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Monday July 7, 2008 - 00:17:06 GMT
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|Ben Bernanke warns the market about inflation and a
weak dollar but forgoes a rate hike. Jean Claude Trichet raises rates but drops
verbal intervention. Six months is an age in the currency markets and the euro
is trading square in the middle of the 1.5400/1.5900 range that has dominated
since early March. Neither central bank has been able to affect the euro/dollar
rate for almost half a year and for one very good reason: the trading rate of
each currency against the other is a distant third in the responsibilities and
concerns of the European Central Bank and the American Federal
Two parallel quotations from a month apart: Ben Bernanke on June
3rd, â€śFor now policy seems well positioned to promote moderate growth and price
stability over timeâ€ť; Jean Claude Trichet on July 3rd, â€śThe monetary policy
stance following todayâ€™s decision will contribute to achieving our objectiveâ€ť.
Both central bankers are trapped between their primary responsibility,
for the ECB inflation, for the Fed economic growth and jobs, and their secondary
mandates, GDP growth for the ECB and inflation for the Fed. Each has been true
to their primary responsibility while hoping for the best with the second. And
both central bankers have kept their word for transparency by keeping the
markets apprised of their changing policies and largely free from rate shocks.
Neither bank provided any drama with their most recent policy pronouncements.
Only developments in the American and Eurozone economies can release
Jean Claude Trichet and Ben Bernanke from their respective traps. American
statistics have been slowly turning south for six months. Non Farm Payrolls
registered its sixth consecutive negative result and US payrolls have now lost
almost 400,000 jobs since January. The Fed has already prescribed and
administered its economic medicine, 325 basis points of rate reductions in the
past ten months. There is a limited amount that the Fed can do to provide more
Eurozone inflation has more than doubled in a year. The ECB
raised rates 0.25% but such a hike cannot squeeze inflation out of the European
Monetary Union (EMU) economy. At best it is a warning to unions negotiating for
wage increases. The ECB cannot prevent inflation with rate hikes; it can only
retard the development of the feared wage - price spiral. It is essentially
anti-inflation rhetoric by other means. Further rate hikes could quite easily
push the EMU economy into recession. But even a recession might not prevent
inflation in Europe.
It is not an overheated economic cycle at the end
of its run in either the United States or the EMU that is driving inflation.
The US has been slowing for three quarters; inflation is rising. The
Eurozone countries have had moderate growth in the same period, growth that is
nowhere near the level that would double the inflation rate in a little over one
The current inflation in the US and the EMU stems from a level of
worldwide demand for raw materials and commodities fostered by basic
infrastructure expansion on a scale not seen since the reconstruction of Europe
after the Second World War. Higher rates in the EMU and the US will have limited
effect on domestic inflation since its origin is in a worldwide phenomenon.
Demand destruction worldwide is the real key to inflation in the US and the EMU.
If the US and EMU enters recession, China and India , for example, will follow
to lower growth, but probably not recession - their internally based expansion
is strong enough to prevent a recession - and that will finally diminish
inflation in the developed world.
Resource demand will slacken with a
developed world recession but commodities will not return to price levels of a
decade ago. Oil will not return to $50 a barrel until substantial new sources
are developed, likewise for industrial commodities and food. The world must make
a new leap in production for prices to fall. The consumer lifestyle of the
developed world, resource intensive and profligate, is spreading around the
globe. That lifestyle, more than the rate policy of central banks, is
determining growth, recession and inflation. There is no alternative to higher
demand and higher prices except greater supply.
Neither the ECB nor the
Fed is in full control of their economies. The world has changed. More than ever
before domestic economies are propelled by the global market. Even the strongest
central bank is now but one factor in the global economy. The shrunken domain of
the worldâ€™s central bankers is clearly demonstrated by the current inflation and
growth crisis in the developed world.
FX Solutions, LLC
Chief Market Analyst
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