so the banks keep their excess funds there instead of lend them out to borrowers in the economy. This is one big reason why credit growth in the U.S. economy is still substantially negative.
In short, the Fed is paying attractive rates on the banks’ reserves because it is afraid of over-stimulating the economy and creating inflation. But now there are signs that the Feds fear of inflation is asphyxiating the U.S. economy.
The Fed will get over its fear and make interest rates on bank reserves less attractive. Then, the banks will have more incentive to lend out their reserves to businesses and individuals.
Of course,there will likely be lags in the impact on the economy. For one thing, demand for loans is not particularly robust these days. There are other issues, as well, but Ill leave them for a future post.