Stagflation Ahead

One interesting aspect of the economic turmoil is that as a matter of fact, monetary conditions aren't really tight. As I recently reported, euro area monetary growth in July reached an all-time high during the existence of the euro, yet the ECB cancelled the previously signaled rate hike. Meanwhile, the most recent numbers on bank lending and money supply growth in America surprisingly indicate that not only did they decline in August, they accelerated somewhat. M2 and commercial bank lending have increased 1.5% (annual rate of 20%), and MZM by 3% (annual rate of 40%) during the latest four weeks.Despite this, the Fed is likely to cut interest rates by 25 or perhaps even 50 basis points on September 18th.

It remains doubtful given the loss of confidence whether this can actually prevent -or more accurately postpone- the coming U.S. recession. But one thing is for certain, there is not going to be a deflationary recession like some believe. It will be a case of stagflation. This in turn is going to limit the Fed's rate cuts.

Already responding to this inflationary environment is gold, which reached new highs on friday. Gold -and gold producer's stocks- is a particularly attractive investment during stagflation. Like other commodities it is a inflation hedge. But unlike most others, particularly industrial metals, it is also relatively insensitive to cyclical
downturns.