The Cloud Cuckoo Land Of Donald Kohn

Report after report are now confirming the arrival of what I've been predicting during the latest year, namely a recession in America combined with higher price inflation i.e. stagflation.

Stagflation is of course mainly the result of Fed policy. Fed policy have caused too much of productive resources to be devoted to malinvestments, particularly in the housing sector, which have caused a negative supply shock as more and more productive capacity is no longer demanded. Moreover, the gradual decline in the savings rate in America has also caused productive capacity to decline also creating negative supply effects. And last but not least, as the Fed again tries to revive the economy by more inflation it finds that this have only a limited effect on asset prices -which is to day, while it have probably limited the drop in house and stock prices,it haven't been able to induce them to actually rise, unlike the development in 2001 when they managed to get house prices to rise rapidly- and instead it have mainly had the effect of boosting commodity prices, which is now causing even the distorted government price indexes to accelerate in their rate of increase.

So how do Fed vice chairman Donald Kohn respond to this development? Well, in short by asserting the absurd. He asserts that the Fed, the institution that pushed America into recession and is now causing price inflation to surge will:

"do what is needed to help growth and keep consumer prices stable"

And just how will you do that, vice Chairman Kohn? I know how you created the opposite development that we are now seeing -see above-, but just what do you plan to do to promote sound growth? Do you plan on abolishing your institution, or at the very least stop inflating?

Similarly, he later dismiss the notion of stagflation by saying it won't happen because

"The situation in the 1970s was much more difficult than anything we are facing now.It was more difficult because in large measure there was a buildup of inflation over a long period, since the mid-'60s on,''

In retrospect, everybody who studied this period agrees that if this process had been cut off earlier it would have been a lot less painful than it was. That is a lesson that everybody on the Federal Open Market Committee understands."

As if Greenspan hadn't been building up inflation for a long time...
But what is clear given the current response of aggresive interest rate cuts in a period of stagflation is that the current FOMC certainly haven't learned the lesson to limit the damage at an early stage. Instead, while maybe reducing the severity of the downturn in the coming months it will certainly create an even greater and much more painful downturn later on.