Archive for March 13, 2008

Economic Apocalypse Now

March 13, 2008

The NYT writes

…Almost everything seems to be going wrong for the American economy at once. People are buying less, but most things are costing more. Mortgage rates are rising, the dollar is falling and prices of key commodities like oil are leaping from one record high to the next.

On Thursday, the dollar plumbed new lows against the Japanese yen and several other major currencies; the price of an ounce of gold jumped above $1,000 for the first time; and lenders raised home loan rates once again. Government figures showed retail sales fell in February as consumers cut back on cars, furniture and electronics.

Stocks fell sharply after the retail sales report was released early in the day, and a large investment fund said it was nearing collapse. The volatility that has defined the market lately continued unabated…

Newspapers are fond of gloomy sounding titles these days, so I had to best them. But yes, Gold just pierced the $1,000 barrier and the dollar has slid to a record low of $1.56 against the Euro. Now, $1.56 is REALLY low. Back in the early 90s the dollar was low too – down to an equivalent of about $1.40 per Euro. Yet, that was a time when the U.S. was just coming out of a recession, not sliding into one, oil was at just over $10 a barrel, and the stock market was entering its fastest and steepest run-up in history. Just for price comparison purposes, the “true” value of the dollar, meaning the value that would buy you an equivalent basket of goods and services here and in Europe is about $1.10-1.15 per Euro, so the dollar is almost 40% away from where it should be. That’s all relative of course, and depends on your interests. Some people would argue with where it “should” be.

Greg Mankiw noted that real interest rates just turned negative recently, a phenomenon that typically drives people to move their assets into more inflation-proof goods or commodities (hence the run-up in gold) and leads capital to seek out markets with better returns (i.e., people sell dollar denominated assets and buy stocks and bonds denominated in other currencies). That again puts pressure on the dollar, which, in turn stokes the flames of inflation, thereby creating a vicious cycle. So what’s the Fed to do? Fight inflation or try to jump-start the economy?

Charts below courtesy of the Financial Times (a year ago would have been a good time to buy gold…).