Monday, August 3, 2009

The Inflation Monster Cometh


Why the Obama Stimulus Has Us on a Collision Course with Inflation

Has the massive Obama stimulus plan put us on a collision course with virulent inflation?
It sure looks that way.
Let me explain …
When the U.S. Commerce Department on Friday said the U.S. economy contracted at a 1% annual pace in the second quarter, the report was actually seen as good news: It was a slower decline than in each of the two prior quarters, and economists had expected a contraction of 1.5%.
“This is good news,” Nariman Behravesh, an economist with IHS Global Insight Inc. , told The San Francisco Chronicle.
But here’s the wild card: Although government spending did increase during the April-to-June quarter, only about 7.7% – $60.4 billion – of U.S. President Barack Obama’s stimulus package had actually made its way into the U.S. economy by June 30, the quarter’s official conclusion. Of that total, the largest component went to U.S. states to help defray the jump in Medicaid costs, CNNMoney.com reported.
Much of the $43 billion in stimulus tax relief – including the “Making Work Pay” tax credit for individual workers – also took effect during the second quarter, CNNMoney said.
At this point, it’s really difficult to “see how the effect of stimulus has been very large,” Edward Lazear, an economics professor at Stanford’s Graduate School of Business – who served as an advisor to former U.S. President George W. Bush – told CNN. “Very little has gone out.”And that’s the problem.
In short, it looks like we’re already experiencing an economic rebound – without the Obama stimulus having really even kicked in … yet. In fact, the impatience over the continued U.S. malaise, the slowness of the economic turnaround and the fact that when growth does return we’re almost assured of a “jobless recovery” actually has some Washington legislators already pushing for a second stimulus.
That means the economy will be in rebound mode when nearly three-quarters of a trillion dollars in stimulus money starts to flow in. Dumping all that money into an already-growing economy won’t just serve as a simple tailwind that gives the economy a gentle push; it will be more like the head-snapping start followed by the thunderous charge down the quarter mile that we see from one of the supercharged Top Fuel Funny Cars driven by National Hot Rod Association (NHRA) star John Force. (From a standing start, Top Fuel Funny Cars cover a quarter mile in less than five seconds at speeds well in excess of 325 miles per hour).
And there’s only one outcome from that scenario – rampant inflation. In fact, U.S. consumers are probably headed for the worst bout of inflation since the 1980s. And that makes the so-called “exit strategy” of U.S. Federal Reserve Chairman Ben S. Bernanke all the more important.To be sure, the Obama stimulus has given the economy a bit of a boost. So far:
The states have deployed what stimulus money they have received, which helped fuel the biggest surge in state and local spending since 2007.
Some early pieces of the stimulus – such as the $25 increase in unemployment benefits – have allowed consumers to spend more.
And one economist – Economic Policy Institute’s Josh Bivens – said Obama stimulus money may have boosted growth by as much as three percentage points during the second quarter.
But other economists say that – given the environment – the second-quarter GDP numbers were much too strong. After all, business spending dropped 8.9% and hours worked fell 7%. Somehow that doesn’t translate into a mere 1% drop in GDP. That latter figure will most certainly be revised downward in the future.
Unless or until that happens, look for the third quarter GDP statistics to give us a better picture of the U.S. economy’s health. Complaints that the promised stimulus money isn’t getting where it needs to be have Obama’s economic team working overtime to iron out the problems that keep cropping up.
Mark Thoma, an economics professor at the University of Oregon, told CNNMoney that “the third quarter will be a critical time period for assessing the stimulus package.”
And for assessing the inflation threat – which Sound Of Cannons has repeatedly warned is a very real threat. Gold, commodities, and other hard assets will be key holdings. The same is true for dividend-paying stocks. And make sure to go global – the best growth prospects will continue to be overseas.

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