A dose of reality October 1, 2006 The Fed has a tough job ahead of it. As you can see in the table below, year-on-year increases in prices picked up significantly during the second quarter. The Fed's policy is one of price stability, so it does not like it when prices increase.
| Percentage change from a year ago | First quarter | Second quarter |
| Personal consumption price index | 2.00% | 4.00% |
| Gross domestic purchases price index | 2.70% | 4.00% |
Inflation is typically treated by raising interest rates. The problem is that the US economy is slowing down so rapidly, and is so weak, that raising interest rates right now could catapult it into a severe recession, or even a depression. Compare the year-on-year changes in economic data below for the first and second quarters of this year.
| Percentage change from a year ago | First quarter | Second quarter |
| GDP | 5.60% | 2.60% |
| Final sales of domestic products | 5.60% | 2.10% |
| Durable goods purchases | 19.80% | -0.10% |
| Consumer spending | 4.80% | 2.60% |
| Business spending | 13.70% | 4.40% |
| US imports | 9.10% | 1.40% |
| US exports | 14.00% | 6.20% |
| Federal Government spending | 8.80% | -4.50% |
| Corporate profits | 14.80% | 0.30% |
| Residential fixed investment (incl. housing) | -0.30% | -11.10% |
Posturing and politicking ahead of the next US election has already started and I bet there is tremendous pressure on the Fed to make sure that price inflation does not get out of hand nor to let the economy falter.
There isn't all that much Ben Bernanke can do. To prevent prices from rising he'll have to sacrifice economic growth and to save the economy from collapsing he'll have to risk a dramatic increase in price inflation. When faced with such a choice it is easy to see why the Fed left interest rates unchanged during the past two Federal Open Market Committee meetings. Essentially the Fed is doing nothing, and probably hoping that something will happen to make things better. That, however, is unlikely.
The most likely outcome is that consumer confidence continues to erode amid a slowdown in the residential real estate market. 70% of the economic activity in the United States comes directly from consumer spending, which means that even a small decline in consumer spending can have a dramatic effect on US economic growth.
Second quarter GDP growth was 2.6%, so anything more than a 3.7% decline in consumer spending has the potential to tip the US economy into a recession and, if it persists, a depression.
Got gold?
Paul van Eeden
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