"Can Mr. Greenspan postpone a “crash” in the stock market through higher inflation?
Mr. Greenspan and other members of the Fed have said in so many words and on so many occasions that they are determined to prevent inflation in the US from rising, that investors probably assume that a low rate of inflation is an act of God. However we should not forget that neither what constitutes a “low” rate of inflation nor what constitutes a “high” rate of inflation is not determined by economists but rather by politicians. Whenever it suits them right, politicians and central bankers, can claim that 5% is a “low” rate of inflation. No need to kill the stock market and sink the economy just to keep inflation at less than 3% p.a. So to the surprise of many, Mr. Greenspan and the Fed might “allow” inflation to rise and “suddenly” the new target of the Fed will be to maintain “price stability” by keeping inflation at less than 7% p.a. Be assured that the professors who work for the Administration and the IMF will find it quite easy to do a flip flop and explain why a “little” inflation is good for the economy.
Can the Fed postpone a “crash” in the stock market by sneaking in a new definition of “low” inflation?
It definitely can. However it might not be able to. Let me explain.
As we explained earlier the Fed’s “success” in “fine tuning” the economy and the financial markets in the US, was achieved by destabilizing incomes and wealth in other countries. If the Fed can no longer transfer real resources from savers and consumers in other countries to the benefit of US consumers, it might still be able to transfer real resources from some Americans to the benefit of other Americans.
An “unexpected” higher rate of inflation in the US will transfer real resources from investors in fixed rate dollar obligations (bonds, bank deposits, insurance schemes) and from employees on fixed wages to the benefit of asset owners such as shareholders and to the benefit of borrowers. But as this transfer of resources must be a zero sum game within the US, the gain of shareholders (net gain or the avoidance of a loss because of a crash in the stock market) must be financed by the losses of bondholders and wage earners.
If we assume that a crash in the stock market would wipe out thousands of billions of dollars in shareholders’ wealth, then in order to avoid these losses, bondholders and wage earners must lose similar amounts. It means that the “unexpected” inflation must be quite substantial as to erase so much of the value of fixed dollar obligations and wages. So much “unexpected” inflation might prove to be politically unacceptable, certainly so when bondholders and wage earners will try to preserve their assets and their incomes.
So the Fed might be able to postpone a “crash” in the stock market but only until the public realizes what are the costs of the Fed’s “fine tuning” of the stock market. Once investors realize that the Fed can not indefinitely postpone a crash in the stock market, they will proceed to sell shares while the Fed is still attempting to “fine tune” the market. Their actions will cause share prices to stagnate while bond prices continue to slide. Once they feel that the Fed is near the end of the rope as the public is made to pay for the “fine tuning” of the stock market, they will hasten to sell shares.
As we said earlier, such rational expectations might cause the stock market to crash just before the elections in November 2000 or soon thereafter. "
simplex.co.il
well his timing may be off, but not his reasoning: the man is good! |
