The 1970s were America's only peacetime inflation: the only time when uncertainty about prices made every business decision a speculation on monetary policy. In magnitude, the total increase in the price level as a result of the sustained spurt in peacetime inflation to the five-to-ten percent per year range in the 1970s was as large as the jumps in the price level as a result of the major wars of this century.
The truest cause of the inflation of the 1970s was the shadow cast by the Great Depression. The Great Depression made it impossible--for a while--for almost anyone to believe that the business cycle was a fluctuation around rather than a shortfall below some sustainable level of production and employment.
Now lets switch to 2008.
Federal Reserve Chairman Ben Bernanke(United States) made a statement sometime back that he does not believe the United States will experience the out-of-control prices seen with 1970s oil shocks.Then, as now, the U.S. endured a serious oil price shock, sharply rising prices for food and other commodities and sub par economic growth, he said.
Today's economy, however, is more flexible in responding to difficulties and the country is more energy efficient than a generation ago, Bernanke said. This was the situation about 3 months back, in June.
Now in October, Mr. Ben Bernanke says the country’s economic health won’t snap back quickly even if confidence in the U.S. financial system returns and roiled markets finally calm.
And he is the same person who in year 2002 made a eye-brow raising statement: "People know that inflation erodes the real value of the government's debt and, therefore, that it is in the interest of the government to create some inflation."
Ben Bernanke made this statement as one argument why deflation was unlikely: governments benefit from inflation, therefore inflation would normally be promoted. At the time, deflation seemed a real possibility: the Consumer Price Index (CPI) had risen only 1.6% over the 12 months of 2001. At the time, Ben Bernanke was not Fed Chair. Both of those facts would soon change.
Ben Bernanke became Fed Chair in February 2006. For the prior year, the CPI rose at 3.2%. In 2006, it rose only 2.9%-- a very reasonable rate of inflation.
Then something changed. During the twelve months of 2007, the CPI rose 8.6 points, or 4.3%. From January to August of this year, it rose another 8 points, for an annual rate of 5.7%. That's the highest rate of increase since 1989, when it jumped 6.2%. To find a year with an increase greater than that, you'd have to go back to 1979-80, when it rose over 10%.
What caused this sudden resurgence of inflation? The Bush administration's policy of excessive deficit spending surely promoted inflation, but why did it take such a sudden turn for the worse after six years of bad budgeting? There must be surely something else. Lets find out.
For a moment, let's ignore the housing market, the credit crisis, and the plunging stock market. What happens when inflation rises and the Prime Rate remains low? First, more inflation, since banks are pleased to borrow money at cheap rates with the idea of lending it to others (you and me) at higher rates. As they borrow money from the treasury, more and more money goes into circulation. That's the very definition of inflation.
But now arises an important question !!
"What kind of a bank would lend money for less than the inflation rate? Isn't it sure to lose money?"
Sure, banks love to borrow cheap money. But they're loathe to lend cheap money when it's below the rate of inflation. In order to make money, they need to lend their money at a higher rate. That means the supply of cheap money lent between banks and from banks to businesses dries up.
S it seems the lending lockup is a key reason why the U.S. economy is faltering. Unable to borrow money freely or forced to pay a high cost to borrow, employers are cutting jobs and reducing capital investments.
Now can anyone explain me : Why would one loan money at 1.75% when inflation is at say 6%? One wouldn't as common sense suggests.So the question is:
" What does one get by dropping interest rates and encouraging inflation at same time? "
Now look, we are pretty much aware that inflation makes it easier to pay off the staggering national debt.But with it comes the flip side: borrowed money gets more expensive, so companies relying on it can't get it leading to lost jobs, lower profits, and obviously less tax revenues which ultimately causes more national debt. So what goes around, comes around.Finally the conclusion drawn is that by encouraging inflation with irrationally low interest rates, has turned the housing bubble into a global crisis, which is affecting world economies.
So what is happening in India in lieu of this Global Economic Crisis?
Lets have a look at current inflation rate in India which is 11.44%. Far more than January 2008. 2008 began with inflation rate of 3.79 per cent for week ended on January 5, prices rose as the year progressed.
The wholesale price based inflation crossed 4 per cent by end of January and 5 per cent in February. As per the latest data, the price line rose 7 per cent in the week ended March 22.
And it was during January 2008 only when sensex touched 21k mark and now on October 17th it has fallen below 10k.
Similarly 1 US$= INR 39.20 in January'08
And 1 US$= INR 48.68 in October'08
So what does this suggests? There has been certainly something going wrong with Indian Economy in this year. Rising inflations followed by cutting interests rate by RBI shows the double face of Indian Economy. Infusing liquidity in market is the way to get out of this financial crisis as it seems to everyone now. But this would be a short term plan which may infuse some stability in the market, but investors who have stayed invested for long times, what about them? What about pink slips being shown by every other company? I won't even talk about IT industry who have mostly clients from US.
As for the next stability in markets would come by a upward move of US market, which could come by end of this year, when seemingly Govt would change at US.
Investors should stay invested in equities, and should look for short term profit booking by end of November. This is the right time to buy blue chip stocks, because market could see a upward boom by the Christmas. Also General Elections are going to be held next mid-year. That would also bring good news for Indian Stocks. All in all I can foresee sensex touching at least 15k by June'09.
But for that inflation(India) needs to come to 8.5 at least by March'08 and hope Federal Govt. is the opposition(US) comes Christmas this year.
Finally
" What goes around, comes around !! "
