Monday, August 14, 2006

Signs of the Economic Apocalypse, 8-14-06

From Signs of the Times, 8-14-06:

Gold closed at 642.40 dollars an ounce on Friday, down 2.4% from $658.10 at the close of the previous Friday. The dollar closed at 0.7855 euros last week, up 1.2% from 0.7765 euros at the end of the previous week. That puts the euro at 1.2732 dollars compared to 1.2878 at the close of the Friday before. Gold in euros, then, would be 504.56, down 1.3% from 511.03 for the week. Oil closed at 74.30 dollars a barrel Friday, down 0.4% from $74.57 at the close of the previous Friday. Oil in euros would be 58.36 euros a barrel, up 0.8% from 57.90 for the week. The gold/oil ratio closed at 8.64 Friday, down 2.5% from 8.43 at the close of the previous week. In the U.S. stock market, the Dow closed at 11,088.03 Friday, down 1.4% from 11,240.35 at the close of the Friday before. The NASDAQ closed at 2,057.71 Friday, down 1.3% from 2,085.05 for the week. In U.S. interest rates, the yield on the ten-year U.S. Treasury note closed at 4.97%, up eight basis points from 4.89 for the week.

The markets were fairly steady again last week, when the world situation was anything but steady:
Financial markets weather global turmoil
by Ben Perry
Sun Aug 13, 4:25 AM ET

AFP - Global financial markets are seeing limited reactions to geopolitical jitters as investors become used to events such as the alleged plot to destroy US-bound passenger planes, analysts say.

Markets recovered Friday after being rattled by news that police had foiled a scheme to blow up jets flying from Britain to the United States.

Investor sentiment also recovered quickly this year following sharp price movements caused by Iran's nuclear programme and violence in the Middle East.

"Financial markets are aware of the risk associated with geopolitical tension," said Jeremy Batstone, director of private client research at Charles Stanley stockbrokers, in the wake of the latest scare.

The thwarted bomb plot "wasn't an attack on the financial system, it was a commercial target. The financial market's behaviour was appropriate".

Batstone added, however, that had planes been destroyed, the consequences would have been "horrific" for trading sentiment.

World oil prices tumbled more than two dollars a barrel Thursday on forecasts that air traffic could suffer.

"I think that was a knee-jerk reaction of the market," said Victor Shum, a Singapore-based analyst with energy consultancy Purvin and Gertz.

Crude futures recovered Friday in New York and London and the International Energy Agency (IEA) said fresh geopolitical tension could send oil prices even higher.

Oil prices which hit a record high 78.64 dollars per barrel in London on Monday are widely regarded as a key barometer of the global economy because they impact equity, foreign exchange and commodity markets.

In its latest monthly report, the IEA said Friday that disruptions to oil supplies, the threat of platform damage from hurricanes, turmoil in the Middle East and concern over Iran presented a tight picture for the crude market.

But "scratch below the surface ... and these geopolitical and supply issues are less defining for the oil market than they appear", it added.

European stock markets tumbled Thursday as well, hammering share prices across the airline sector.

British Airways closed down 5.0 percent as the airline cancelled most short-haul flights departing from its hub at London's Heathrow airport.

Air France-KLM and German carrier Lufthansa both finished more than three percent lower on Thursday, but Air France-KLM recovered slightly on Friday.

"It's worth remembering that markets tend to be pretty resilient," said Henk Potts, equity strategist at Barclays Stockbrokers.

"When we have seen events in the past, such as the London attacks (on July 7, 2005), stocks have bounced back."

Wall Street shares actually gained ground on Thursday even though US airline stocks came in for a rocky ride.

On currency markets, the pound dropped on news of the Britain-US bomb scare but the dollar climbed on better-than-expected US trade data for June.

"The markets anticipate terrorist threats these days," said Steven Saywell, a currency analyst with US group Citibank.

"The initial September 11 attack was the first of its kind and the market did not know what the outcome would be," he said in reference to the 2001 strikes on the United States.

"But now there is now a much more muted response to these attacks."

The price of gold, which traditionally benefits from safe-haven status in times in geopolitical instability, steadied as police updated media on the latest terror probe.

Contained wars can be “good” for the markets, stimulating profits in corporations located far from the fighting. It is hard to see how an uncontained, global conflagration can be any good, though. But the “cease fire” announced (but not implemented) late last week gave hope to the markets that the Middle East wars will remain contained.

