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www.ambiente.us  MAY / MAYO 2008

Stagflation
by Carlos T. Mock, M.D.

I have been saying since February 17th 2007 that the US
economy is heading for a hard landing, possibly a recession
while Mr. Bernanke and President Bush were insisting that
we had a “strong economy” I predicted that concerns over
risky US mortgage lending were a key indicator of credit
problems hovered at record levels, after many mortgage
lenders failed and a big homebuilders admitted that borrowers'
difficulties could damage their businesses.  

I also predicted that investor worries over loans made to US
borrowers with weak credit histories would grow over the
year. I predicted that the American consumer would take all
the equity from their homes to buy luxuries they could now
afford with easy credit. I even predicted the housing bubble
and the subsequent subprime crisis.

That was then, this is now: Wolfgang Munchau from the Financial Times says that “ “The bottom line is that this year marks the
start of an asymmetric global economic downturn that is likely to persist for some time and will probably be quite unpleasant,
but which will be well short of catastrophic.”  I politely disagree.

Despite his sugarcoating our economy earlier, Ben Bernanke has finally conceded that the nation could wallow in a recession
for much of the year.  Facing hostile grilling at times yesterday by members of Congress who were seeking easier answers, the
Federal Reserve chairman deftly kept tossing the hot potato back into their laps.  I raise the ante and suggest that we are
beyond recession and going straight to stagflation.

Yes, Stagflation. Stagflation is a combination of the words stagnation and inflation, and is a term in general use within
modern macroeconomics to describe a period of out-of-control price inflation combined with slow-to-no output growth, rising
unemployment, and eventually recession. The term stagflation is generally attributed to United Kingdom Chancellor of the
Exchequer, Iain MacLeod in a speech to parliament in 1965. "Stag" is drawn from the first syllable of "stagnation", a reference
to a sluggish economy, while "flation" is drawn from the second and third syllables of "inflation”—a reference to an upward
spiral in consumer prices.

Stagflation becomes a dilemma for monetary policy when policies usually used to increase economic growth will further
increase runaway inflation while policies used to fight inflation will further the decline of an already-declining economy. For
example, the Central Banks of the world have been printing money to the tune of billions of dollars to ease the credit crunch
of local banks—a move that causes inflation in itself—to try to prevent lowering the lending rates. Unfortunately today’s weak
jobs data, the weak dollar, the trade and budgetary deficits, and the subprime crisis are so out of control that now we expect
the Fed will cut the interest rate again—in you are of the belief that interest rates will be predicted by the two year treasury bill
which is now yielding 1.75%.   Usually, this is an important monetary mechanism to increase economic growth because it
reduces the cost for consumers to buy products on credit and businesses to borrow to expand production. While this can
increase economic activity, it can also result in increased inflation.

Stagflation will become a problem because lowering the interest rates will cause more marginal harm than marginal good,
when used. The central bank’s power to either stimulate the economy or attempt to rein it in through the mechanism of
adjusting the domestic interest rate has become ineffective. Americans are Cash-strapped consumers. Americans bought fewer
gifts while paying more for necessities. From Thanksgiving to Christmas, spending rose only 3.6 percent over the same period
last year, the weakest performance in at least four years, according to early tallies from MasterCard Advisors, a unit of the
credit card company. One-third of that increase was for gas purchases. U.S. food prices have risen this year at more than twice
the rate of 2006, and at a pace not seen since 1990. The outlook isn't any better. Many economists say in 2008 the estimated
price increase of about 5 percent could be part of a trend that threatens to ratchet up food costs for years. U.S. personal
bankruptcy filings jumped 40 percent in 2007 because of rising mortgage payments, job losses, and other financial pressures.

Regarding the housing market crisis, mortgage rates are on the way up in spite of the fed cuts.  This is because the credit
crunch has banks afraid of lending and only Fanny May and Freddy Mac are writing loans.

The bailout of Bear Sterns underlines the degree of damage done to the economy.  We are using bailouts not seen since the
great depression.  

A choice can be implemented that tends to improve growth, but does it ignite systemic inflation? A choice can be
implemented that tends to fight inflation, but how badly does it impinge growth? I predict that we’ll see stagflation in 2008. In
modern times, it will be only after the central bank has used all possible tools to meet both goals, using the best quantitative
measures it has at its disposal, for stagflation to occur. Major economic conditions of unusual proportion have already created
near-crises on both fronts. Stagflation will occur because the central bank has rendered itself powerless to fix either inflation or
stagnation.

Carlos T. Mock, MD
773-561-6617
Uptown Chicago
Www.carlostmock.com
Author: Borrowing Time: A Latino Sexual Odyssey - Floricanto Press 2003.
Nominated for a Stonewall Award by the American Library Association GLBT
Round Table.
Author: The Mosaic Virus – Floricanto Press 2007.  Nominated for a Stonewall Award by the American Library Association
GLBT Round Table, and a Lammie from The Lambda Literary Foundation
Author: Author: Papi Chulo – Floricanto Press 2007.  Nominated for a Stonewall Award by the American Library Association
GLBT Round Table, and a Lammie from The Lambda Literary Foundation




OPEC Nations are again discussing which currency should be used to pay for petroleum.  The disagreement was revealed
when a ministerial meeting last November, supposed to be in closed session, was accidentally broadcasted live to reporters.

