Sunday, June 29, 2008

American Economy at Crossroads

1. Bernanke Fed was late last year to reduce interest rates and as a result a potential chance to decrease the pain of credit crisis was lost. It seems same hesitancy is playing this time in increasing interest rates. Unless interest rates go up, there is no hope for Dollar and consequently oil price. Oil price increase has ignited overall inflation and the only text book answer to that is high interest rate. ‘No wage pressure’ is not the solace this time. Or arguments like ‘oil price is not a monetary phenomenon’ are not applicable for the simple reason that the oil trade is denominated in dollar terms and with low interest income for dollar; world has less reason to value the dollar any better. This trashing of Dollar is showing up in ever increasing oil prices.

2. Daniel Dicker makes a solid case in RealMoney ( about why ‘liquidation-only’ rules are needed in oil futures market to control the spiraling price of oil. He makes it very clear how many of the other proposed regulations to control ‘speculation’ in oil trade are of less utility. His point is ‘liquidation-only’ will determine once and for all what component is ‘speculation’ in the oil price and that will be knocked off. The oil price increase may not be entirely due to speculation and fundamentals are sure to play the role. But removal of speculative premium from the oil price will be welcome in itself.

3. Even if reduced oil prices may give breathing room for consumers; the mess in American financial system and housing market will not go away quickly. Falling house values, tighter credit norms and higher interests rates; all these things will make any recovery hard and long. This means unless there are meaningful stimuli from Congress (like the bill to provide $300 billion for distressed borrowers); we are not going to get out of this hole.

4. Finally, we all know reduction in oil price is only a temporary and partial solution. The real solution is to go away from carbon fossil energy sources to alternative, renewable energy sources. It is no more long term solution, but the solution which needs actions now.

Essentially relevance of American political and financial establishment will be measured along what action these actors take in next few months. Fed, regulatory institutions and Congress – all eyes will be on these players and unless these players take appropriate actions along above lines; America’s current downturn will turn into potentially permanent down turn. That could be true end of America’s Global Economic (and consequently Political) Leadership.

No comments: