Unemployment or Inflation: Which is the better of these two evils? Put another way, if you were the governor of a Central Bank what would concern you the most: average Joe losing his job today - unemployment - or average Joe paying much higher prices for bread and milk tomorrow - inflation? That’s a tough one, isn’t it? Well, that’s the choice Federal Reserve Chairman (or U.S. Central Bank governor) Ben Bernanke and his posse of regional governors – collectively known as the Fed - have now faced for a year.
You would probably say it’s better for average Joe to pay a higher price for bread tomorrow than to lose his job today. Well, guess what. The Fed agrees with you, which is why it’s been cutting interest rates since September 2007. Lately, the Fed has got very aggressive on rate cuts and this is making me nervous. Chairman Bernanke reportedly has reduced interest rates faster than any Fed Chairman since 1982.
However, when the subprime slime started around this time in 2007 the Fed saw things differently. Back then, the Fed was more concerned about inflation than job losses and was more reluctant to cut interest rates. So what changed the mind of the Fed? I don’t know. Perhaps it’s politics, since it’s an election year. Whatever it is the Fed has blown it. It’s now trying to prevent a recession at the risk of higher inflation tomorrow. Big mistake.
Interest rate cuts fuel inflation by weakening the dollar and thus making imports more expensive. Rising oil and food grain prices, which the Fed cannot control, also fuel inflation. So hasn’t it noticed that oil is now over $100 a barrel and that the price of wheat, which is a principal ingredient in many food products, reached a record high last week? Gold, which is a natural hedge against rising inflation, is fast approaching a record $1,000 an ounce and the price of Silver is up almost 34% year-to-date (YTD), a run-up not seen since 1980. By the way, if you don't already have some commodities in your portfolio now is not the right time to buy.
Laugh Now, Cry Later
Maybe the Fed knows something the market does not but it seems to me we already have enough inflation coming our way. In 2007, inflation jumped 4.1%, reportedly the fastest pace since 1990. No wonder the price of milk at my local organic store has crept up. Why aggressively cut interest rates to put the economy on a K-leg only for inflation to crush it two or three years from now?
I think the Fed’s fear of a recession is misplaced. A mild recession today is better than hyperinflation tomorrow because inflation can do much more damage to the economy than a recession. Inflation can cause a recession but a recession cannot cause inflation. The recession this year probably will be short-lived because of the “economic stimulus” tax rebates the government just approved.
Even if consumers don’t spend the bulk of their rebates businesses will reinvest their tax credits, which will boost the economy and stave off a brutal recession. So the chances of average Joe being unemployed for a long time if he lost his job today are slim. However, if we get hyperinflation in a few years…..well, just look at what is happening with food prices in Zimbabwe. Even Wall Street fears inflation more than a recession.
Yes, I know the housing sector is bleeding and the lending department at your local bank won’t give you the time of the day even with good credit. However, it was the aggressive rate cuts by former Fed Chairman Alan Greenspan that partially caused this mess we’re in today. The inflation signal is now flashing red. The Central Bank should stop leading us to the slaughterhouse again with aggressive rate cuts.
