Friday, December 14, 2007


Nancy Pelosi has declared victory! The house got what they wanted, an increase in CAFE standards and an increase in the mandated use of bio fuels. I may have missed the declaration of victory by the Bush administration. The administration got what it wanted, the elimination of tax increases and the elimination of forced alternatives to the power companies. This is the nature of politics. The special interest won subsidies and campaign contributions while the worst of the provisions were scaled back. Forty one votes in the Senate held off the most onerous of the prior bills provisions.

The CAFE standards will force a reduction in the use of gasoline. The CAFE standards are not the solution to the problem but they will serve as a band aid until the solutions are put in place. Since the CAFE standards will slow the bleeding, they will remove some of the pressure to find the final solution. Still the reduction in demand will be real and fuel prices will decline just in time for the election.


The big inflation numbers hit the level reached in 1995. As you know, the last mid cycle turn happened to hit in the middle of the 1990's. Since inflation is a lagging indicator, it is no surprise that the inflation numbers are high at this mid cycle turn. Airline fares were among the the big increases last month. Fares increased by 2.6%. No, they will not go up by 2.6% every month of the year but monthly increases compound prior increases. If fares were to continue to rise at the current rate, the annual rate the simple average rate would be 31.2% . No, I do not believe the rate one year from now will be more than 7 or 10% higher than today's fares but whatever the increase, much of the new money will flow to the bottom line.


Bernanke has taken a lot of grief for moving too slow, but, as noted before, monetary policy is sometimes used to influence fiscal policy. This is one of those dirty little secrets that no one in power has any reason to admit. The game of power politics is played by both sides. The fact remains that the second half of the business cycle requires the FOMC to play a tough game of defense to fight off inflation. The second half, when unemployment remains low and when most productive capacity is in use, the pressure on prices will remain. The good news today is that there is one more reason for the FOMC to "let up". The deal on the energy bill has been made. The power play is almost over. The congress also passed a one week continuing resolution after a budget deal was reached. Bush will get something like 50 to 70 billion to fund the war and the democrats will be allowed to spend about 7 Billion as "emergency spending". This means they will break pay go rules twice, once to pass the AMT and once to spend 7 Billion on pet projects.