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Economic Review

9/14/2009

IS there a problem with the re-flation trade?? Of course there is and it’s not just potential inflation.

Over the past month or so, we raised the awareness on the potential of a re-flation strategy to help re-ignite the US economy.  An inflation of asset prices could imply higher Stocks and higher real estate prices, both of which could stimulate our beleaguered state of affairs.  However, as simple as this idea may be, the downside of some of the factors needed to support this tactic are dire.

Initially, the no-brainer factor to consider is that with a falling US currency and a just about zero interest rate policy, with ongoing injections of liquidity into the system, the most dangerous fallout from re-flation is a significant increase in inflation. This would be particularly detrimental to our situation given the high level of unemployment and ultra stagnant wage growth for those that have jobs.  Believe it or not, this is not the greatest danger.  The true danger lies in substantial deprecations in the US currency.

The Greenback is not far from historic lows via the EURO and recent market moves have been a weakening of the US currency.  If this continues to transpire, potential fallout could be lack of international investment in US financial assets, where market ramifications could involve higher US interest rates, lower stock prices and yes, inflation on goods and services imported from abroad, to name a few.

The strategy of re-flation could be seen as a short term fix (although the Doc doesn’t like any part of it) but the long term fallout or even medium term could be a mess.

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