But looking only at “markets” obscures the larger economic significance of the events. To see that, it can help to look at events in terms of imperial competition to secure natural resources and control over cheap labor. Among those who see the wars in the Middle East as essentially imperial wars, wars to secure power and wealth, there is some dispute as to whether the United States or Israel is in the driver’s seat. Bill Van Auken argues that the United States, as the leading power in world capitalism, is:
Bush’s “strategy” is to widen the wars for “regime change” in the Middle East that began with the toppling of Saddam Hussein in Iraq. When the American president—whose closest allies in the region are the police state regimes and absolutist monarchies of Egypt, Saudi Arabia and Jordan—uses the words “freedom” and “liberty,” he is talking about the freedom of American banks and corporations to exercise exclusive domination over Middle East and its oil wealth.

Facing a catastrophe in its occupation of Iraq (with thousands of US forces now being sent back into Baghdad to resecure the capital and confront its restive Shiite population), the Bush administration has decided that the solution is not to withdraw, but rather to launch new wars, not only in Lebanon, but ultimately against Syria and Iran.

There is undoubtedly an element of madness in this strategy of escalating militarism, but this is not merely the lunacy of America’s dim-witted president and his advisors. Rather, it reflects an irrational social system based on private ownership of the planet’s productive forces and vital resources and the division of a globally integrated world economy into rival nation states.

US policy is essentially to utilize its military power to assert domination over the oil resources of the Middle East and Central Asia, and thereby assure American capitalism both a secure energy supply and the ability to dictate terms to its economic rivals.

The turn to escalating militarism is also driven by the profound internal contradictions of American society, dominated by an unprecedented polarization between a wealthy elite and the masses of working people, and faced with a growing prospect of economic slump combined with rising inflation—a recipe for social explosions.

A military attack on Syria and Iran has the gravest implications. With US military forces already stretched to the limit by the failing imperialist adventure in Iraq, a new war will inevitably bring with it the reinstitution of the draft, forcing American young people to serve as cannon fodder for the conquest of Iranian oil fields.

Moreover, a war against Iran has the most deadly implications. A US attack would provoke an Iranian response against Israel, and, in turn, a possible nuclear retaliation by Israel. The path now being taken by US imperialism leads to the death of millions.

The carnage in Lebanon has demonstrated that there exists no genuine political opposition to this turn towards global warfare within the US political establishment, with the ostensible opposition party, the Democrats, seeking to outdo the Republicans in their support for Israel. At the same time, the draft resolution produced by the US and France makes it clear, once again, that the European bourgeoisie is incapable of mounting any opposition to US militarism, and that the UN itself serves only as a tool for imperialist policy.

Mike Whitney, on the other hand, sees the Israeli aggression against Lebanon as an attempt to establish Israel as at least an imperial equal to the United States:

Israel, oil and the "planned demolition" of Lebanon
Mike Whitney

Online Journal Contributing Writer

Aug 8, 2006

…The media portrayal of the current conflict is blatantly absurd. It has nothing to due with “captured soldiers” or Israel’s “right to defend itself.” This is a traditional war with clear territorial and political objectives. The border controversy is nonsense. Israel is trying to seize more land to realize its vision of “Greater Israel,” while reducing an adjacent Arab country to a “permanent state of colonial dependency.”

This explains the vast and deliberate destruction to Lebanon’s civilian infrastructure. Israel’s dominance requires that its neighbors endure abject poverty and oppression. By destroying the infrastructure and life-support systems, Israel hopes to eliminate the rise of a potential rival as well as to diminish the ability of the Lebanese resistance to wage war against the Jewish state. Once Lebanon is decimated, it will be delivered to Zionists at the World Bank (Paul Wolfowitz) who will apply the shackle of reconstruction loans and structural readjustment, which will keep Lebanon as an indentured servant to the global banking establishment. This model of economic servitude has been used throughout the developing world with varying degrees of success. It anticipates Israel’s regional ascendancy while ensuring that Lebanon’s sovereignty will be compromised for decades to come.

The United States has played a unique role in Israel’s war on Lebanon. In its 230-year history, the US has never deliberately assisted in an attack on an ally. That record will end with Lebanon.

