I think the interest rate goes up for the following reason:
Since 1980s, monetary inflation did not cause the statistical value of CPI to increase much (as assets are not included in CPI - however there was productivity enhancement due to labor usage from india/china which was causing prices to fall i.e we used goods from these countries which formed part of the CPI and kept it low to a great extent). Why would monetary deflation cause this statistical data to fall?
The hedonic adjustments etc are going to rise in reverse gear when the economy falls!!! i.e currently, everyone is going into house and hence rents are falling. The rental equivalent are used for CPI calculation. When the house price falls (i.e during recession), everyone who defaulted will be moving to rentals and the rentals appreciate (another reason being - currently all rental props are being sold as condos hence scarcity of rental properties). Hence the statistical data CPI will increase. This happened in 1982 when LA props fell and rents increased and this showed in CPI!! Obviously, this is the price one pays for hedonic adjustments. While getting addicted, it gives oomph. During withdrawal it "scorches" you dry!! It takes the extremes!!!
In a recession (both inflationary recession as in 1970s) and deflationary recessions (1930s) - there is only ONE thing in common - The higher order goods (like real estate, stocks, mining etc) falls in price MUCH more than lower order goods (like food etc.). In inflationary recession, the food etc increases much more than real estate etc. i.e real estate, raw materials can fall slightly (this happened in 1970s) but the lower order goods increased a lot. Why so? In all recessions - people will say this - before recession it costed me 50,000 lunches to buy a house (higher order good) and during recession, he would say, it only costs me 10,000 lunches to buy a house!! i.e recessions make sure lower order goods are preferred and higher order goods are not.
We can not call oil today as higher order goods. It has become essentially a lower order goods because people live so far away from everything, and everything they do needs oil. I strongly feel, the dollar will be falling (MUCH more than other currencies for variuos reasons) and I think oil price in dollar will maintain a high price. This will not allow the CPI statistical value to fall. CPI constitutes mainly lower order goods and MOST of these goods are currently imported (and hence the CPI is not increasing much today). But during recession, If it has to be substituted by local US economy, it will be inflationary - If not, the USD fall will make it inflationary to import.
Hence interest rates will go up to ease the price pain of lower order goods in a deflationary environment. Money stock will still fall significantly because higher order goods have taken such a huge percentage of today's economy. In 1929, lower order goods had quite a high percentage of GDP compared to higher order goods. Today it is relegated to a low percentage. So even if the lower order goods rise 100%, and higher order goods falls 20%, there will be decline in money stock (monetary deflation)!!!
Can you tell me why a farmer in US is going to produce food at a lower cost during recession? Because the dollar falls (which is a separate topic), the mexican workers will not take lesser salary in dollar terms. THe oil, fertilizer etc are not going to fall in USD (it might fall against yuan, yen etc). Hence food prices are going to remain same or increase!! Only way to increase dollar value is to increase interest rate...So that people - although they loose asset and job - they can atleast bear the inflation....
Mish, Russ - your opinions will be highly appreciated... |