The Iranian and Venezuelan ministers called for measures that are more radical and a specific mention of the effect of the
dollar to be added to the draft declaration: specifically to change the OPEC currency from the dollar to the Euro.  This is very
significant because petroleum based on the dollar has been the “flywheel” of our economy, keeping it steadily moving through
the world economy’s ups and downs.

But Saud Al-Faisal, the Saudi foreign affairs minister, warned the meeting: “The mere mention that OPEC is studying the issue
of the dollar is going to have an impact.”  He said a reference to the US currency in the declaration could cause the dollar to
“collapse”.

As the dollar continues its relentless six-year slide against the euro and other main currencies, the question is being asked
more and more: what would it mean if the dollar ceded its global dominance to the euro?

Now turn the clock backwards to 2001. After 9/11 and the collapse of the US economy, Iraq, Iran, and Venezuela ministers
wanted to change the OPEC’s currency from the dollar to the euro.  An intelligence report came to the US administration that
the Saudi minister was leaning towards the idea.

The main rationale for the Iraq Invasion and Occupation offered by U.S. President George W. Bush, former Prime Minister of
the United Kingdom Tony Blair, former Prime Minister of Spain José María Aznar and their domestic and foreign supporters,
was the allegation that Iraq possessed and was actively developing weapons of mass destruction (WMD). Leaders and
diplomats from countries on the U.N. Security Council that opposed the war made statements that contested this view.  These
weapons, it was argued, posed a threat to the United States, its allies and interests.  In the 2003 State of the Union Address,
Bush claimed that the U.S. could not wait until the threat from Iraqi leader Saddam Hussein became imminent.  In January
2005, the Iraq Survey Group concluded that Iraq had ended its WMD programs in 1991 and had no WMD at the time of the
invasion; although some misplaced or abandoned remnants of pre-1991 production were found, US Government spokespeople
confirmed that these were not the weapons for which the US "went to war".  The weapons for which the US and coalition
partners invaded have not been found. Some U.S. officials cited claims of a connection between Saddam Hussein and al-
Qaeda. No evidence of any operational or collaborative relationship with al-Qaeda has been found.

But all this was fine with President Bush.  The USA had delivered Saudi Arabia “a clear picture” of what could happen in they
abandoned the US Dollar for the Euro currency.  Even Iran, who in 11 years could not destroy the Iraqi army, was suddenly
mum on the dollar issue.

The dollar vs. Euro question is today a serious one because the US Federal Reserve has been pumping new dollars into the
global economy at an astounding pace.  A broad measure of US money supply growth was increasing at a rate not seen since
1971 when President Richard Nixon imposed price controls and ended the dollar’s convertibility into gold, which recently
roared above $1,000 an ounce.  The result is consumer prices having recently climbed 4 per cent from a year ago, and
wholesale prices having soared 6.9 per cent.  All of this leads to higher consumer price inflation around the corner. We are
living witnesses to Milton Friedman’s famous dictum that “inflation is always and everywhere a monetary phenomenon, in the
sense that it cannot occur without a more rapid increase in the quantity of money than in output”.

The Fed is acting with the best of intentions to head off a recession.  But in a rapidly globalizing financial marketplace, it is in
fact accelerating the demise of its own unique powers.  Virtually all national economies show a positive link between currency
depreciation and inflation and between depreciation and interest rates, meaning that their central banks cannot use loose
monetary policy to stimulate their economies – it only fuels capital outflows and a rise in market interest rates to attract it
back.  Not so the US, whose currency has commanded a unique premium as the global store of value and the transaction
vehicle for international trade. But this may be changing. The dollar is looking increasingly like a typical developing country’s
currency, with long-term market interest rates, crucial to determining borrowing and investment behavior, climbing as the Fed
pushes hard in the other direction—Stagflation.

If international use of the euro were to continue to rise, the Fed would lose other important powers.  In a financial crisis,
central banks are supposed to act as “lenders of last resort”, printing money to prop up banks and reassure their depositors.  This
does not work in developing countries.  People withdraw money anyway.  Their fear is not that the government will let the
banks collapse but rather that printing money brings inflation and depreciation.  So, they exchange their currency for “hard
currency”, undermining the putative powers of their central banks.  

But what if Americans were to do the same, selling dollars for euros in a crisis? The Fed would become impotent. This is not
science fiction. American investors have lately been pouring money into foreign bond funds at a record rate.

What about America’s political power in the world?  A continuing fall in the dollar means a fall in the global purchasing power
of all its foreign assistance, whether for humanitarian, economic, or military purposes.

But it means much more than that. The US has exploited the unique role of the dollar in international trade and investment to
disrupt the financial flows of its adversaries, such as North Korea and Iran.  If such transactions switched to euros and were
funneled through institutions not doing business in the US, this power would be neutered.  The US would likewise lose
influence over both friends and enemies facing financial problems, as they would be looking increasingly to Europe for euros,
rather than to America for dollars.

The irony of this is that the current administration has not learned from the Iraq fiasco: invading a country does not protect
your currency.  Fast forward to 2008 and now there’s talk of invading Iran.  You will hear threats of nuclear proliferation being
mentioned by the current President Bush.  But in the end, it is always about money.  Iran would be the next easiest target to
again influence “our friends” the Saudi's to “stay the course of the dollar.”