Thursday, June 12, 2008

Not the 70s

Many people are comparing the current economic environment to that of the stagflationary 70s. As I have pointed out in my commentaries and blog posts, this comparison is overwrought at best. Steve Chapman at Reason agrees:

Critics insist that the Fed has surrendered on inflation, pumping money out in a desperate attempt to prevent a full-fledged downturn. Exhibit A in the charge is the weakness of the dollar. Bernanke's detractors say he's let the greenback sink, which in turn has pushed up the price of oil and doomed us to the sort of inflation we haven't seen in a long time.

But the theory and the evidence find themselves at odds. The dollar has actually been stable over the last three months, both against the Euro and against other currencies. Three months ago, however, the price of oil was below $100, and lately, it's been above $130. A dollar that's not declining can't explain why oil prices are rising.

If the dollar were steadily losing value, another commodity should also be soaring in price—namely gold, the traditional haven for the inflation-wary. In fact, gold, which came within sight of $1,000 per ounce back in March, has been trading well below $900.

I pointed out the divergence between gold and oil in a post below. These divergences don't tend to last long and I suspect that this will be resolved by a fall in the price of oil, especially if the dollar continues it's recent action.

The US economy has proven very resilient in the face of signficant headwinds. This is typical of the economic slowdowns of the last 20 years and is very different than the 70s. I am not a fan of the Federal Reserve but they are doing a much better job than their 70s counterparts.

So far, the Fed has managed to keep inflation in check, and it's done so without strangling the economy. These may not be the days of wine and roses, but the 1970s never had it so good.

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