Economic Outlook

Federal Reserve Chairman Ben Bernanke addressed the economic outlook this morning. While the maestro seems to have orchestrated a masterpiece, what if he has underestimated the inflation lion...

America's economic captain addressed the International Monetary Conference today. Bernanke focused his speech on the causes and effects of recent economic strife, including the drivers of the housing bust, commodity price rise and credit and financial market unraveling. He then looked forward, and offered the Federal Reserve's forecast and expectations for the year and years ahead.

By now, you pretty well understand the causes of our economic condition. It's time to look ahead, and begin to seriously consider the potential economic fishtail that lay before us. Many economists, and our own econometrics genius Steven Ferguson, have outlined these risks we face now due in large part to Fed monetary policy (please take a look at his work through the link offered).

Putting it bluntly, the Federal Reserve's actions, specifically flooding the system with cash, has devalued the dollar. While this has had favorable impact to the economy, especially by supporting U.S. exports, it at the same time is playing a role in raising domestic inflation.

The Oil Peg

Oil, as you know, is priced via dollars, so when the dollar weakens, the dollar cost of oil rises. For this reason, naive economist wannabes like Mahmoud Ahmadinejad, want to peg crude prices to the euro. What Mahmoud doesn't get is that the real cost of oil does not change for anyone outside of America (or those unfortunately dollar pegged) because of change in currency metric. The other factor driving rising energy prices, demand supply imbalance, cannot be addressed by changing pricing metric. However, someone should write a book addressing Ahmadinejad's confusion on just about every topic ranging from the understanding of his own religion to economics to world history.

In any event, oil, gasoline and basic energy are more expensive for Americans in both nominal and real terms; but America is also the worlds greatest consumer of goods and services. So, if Americans are stressed by so many factors (not just gasoline prices), the global economy feels some repercussion. Besides this, there is global demand destruction caused by price rise. Bernanke is banking on global economic slowing to help ease global demand for commodities while he attempts to resurrect the American economy. If that does not happen, however, prices and interest rates will not favor American economic recovery.

Overall Inflation Threat

It's overall price rise that is the threat. Emerging market growth has stressed our limited resources, driving up the price of goods ranging from copper to corn. Bernanke is unfazed though, while at the same time keeping a close eye on inflation. He is confident that prices will generally moderate due to domestic economic softness, and his expectations for global economic growth slowing. While Bernanke believes inflation will moderate as a natural consequence of market processes, we have to ask, what if he is wrong...? Many global strategists point to the decoupling of economies from the United States, and the decreasing significance of it. The one word answer is, DISASTER!

We are Two-Faced!

We offered kudos to Bernanke here this past weekend (kind of), with our article, "Maestro Bernanke." His actions, and other aggressive government moves have thus far mitigated some of the market's troubles, which by the way, we here at "The Greek" blame the government for in the first place. Really though, it's human nature that is to blame. See today's article, "It's Fun to Blame the Government."

Despite today's criticism, "The Greek" believes we can attribute our economic survival to date to Bernanke, Paulson, Congress and President Bush, and their aggressive actions in the face of one of the toughest economic situations of our generation. The unraveling of housing and lending markets and systems threatened to send us into depression if no action were taken. The economic stimulus, Fed rate cuts and other liquidity supporting actions, not to mention financial system saving corporate bailout, have no doubt helped significantly. We may now avoid recession, IF inflation follows the path Bernanke believes it will.

Dollar by Design?

The weakening dollar may not have resulted by complete coincidence, despite Paulson's reassurance of a strong dollar policy. The soft dollar has saved American multinationals, and kept the American workforce relatively well-employed. I know Michigan will find that hard to believe, and I feel for you. In any event, without foreign demand for price competitive American goods, a result of dollar weakness, we can say with confidence that recession would have already overwhelmed us. Also, there are other benefits.

The weak dollar discourages Americans from traveling overseas and spending money in support of foreign economies, at the cost of ours. Instead, Americans are taking holiday at the local beach, lake, mountain and amusement park. Or, we're sad to say, at Wal-Mart (NYSE: WMT), as we buy those little pathetic plastic swimming pools most of us can barely fit our cheeseburger reared buttocks into. At the same time, foreigners are encouraged to come spend their golden euros at Disneyworld (NYSE: DIS) and on 5th Avenue (NYSE: TIF). This is part of the reason we call Bernanke Maestro here. He's put together a masterpiece, perhaps by dollar design, IF inflation obeys.

Inflation Lion

Inflation, unfortunately, is like the lion tamer's wild cat. We can control it for as long as it agrees, but it has a mind of its own as well. The minute it loses composure, our hours of training becoming meaningless, and we suffer the swipe of the sharp lion's claw and the bite of the lion's jaw. Bernanke is playing with a lion, but he has no choice because government regulators slept while credit rating agencies got away with negligence and mortgage brokers committed crime.

Economic Outlook - "The Greek's" View

While it looks like the maestro might have kept recession at bay, and thanks partly to Hank Paulson's swift pushing of economic stimulus, we do not see a robust economic recovery in store. Inflation is a factor here, and despite some demand destruction, and the progress of conservation, alternative energy and other efforts toward universal resolution, we do not see the adjustments coming quickly enough. In the meantime, American industry raises prices, as evidenced by recent announcements from Dow Chemical (NYSE: DOW) and Kimberly-Clark (NYSE: KMB). So, we anticipate inflation limiting domestic recovery.

Iran Not Ignorable

We expect the economy will drift here through the rest of the year, and depending on how important Iran is to Israel; how important the loss of Bush is to Israel; how well-prepared for war Iran is after years of warning and an example in Iraq to learn from; and how much conviction Iran's allies have, and the composition of that group; we could yet see that depression.

Besides the clear direct risk of gorilla warfare (also known as terrorism) on the streets of America, Saudi Arabia, Iraq and Kuwait, and thus global energy supply are threatened as well. The Middle East is too important to the world to be neglected by it, and so the interests of China might be tested to their limit by the United States and Israel. And the opportunistic Russian leadership might react in a manner not anticipated as well. These complications and risks have thus far kept an event at bay, but the strategic oil reserve is full, Israel is well-armed and a maniac holds the presidency of Iran as it develops nuclear weapons. Pure logic tells you what comes next, and this geopolitical factor cannot be and is not ignored by the market. We expect this is partly evident in the price of crude oil.

If Iran is not confronted yet, or if the confrontation is less complicated that I surmise it will be, Bernanke might be right that economic growth will improve in 2009. However, the issues of global resource demand/supply imbalance remain unresolved. We will require human creativity and technological innovation like never before. Alternative energy will soon be referred to as simply energy as a result.

We are a dynamic species, and we learn, adjust, develop and progress. If we analyze our future based on our present alone, and fail to discount human creativity and innovation, we underestimate our potential. We will find ways to survive and to progress, as long as we don't find reason to destroy each other.

Please see our disclosure at the Wall Street Greek website. Article interests AMEX: DIA, AMEX: SPY, AMEX: DOG, AMEX: SDS, AMEX: QLD, Nasdaq: QQQQ.