Dollar, oil prices hint of inflation

Rising energy costs and the declining dollar pose trouble.

from the November 8, 2007 edition

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By his estimates, $30 to $40 of the current per-barrel price of oil should be understood as an adjustment to account for the falling dollar.

Mr. Darda views the US economy as strong enough to weather the housing downturn without falling into a recession. Thus, he says, the Fed's recent interest-rate cuts are a bad move that will come back to hurt America. When the Fed later has to raise rates to curb inflation, he says, that "could cause a recession."

Peter Schiff, president of Euro Pacific Capital in Darien, Conn., also pins blame on the Fed for being too focused on providing short-term relief - through lower interest rates – to troubled Wall Street banks.

Recently, powerhouses such as Citigroup and Merrill Lynch have announced big write-offs of bad investments tied to the housing market. A fear is that a continued fall in US home prices and a tightening of credit by banks could drive the economy into recession.

"Why else would the Federal Reserve be sitting back and watching the value of the dollar decline every day?" Mr. Schiff asks.

To Schiff, a recession would be the lesser among evils. He has written the book "Crash Proof: How to Profit From the Coming Economic Collapse," arguing that the economy needs to make a painful adjustment from credit-driven consumption toward more saving and production.

Most economists applaud recent Fed action as part of a needed effort to restore the normal flow of credit.

But the value of the dollar hints at the Fed's difficult situation. If it eases monetary policy too much, it could simply push more investors globally to buy higher-yielding (and perhaps less inflationary) currencies elsewhere.

On Wednesday, an official in China reiterated that nation's desire to diversify its large foreign-currency holdings more widely beyond the dollar.

At the same time, economists generally see recession as a genuine risk – one that the Fed generally hopes to avert.

General Motors Corp., one US bellwether, Wednesday reported a record quarterly loss – one of the worst in US history. Most of it related to one-time costs of a health insurance deal with the United Auto Workers union. But US car sales are also being hampered by the effects of the housing downturn, GM said.

"In our view, [spending by consumers] is on the precipice of experiencing its first recessionary phase since 1991," Merrill Lynch economist David Rosenberg writes in a recent analysis. As in 1991, he says, consumers face "the combination of punishingly high energy prices, weakening employment conditions, real estate deflation, and tightening credit conditions."

Yet Mr. Mayland, the economist in Cleveland, expects the overall economy to escape recession. To some degree, the recent moves in financial markets are driven by "momentum players" betting that current trends will continue, he says. The falling dollar is "a kind of payback for that period when the trade deficit was rising and we had the easy ride with the stronger dollar."

But if the dollar is now weighing on the US standard of living, other factors are working in the opposite way, Mayland says: "Today, productivity numbers came out and they came out much stronger," at a nearly 5 percent annualized pace.

That means that workers are adding more to the nation's gross domestic product with every hour they work. "That's something that raises our standard of living," Mayland says.

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