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Strategies & Market Trends : Mish's Global Economic Trend Analysis
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To: CalculatedRisk who wrote (15139)11/8/2004 3:12:04 PM
From: mishedlo  Read Replies (1) of 116555
 
You make a strong argument, but what happens if we have a currency crisis?

I would think the FED would raise interest rates to attract foreign investment. On the surface, that would be a double whammy to the US economy since we would have higher prices for imported goods AND higher interest rates for the domestic economy leading to a slowdown in interest rate sensitive businesses, and most likely leading to a serious recession.

But what if the FED responded by reducing interest rates and increasing the money supply in an attempt to keep the economy out of recession? Now you would have a downward spiral: a lower dollar leads to higher money supply leads to lower dollar, etc. That would be very inflationary.

Inflation vs. deflation depends on how the FED reacts going forward. My guess is the FED will choose the first option (raise rates). It also depends on how foreign CBs react.

I am pretty sure the FED wants a lower US$, just not a crashing one. But worse than a crashing US$ would be crashing bonds and US equities. That would happen on a sudden unexpected large move up in interest rates.

As for the downward interest rate spiral causing inflation, all I can say is that it did not casue inflation in Japan. There is no guatrantee it would here either.

IMO the FED's mission is clear. They intend to stay behind but not severly behind the interest rate curve. The problem for the FED is a huge one: What if they already overshot and things are too tight? Heinz believes we overshot already, and I think we are on the cusp. IMO it all depends on what happens to housing from here. One thing is certain however, there is not much demand for stuff in Japan, Europe, and the UK. The latter just starting now after 5 hikes. We have our 4th this week. Given the demand situation being what it is, and Europe and Japan both bitching about the strength of their currencies, how likely is it for everyone to stop buying treasuries. If nothing else, the FED itself would step in IMO.

Mish
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