Tuesday, May 10, 2005


I continue to read or hear the word stagflation. We are so far from stagflation that it is pathetic. If the FOMC were raising rates dramatically and neither inflation nor the economy were slowing then I could see danger of stagflation. The reality is that the fed has been raising rates at a very modest pace and the manufacturing economy has been effected. Commodity prices have stopped climbing and are going down, durable goods orders have slowed, other inflation indicators are rolling over and corporate profits are soaring.

During a period of stagflation, corporations have a difficult time making any money. Their costs climb fast and they have no power to raise produced goods as fast as costs rise. In the current environment, profits rose 14% during the first quarter and appear to be ready to accelerate in the second!

Ironically, when the third of the three components to inflation (raw materials, labor and capital) goes up, inflation goes up but the increase in interest rates happens as a way to lower the inflation of materials and labor. We just had a small bubble in the price of steel, copper and other materials. The rise in rates and indeed the rise in the cost of these materials have slowed the worlds economy a bit. Labor inflation is tame and the inflation of interest rates while non-existent on the long end is almost over on the short end.

There is no stagflation. Our economic growth had simply gotten a little too strong and corrective action was taken. The corrective action has almost run its course. Greenspan may raise short rates one or two more times but companies continue to make profits, the economy is still strong and indeed a significant portion of the economy (the housing market) is still extremely strong.

Buy stocks, they do well during periods of moderate inflation.