Lebanon's was a demonstrably “pro-American” government on friendly terms with Washington. In fact, American NGOs and intelligence organizations helped to activate the “Cedar Revolution,” which gave rise to the Fouad Siniora government and the eventual expulsion of Syrian troops. To a large extent, Washington and Tel Aviv had achieved what they wanted to by meddling in Lebanon’s political affairs. The country was singled out as a shining example of Bush’s “global democratic revolution,” which was the stated goal of American intervention in the Middle East.

Lebanon has since been rewarded for its cooperation by the total obliteration of its economy and infrastructure. The Bush administration has abandoned any pretense of being an “honest broker” and is now providing Israel with precision-guided missiles to prosecute a war against a (mainly) civilian population. They are also actively collaborating with the Olmert regime to foil all plans for an immediate cease-fire. The United States is a fully engaged partner in the premeditated destruction of a democratic country. It is as much a part of the Israeli aggression as any IDF tank commander rumbling towards Beirut.

The United Nations has been sidelined by the administration’s obstructionism at the Security Council. The efforts of the Bolton-Rice team are tantamount to a “declaration of war.” So far, the Israeli offensive has uprooted nearly 1 million people in the south; making refugees of approximately 25 percent of Lebanon’s total population. The UN has done nothing to respond to this calamity. Its ineffectiveness casts doubt on whether it will survive the present crisis. Security in the new century will ultimately depend on alliances between the individual countries. The UN model of one, monolithic international institution trying to "preserve the peace” has proved to be a wretched failure.

The scene in the south of Lebanon is hauntingly similar to the ethnic cleansing of Palestinians in 1948; the Nakba. Once again, Israel is seen driving Muslims from their homes in an attempt to expand its territory. The “deliberate” attack on Qana, which killed 57 civilians, as well as the bombing of clearly marked ambulances and “white flag-waving” mini-buses chock-full of fleeing villagers, shows that the Israeli high-command still understands the importance of using terror as a means of controlling behavior. Israel’s carefully calculated atrocities have had the desired effect; triggering the mass-exodus of hundreds of thousands of frightened civilians and leaving Hezbollah guerillas to fight it out with the IDF.

The Bush administration is now attempting to pacify its critics by pushing a resolution that calls for a “full cessation of hostilities.” The resolution does not demand that Israel stop attacking Hezbollah nor does it require the IDF to leave Lebanon. It is Munich all over again; a miserable “sell-out” by the Security Council that guarantees a steady increase in the violence as well as an intensification of the rage that is sweeping across the Muslim world. The UN has unwittingly endorsed Israeli occupation of southern Lebanon and created the foundation for another generation of terrorists. The resolution shows that the UN is nothing more than a “cat’s paw” for US/Israeli geopolitical ambitions and that the “post-colonial” European allies are willing to succumb to the neocon plan for a “New Middle East…”

What does Israel want?

The only way that Israel can maintain its dominance in the region is by becoming a main-player in the oil-trade. Otherwise it will continue to be dependent on the United States to strengthen its military and defend its interests. Israel’s determination to “stand on its own two feet” is outlined in the neocon plan for “rebuilding Zionism” in the 21st century; “A Clean Break: A New Strategy for Securing the Realm.” The document is the blueprint for redrawing the map of the Middle East and eliminating rivals to Israeli power. Most of the attention has been focused on the parts of the paper which presage the attacks on Iraq, Lebanon and Syria; including this ominous passage:

Securing the Northern Border:

Syria challenges Israel on Lebanese soil. An effective approach, and one with which America can sympathize, would be if Israel seized the strategic initiative along its northern borders by engaging Hezbollah, Syria, and Iran, as the principle agents of aggression in Lebanon, including by:

· paralleling Syria’s behavior by establishing the precedent that Syria is not immune to attacks emanating from Lebanon by Israeli proxy forces.

· striking Syrian military targets in Lebanon, and should that prove to be insufficient, string at select targets in Syria proper.” (“A Clean Break”; Richard Perle, Douglas Feith, David Wurmser)

Clearly, this is the basic schema for US/Israeli aggression in the region. What has been overlooked, however, is Israel’s determination to “break away” from its traditional dependence on American support.

