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Greenspan’s Real Conundrum, Stagflation

Greenspan’s Real Conundrum, Stagflation

Today’s release of March’s much weaker than expected non-farm payroll numbers (110,000 verses average estimates of 213,000), together with February’s downward revisions, provides clear evidence that the “recovery” is indeed faltering. Traders sold dollars and bought stocks and Treasuries, on the theory that weaker jobs growth might slow the pace of future rate hikes. However, an hour and a half later, traders bought the dollar back, and dumped stocks and Treasuries, when the Institute of Supply Management released that its February prices paid index surged from 65.5 to 73, causing them to reassess their assumptions.

The conundrum: With job growth faltering, could the economy be headed for the dreaded double dip? However, with the dollar still on the defensive, oil and other commodity prices on the rise (oil prices surged today above $57 per barrel,) employment cost pressures mounting, and foreign producers beginning to pass on higher production and transportation costs to American consumers, inflationary pressures are clearly intensifying. Recession or inflation, which dragon is Sir Prints-a-lot prepared to slay? My guess is neither. Once traders comprehend this dismal reality, they will sell dollars, Treasuries, and stocks, feeding both beasts simultaneously.

An asset driven bubble-economy that lives on credit, dies by it as well. As Greenspan slowly removes the punch bowl, the long intoxicated party guests, as they finally emerge from their drunken stupors, will be confronted with the sobering reality of dealing with the consequences of their inebriation. As interest rates rise, borrowers will realize that they have paid way too much for houses and other assets, and committed to interest payments they cannot afford to make and principals they will never be able to repay. Lenders will also realize they have recklessly lent money to non-creditworthy borrowers, based on insufficient collateral and pie-in-the-sky assumptions. As credit contracts and asset prices fall, so too will consumer spending, and the consumption based economy it supports.

To fight off the recession dragon, Greenspan will look to brandish his only weapon, his interest-rate-cutting sword. However, the minute he does, he will be attacked by his other nemesis, the now much fiercer inflation dragon. To fight this monster, Greenspan will reach for his other weapon, his interest-rate-hiking sword. Realizing that he cannot wield both swords simultaneously, he will slay neither, and be consumed by both.

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