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Inflation Burns While the Fed Fiddles

Inflation Burns While the Fed Fiddles

Despite fresh signs of
surging inflation (crude oil prices surpassing $39 per barrel for the first
in 14 years, and yesterday’s ISM report that
showed the employment cost index at a 17 year high and the prices paid index
soaring 38.5% year-over-year to a 25 year high), the Fed left its funds rate
unchanged at a 45 year low. Continuing its absurd pretense that there is no
inflation, the Open Market Committee stated that “with inflation low and
resource use slack… policy accommodation can be removed at a pace that is
likely to be measured,” that “the risks to the goal of price stability
have moved into balance, ” and that “long-term inflation expectations
appear to have remained well contained.” They have got to be kidding!

The dollar, which had already weakened ahead of the Fed’s announcement, continued
its decline, with the euro hitting a four week high. Bonds, which originally
rallied on the Fed’s dovish statement, reversed, with the yield on the ten
year treasure rising to 4.57%. Gold stocks surged, with the Philadelphia gold
and silver index gaining over 5%. This suggests that the bear market rally
in the dollar has ended and that bond investors are becoming increasingly more
aware that the Fed is way behind the inflation curve.

Meanwhile, recent actions by the Chinese government to restrain credit growth,
(which is the result of the monetary expansion necessary to maintain the Yuan’s
pegged exchange rate with the dollar), is evidence that China’s ability to
prop up the U.S. dollar is nearing an end. However, by addressing bank lending
Chinese officials are targeting the symptoms rather than the disease, which
is the currency peg itself. These misguided efforts, which represent a desperate
attempt to maintain the status quo, are doomed to fail, and is perhaps the
clearest warning that American profligacy is now too great a burden for the
Chinese economy to bear.

Judging by the muted reaction in the stock market, Wall Street remains convinced
that so long as the Fed maintains its casual regard for inflation, it can stay
unconcerned as well. However, recent technical action suggests that the bear
market rally in stocks has ended, and that the risk of a major stock market
decline is high. The problem for the Fed is that it typically responds to such
stock market declines by cutting interest rates. With the Fed funds rate already
at 1% and inflationary pressure becoming increasingly more evident, such a
policy response appears impossible.

What should really disturb
the Street is the Fed’s unbelievable complacency in the face of enormous
pressures. Why is the Fed so afraid to
raise rates? Could it be that the Fed understands that the current “recovery” can
only be sustained through continued reckless credit expansion at ridiculously
low interest rates. Instead of fixating on the meaningless wording of Fed propaganda,
investors should instead focus on surging real world prices, straining global
imbalances, and the irresponsible Fed policy creating these problems.

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