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Thursday, October 28, 2010

ECRI Warns of High Inflation Nightmare From QE2

ECRI Warns The Fed's QE2 May Cause High Inflation Nightmare
The Economic Cycle Research Institute, ECRI - a New York-based independent forecasting group, says there will be no double dip recession and Fed's planned QE2, a second round of quantitative easing, could lead to unintended "worse nightmare" of high inflation. (More about ECRI)  
Earlier today, Lakshman Achuthan, ECRI's co-founder and chief operating officer. and Anirvan Banerji,ECRI's co-founder and chief research officer, wrote
  • "The much-feared double-dip recession is not going to happen."
  • "That is the message from leading business cycle indicators, which are unmistakably veering away from the recession track, following the patterns seen in post-World War II slowdowns that didn't lead to recession."
  • After completing an exhaustive review of key drivers of the business cycle, ranging from credit to inventories and measures of labor market conditions, we can forecast with confidence that the economy will avoid a double dip.
But ECRI warned there is bad news for growth and jobs
  • But the bad news is that a revival in economic growth is not yet in sight
  • The slowing of economic growth that began in mid-2010 will continue through early 2011. 
  • Thus, private sector job growth, which is already easing, will slow further, keeping the double-dip debate alive. 
Even worse, the Fed could be behind the curve yet again with QE2 leading to unintended inflation down the road.
  • The problem with QE2. The worse news is that, even without the nightmare of a new recession, an uglier scenario may still lie ahead in the form of unintended consequences of such Fed stimulus.
ECRI warns that the Fed, using its rear-view mirror indicators, may be goosing the economy with an inflationary stimulus program when it isn't needed and worse, just before the economy could get better.
  • Because monetary policy acts with "long and variable lags," the Fed should, in principle, rely on forward-looking measures to time its actions. Yet, in practice, it does pretty much the opposite, relying on backward-looking statistics like core inflation and hard-to-assess measures of the so-called output gap, including estimates of "full employment."
  • In mid-2003, the last time "core" inflation was this low, the Fed cut rates to just 1% and kept it there for a year, contributing in no small measure to the inflation of the housing bubble that ended so disastrously.
  • In fact, the Fed is about to launch QE2 because it believes inflation to be too low, which really means they are willing to go to new extremes to head off the risk of deflation.  Yet, over the last two centuries the U.S. economy has seen sustained deflation only when it has mostly been in recession -- a scenario that our analysis rules out for now.
If the Fed goes ahead with its planned QE2 program, then the question for us investors will be "where is the next bubble forming?"
  • Today, the car that is the U.S. economy is crawling uphill, slowing as its engine sputters. With politicians fighting about whether to use a screwdriver or a spanner wrench to fix the motor, the Fed is convinced we'll end up using neither. Determined not to let the car start rolling back disastrously downhill, yet unaware that the road is about to level off, the Fed is strapping an untested rocket onto the car in hopes of blasting it over the top.
  • The Fed, looking out the rear-view mirror to steer the car, won't know when we're approaching a bend in the road, though we're now high up in the mountains, with a dangerous abyss below.
If the Fed goes ahead with its planned QE2 program, then the question for us investors will likely be "where is the next bubble forming?"  The very high returns for my individual TIPS and TIPS funds (FINPX Charts and VIPSX Charts)  these past two years plus the large gains in gold (Gold Charts and Quote) and commodities, despite low CPI inflation, might be signaling what lies ahead.


  1. The US economy has avoided any threat of reverting back into recession even though growth won't be robust, economist Lackshman Achuthan told CNBC.

    Achuthan, managing director of the Economic Cycle Research Institute, said the economy likely would move into a "soft landing" phase but would not see the dreaded double-dip scenario.

    "Being very definitive on this, we're not going to go into a new recession anytime soon," he said. "That has a lot of implications when you can rule out a certain nightmare scenario."

    Numerous leading economic indicators, including credit, inventories, employment and housing have convinced experts at the ECRI that the economy is safe.

    "What we're looking at is the collective pattern in the wake of recessions," Achuthan said. "You have a little bit of a spurt into recovery, then it throttles back and at that point you come to a fork in the road, and you either go into a new recession...or you veer away into the soft landing track. We've done the latter."

    Ahead of next week's Federal Reserve meeting, Achuthan warned about possible "unintended consequences" from the central bank's expected move to announce another round of asset purchases intended to stimulate the economy—also known as quantitative easing, or QE.

    He said the Fed needs an exit strategy for how it will begin normalizing monetary policy after an aggressive sequence of money-printing moves

    "That's the real risk here, not so much that the QE2 itself is going to make craziness happen, but they won't be able to dial it back at the right time," he said.

  2. While generally supportive of the fed action during the recent crisis and don't see the case for QE2. The economy appears to be recovering, slowly, on it's own and the money from QE1 is simply sitting their one bank balance sheets. The problem is the willingness of banks to lend not their access to cash nor interest rates.

    Then of course we have the long term problem of an exit strategy. Will we exit in a way that allows us to avoid inflation ?

    Inflation is like cancer. It's much better to avoid it in the first place then take the attitude of I'll deal with it after I have it.


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