As stated in the text: (Israel intends to) “forge a new basis for relations with the US -- stressing self-reliance, maturity, strategic cooperation on areas of mutual concern, and furthering values inherent to the West. This can only be done if Israel takes serious steps to terminate aid, which prevents economic reform. Israel can make a clean-break from the past and establish a new vision for the US-Israeli partnership based on self-reliance, maturity, and mutuality -- not one narrowly focused on territorial disputes. (Israel) does not need US troops in any capacity to defend it . . . and can manage its own affairs. Such self-reliance will grant Israel greater freedom of action and remove a significant lever of pressure used against it in the past. . . . No amount of weapons or victories will grant Israel the peace it seeks. When Israel is on sound footing, and is free, powerful, and healthy internally, it will no longer simply manage the Arab-Israeli conflict; it will transcend it.”

Israel’s “economic freedom” depends in large part on its ability to become a central petroleum-depot for the global oil trade. In Michel Chossudovsky’s recent article “Triple Alliance: US, Turkey, Israel and the War on Lebanon,” the author provides a detailed account of the alliances and agreements which underscore the current war. As Chossudovsky says, “We are not dealing with a limited conflict between the Israeli Armed Forces and Hezbollah as conveyed by the Western media. The Lebanese War Theater is part of a broader US military agenda, which encompasses a region extending from the Eastern Mediterranean into the heartland of Central Asia. The war on Lebanon must be viewed as ‘a stage’ in this broader ‘military road map.’”

Chossudovsky shows how the recently completed Baku-Tblisi-Ceyhan pipeline has strengthened the Israel-Turkey alliance and foreshadows an attempt to establish “military control over a coastal corridor extending from the Israeli-Lebanese border to the East Mediterranean border between Syria and Turkey.”
Lebanese sovereignty is one of the unfortunate casualties of this Israel-Turkey strategy.

Most of the oil from the Baku-Tblisi-Ceyhan pipeline will be transported to western markets but, what is less well-known, is that a percentage of the oil will be diverted through a “proposed” Ceyhan-Ashkelon pipeline which will connect Israel directly to rich deposits in the Caspian. This will allow Israel to supply markets in the Far East from its port at Eilat on the Red Sea. It is an ambitious plan that ensures that Israel will be a critical part of the global energy distribution system. (See Michel Chossudovsky, The war on Lebanon and the Battle for Oil, July 2006)

Oil is also a major factor in the calls for “regime change” in Syria. An article in the UK Observer “Israel Seeks Pipeline for Iraqi Oil” notes that Washington and Tel Aviv are hammering out the details for a pipeline that will run through Syria and “create and endless and easily accessible source of cheap oil for the US guaranteed by reliable allies other than Saudi Arabia.” The pipeline “would transform economic power in the region, bringing revenue to the new US-dominated Iraq, cutting out Syria, and solving Israel’s energy crisis at a stroke.”

The Israeli Mossad is already operating in northern Iraq where the pipeline will originate and have developed good relations with the Kurds. The only remaining obstacle is the current Syrian regime which has already entered the US/Israeli crosshairs. The Observer quotes a CIA official who said, “It has long been a dream of a powerful section of the people now driving this administration and the war in Iraq to safeguard Israel’s energy supply as well as that of the US. The Haifa pipeline was something that existed, was resurrected as a dream, and is now a viable project -- albeit with a lot of building to do.”

Former US Ambassador James Atkins added, “This is a new world order now. This is what things look like particularly if we wipe out Syria. It just goes to show that it is all about oil, for the United States and its ally.”


The Middle East is being reshaped according to the ideological aspirations of Zionists and the exigencies of a viciously-competitive energy market. Behind the bombed-out ruins of Qana and the endless sorties laying Lebanon to waste, are the tireless machinations of the energy giants, the corporate media, the banking establishment and Israel.

Don’t expect a quick return to peace. This war is just beginning.

Regardless of who is driving, especially since it is essentially the same group controlling both Israel and the United States, the aggressive moves of both of these powers obscure the fact that both of them are losing wars. Losing wars is never a sign of a rising imperial power. Since Great Britain and the United States have dominated world financial system for two centuries, an end to that system will provide a test to see how truly “global” world markets really are. Does it still matter to the multinational corporations which currency dominates the world? Does it even matter to the wealthy in any country? We shall see.

In the meantime, the weaknesses of the U.S. economy become more apparent. The economist Nouriel Roubini sees a bad recession in the United States in 2007:
The Next Move by the Fed Will be a Cut, Not a Hike, as the US Slips into a Recession...

