Thursday, December 27, 2007

Depression, Recession, Stagflation, Hyperinflation, Life as usual

We are living in an interesting time. Depending on who you read, you can conclude that the US economy is going to experience

  1. Depression
  2. Recession
  3. Soft landing. i.e cooling of the current growth. with no major problems. Life would be as usual
  4. Stagflation
  5. Hyperinflation
The proponents of each of these scenarios have convincing arguments. Surely some one is right and the rest are all wrong.

Here is my take on what will happen.
The Fed seems more comfortable fighting inflation than deflation. So they would rather err on the side of inflation. So scenario 4 or 5 is more likely. Ideally they would like to pull off a scenario 3, but given the extent of the losses in the banking and the shadow banking system, the over stretched consumer debt, the tottering real estate sector and very high trade deficit, Scenario 3 seems more of a hope. The Fed is more likely to let the dollar depreciate further ( By increasing money supply to ward of any deflation and cutting rates to stimulate growth ) . The resulting high inflation will probably need a Volcker like response down the line, but that would be a battle for another day.

Occurrence of Scenario 4 or 5 is going to depend on how much confidence the rest of the world has on the US dollar( A rapid fall of the US dollar can trigger hyperinflation), the extent to which the foreign holders of US dollars/ exporters to the US can break away from the impact of the fall of the US dollar, and how quickly the US economy will get back on its feet & start producing goods & services needed by the rest of the world.

What does this mean for an investor in India ? I do not know. Just make sure you only have that much money in the stock market that you can afford to lose.

2 comments:

Anonymous said...

Well the dangerous thing is 2, 4 and 5 can lead to scenario one, which may sound odd because Hyperinflation and depression are opposites in many ways, however as we saw in the 1920's Germany's hyperinflation, coupled with US market problems dragged the world into depression, its possible that in trying to fight hyperinflation/stagflation we will set the stage for a depression, as our debt keeps rising, see that's the thing, we are currently faced with an almost perfect storm of problems, the US has debt which is rising, and set to skyrocket over the next 10-15 years, the dollar is falling to record lows and oil is rising, in addition we have low private savings rate, large household debts, a failing housing market, a rise in unemployment. If our economy starts experiencing inflation/stagflation, just as other nations also end up in economic contractions, and stop supporting our rising debt we could be looking at a repeat.

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