Stagflation

For an interesting read about the economy, check out Friday’s feature WSJ article: Fears of Economic Stagflation Return As Price Increases Gain Pace:

Here’s the most interesting quote from the article:

Mohawk Industries, Inc. raised carpet prices in December and again in January because of rising material costs, even though sales have been hurt by the slumping housing market.

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Over the last few years, manufacturers have become much better at managing their inventory.  Cheap transportation and “just-in-time” deliveries means that companies can place orders for materials and receive them in days or even hours.  So a company like Mohawk might only manufacture carpets when they receive a customer order.

Unless Mohawk is desperate for market share, they might see no reason to eat higher raw material costs and accept lower margins.  Instead, they might just turn away business that isn’t profitable enough.

Since the current inflation is largely a demand-driven global phenomenon, even if the US slows, prices will continue higher because there is so much global demand.

Interest rate cuts by the Fed may not do much to stimulate the US economy, but they could further increase demand from the rest of the world.  Since some of our trading partners, China and Hong Kong as an example, peg their currencies to the USD, an interest rate cut by the Fed causes rates to decline in Hong Kong and China, too.  So, at a time when these economies are overheating, they are further stimulated with cheap money.  This, of course, intensifies the pressure the Chinese government feels to allow the Yuan to strengthen against the dollar.  A strengthening Yuan leads to higher import prices which is very inflationary.   

In my view, the Fed is very scared about a de-leveraging, asset price deflating, weak-demand, slump in the United States and they view the threat as very real.  They view the potential for a major recession as a bigger problem than inflation.  Thus, if they succeed in their mission to prevent a recession, it will almost certainly come with a ton of inflation.

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