Monday, December 7, 2009

The World is Headed Towards Stagflation Because a Weak Currency is/will be the Goal of Every Central Bank

Author: Andy Xie (ex-Morgan Stanley Chief Economist for Asia Pacific) in Caijing
The Australian central bank just raised its policy rate by 25 bps (0.25%), the first major central bank to do so since one year ago when the crisis caused all the major economies to cut interest rates to historical lows. Financial markets have been chattering about the end of the stimulus for the past month now and the consensus is that the central banks will keep rates extremely low through 2010 and possibly beyond.
Central banks, on their side, have been delivering the message that they know how to exit, will exit before inflation becomes a problem, and that they don't see the need to exit anytime soon.They are trying to assure bond investors that they don't have to worry a lot about their holdings despite low bond yields, while stock investors are told that they don't need to worry about high stock prices as liquidity should remain strong for the foreseeable future. So far the central banks have made both parties happy, but Australia's action is likely to cause some concerns among financial investors.
Different economies will exit at their own pace according to local conditions. The US and the UK will keep real interest rates as low as possible in order to support their financial institutions. They don't want to stop inflation, but rather to slow it. The Fed will raise interest rates by 100 bps in 2010, 150 bps in 2011, and 200 bps in 2012.The US could be stuck with a 4-5% inflation rate by 2012 and for many years beyond.
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