The Consequences of High US Inflation or Even Worse – Stagflation

The ability of the United States to not only recover from her recessionary doldrums, but also her ability to combat inflation and at the same time maintain the integrity of the US financial system will remain key criteria for the US to maintain her status as world economic leader.

These strong words come on the back of a mighty great scare that the world endured through the Global Financial Crisis, and one that few want to relive in the future. Many attribute responsibility to the US for her deregulated financial markets and her unbridled consumerism, so much so that the next phase of globalization will be sure to include some debate on the future of US dollar hegemony.

This being the case, the Federal Reserve will be sure to treat the now tentative signs of growth in the economy with kid gloves. The last thing the Federal Reserve would intend is an enduring recession, and yet at the same time, must remain vigilant as any economist would toward the fight against inflation.

Things are not as they seem.

The US financial system will need to be protected for reasons of legitimacy. If they have indeed survived, financial institutions in the US are emerging as restructured conservative entities simply inundated with self regulation, policy, and procedure. This excess is sure to warrant a gentle hand when regulation is introduced, as if anything, the banks are hoarding cash in self preservation; the Federal reserve needs to encourage them to lend freely.

At the same time, the Fed will seek to protect the bank’s livelihood, and maintain a steady margin between the poles of the yield curve. With the inflationary concerns emerging in the bond markets at present this ought not be too difficult a task, but when it comes to thwarting real inflation as the economy gains momentum, the Fed may have a challenging experience.

Investors are already beginning to show concern for the consequences of the $863billion stimulus. If the US slips into a profound inflationary climate, or worse still, stagflation, with low economic growth, high unemployment and high inflation, investors will clamor for property. Alternative investments will simply not survive scrutiny at this stage. Bonds will need to provide large protection to combat inflationary erosion. Equities that are ordinarily a wonderful hedge against inflation will also dive lower due to the lack of economic activity and subsequent unemployment, yet Americans will be paying a fortune for a loaf of bread…..

No, when the balance hits tipping point such as in this scenario, the only safe haven is property.

The US dollar will be sold heavily across the markets of the world, which presumably will opt for the Yen, the Euro, or even a Renminbi Bond, but the astute foreign investor will recognize the golden opportunity that exists in US property that remains awash with distressed sales. The sheer volume of foreclosures has yet to be taken up, with certain sectors of US short sales being favored over others. Infrastructural investment has contributed to the establishment costs of many commercial enterprises, and economic growth has returned. Mortgagees simply want to clear the sheer volume off their books. Thus remains a slender opportunity for foreign investors that have not suffered asset depreciation as many US investors have.

Beyond the material advantage of distressed property sale offered to foreign investment, the weakness in the US dollar will reduce the investment even further, and provide returns of some magnitude at exit point.

Posted by Arnold Balthazaar on Jul 14 2010. Filed under Economic Updates. You can follow any responses to this entry through the RSS 2.0. You can leave a response or trackback to this entry