Nouriel Roubini
Aug 09, 2006

As I pointed out in my previous blog, markets and investors are behind the curve in terms of their views of what the Fed will do next. The debate and commentary among markets, bloggers and investors – based on yesterday’s FOMC statement – is still on the question of whether the Fed will keep its pause in the fall or whether – given rising inflation – it will tighten again some time in 2006. The reality is that the next move of the Fed will be an easing - i.e. a cut in the Fed Funds rate - not a tightening, most likely in the fall or winter of this year.

My out-of-consensus call for the next Fed move to be an easing – rather than a hike - is based on a simple point: the U.S. economy is headed towards a sharp recession by early 2007 . Thus, while most commentators are still pondering and stressing the alleged “tightening bias” in yesterday’s FOMC statement, it is because they are still deluding themselves that the economy will face a soft landing; unfortunately the landing will be hard and ugly with a severe recession. Thus, unless core inflation sharply rises (as it could if oil goes sharply higher from here), there is only one choice and direction for the Fed ahead: to cut the Fed Funds rate as soon as there are strong signals that the economy is spinning into a recession. Such recession signals would – with one caveat – certainly lead to a cut in the Fed Funds rate as – unless stagflationary effects of higher oil become much larger – the inflation rate will tend to fall in the coming recession as demand falls, the unemployment rate goes up and wage growth slows down once workers lose jobs.

The only caveat to this easing call is a nightmare scenario where you have true stagflation, rather than stagflation-lite: i.e. a scenario where oil price keep on rising and get into core inflation via second and third round effects while the economy is spinning into a sharp recession. I.e. you need the anti-inflationary forces of lower demand and higher unemployment to be weaker than the inflationary forces of geopolitical shocks bringing oil prices higher (as non-energy commodity prices will start to fall sharply as soon as the U.S. recession trend is evident) for inflation to significantly rise in the coming recession.

Could this true stagflation (inflation sharply up while growth goes to zero and then negative) occur? It is possible only if geopolitics (tensions with Iran, a worsening security situation in Iraq, a wider Middle East conflict, a worsening civil war in Nigeria, a greater confrontation with Chavez) or “nature” (a major Katrina-style hurricane, even worse pipeline problems in Alaska or somewhere else, another workers’ strike in the North Sea) lead to sharply higher oil prices. During recessions, usually prices for energy and non-energy commodities sharply fall (as both demand and supply are price inelastic); but while a US recession and global slowdown will sharply hit non-energy commodity prices, energy prices may remain close to current levels – rather than sharply fall – if geopolitics or “nature” causes another supply shock.

But barring such a major oil supply shock, as the economy spins into a recession, inflationary pressures will dampen over time (with a possible lag given the inflation pressures in the pipeline) and the Fed will get into a panic mode of having realized that it overreacted - with excessive tightening until now - and will thus cut rates. This is the same pattern that we observed in 2000-2001. Then, the Fed expected a soft landing and paused in June 2000 six months before the onset of the recession. But the tech bust led to a growth slump and then recession – like the housing bust will now lead to a recession – and, once the Fed realized too late at Christmas in 2000, that the recession was coming it started to cut the Fed Funds rate – in between FOMC meetings – as early January 2001. This Fed Fund aggressive easing in 2001 did not prevent the mounting recession; and the Fed easing this fall or winter will – similarly - not prevent the coming US recession.

…So, leading Fed watcher John Berry – citing my recession call and that of DeLong – says today that no one at the Fed is yet worried about a recession. But Fed officials are much more worried about the recession risk than they are claiming or admitting in public. The simple proof: why would the Fed ever pause, as it did yesterday, when all inflationary signals and pressures are mounting (headline, every measure of core, wage growth, falling productivity growth, sharply rising unit labor cost, oil, commodities, you name it)?

Why? The only and simple answer is: they are starting to get scared of the coming recession. Their official argument or excuse for the pause is, of course, that the delayed effects of previous tightening that are in the pipeline and the slowing economy will lead to a slowdown in inflation. But investors should read more carefully the FOMC statement. I have been speaking for the last 8 months of the Three Ugly Bears of slumping housing, high oil prices and the delayed effects of rising interest rates triggering a recession. And yesterday the FOMC endorsed the Three Bears view by stating: “Economic growth has moderated from its quite strong pace earlier this year, partly reflecting a gradual cooling of the housing market and the lagged effects of increases in interest rates and energy prices.?” Three Bears! Is that plain English clear or what?

Then, the Fed also added: “inflation pressures seem likely to moderate over time, reflecting contained inflation expectations and the cumulative effects of monetary policy actions and other factors restraining aggregate demand.” So, lagged monetary policy will slow down the economy by pushing demand down and unemployment up thus leading to lower inflation; and, on top of the “other factors restraining aggregate demand” will slow down inflation. What are those factors? In Q2 a fall in residential housing, a fall in consumption of durables, a fall in real investment in software and equipment, an increase in inventories as demand slows relative to output. And, as the Fed says, these forces will be stronger ahead: in fact, if these anti-inflationary forces did not prevent a rise in inflation in Q2, the Fed must believe that the fall in durables consumption, in housing, in non-residential investment and in other components of aggregate demand will be larger in H2 than in H1 to trigger the fall in investment. The Fed is telling you that it expects demand to slow further – regardless of the effects of past monetary tightening – and thus lead to lower inflation. Since any basic macro model – say the well respected model of Larry Meyer’s Macroeconomic Advisers that is closely followed by the Fed - tells you that only a significant increase in the unemployment rate will stabilize and then reduce core and headline inflation, if the Fed truly believes that inflation will peak and stabilize or fall in H2 or by early 2007 it must also believe that the growth slowdown will be much more severe than it is admitting it in public. So, there are only two options: either the Fed does not believe that inflation will stabilize in which case it is pausing now because it is already panicky about the recession; or, if it truly believes its own forecast of slowing inflation, it must be expecting a sharp economic slowdown, a much sharper one than the Bernanke forecast or the Fed forecast of a soft landing.

Indeed, Berry, after citing my views on the risks of a recession said: “Well, Fed officials recognize there are substantial risks ahead, particularly given the pressure of high energy prices on both inflation and consumer spending. None of them is expressing concern that a recession is likely.” So, while Fed officials may not believe that a recession is likely, they are not excluding - now in public via the mouthpiece of the only Fed watcher who is a true FOMC insider – that there are “substantial risks” to the growth outlook. Is that clear? Substantial risks…Also, as Berry put it: “Nevertheless, Fed officials are generally sticking by their collective forecasts of slower, but still solid, growth in the second half of the year, though they have to be somewhat troubled by the unexpected dip in business investment in new equipment and software in the second quarter.” So, again, Fed officials are troubled that non-residential investment that was supposed to pick up and sustain aggregate demand at the time when housing is falling and consumption growth is slowing, is instead headed south. This fall in non-residential investment is not a surprise, as I have argued before: corporations are flush with cash and profits but they do not see any good real investment opportunities as there is excess capacity and as demand is now slumping. Thus, the unprecedented share buyback bonanza – the biggest in US history - which we are now experiencing proves that firms do not have any good productive investment use for all the profits they have; and they are thus returning these profits to shareholders. Of all bearish signals in the economy, this investment slump and buyback bonanza is one of the strongest leading indicators of the coming recession.

It is true that the Fed has kept a formal tightening bias by suggesting that additional firming of the Fed Funds rate cannot be ruled out given current inflationary pressure; but it clearly stated that “extent and timing of any additional firming that may be needed to address these risks will depend on the evolution of the outlook for both inflation and economic growth, as implied by incoming information.” So, the Fed is fully data dependent. And this means that if the economy slows down more than expected, there will be no firming and a pause that becomes a stop may end up being a cut. The risks are clearly balanced now in the Fed view: there are downward risks to growth and upward risks to inflation that, in the Fed view, will be moderated by the economic slowdown.

In conclusion: investors are still behind the curve debating whether the FOMC statement suggests a further hike sometime in the fall. The reality is different: the next move of the Fed will be easing, most likely in the fall when the signals of a recession become too self-evident for the Fed to ignore them. The only thing that could prevent a Fed Funds rate cut (and lead the Fed to keep a pause or even hike) or postpone the cut into 2007 is a sharp spike in core and actual inflation driven by a further oil shock or a build-up of domestic inflationary forces. But that would be a true nightmare scenario for the Fed and for the economy: a recession with a sharply rising inflation. Then, if the Fed lost control of the inflationary process, it may well be forced to hike even during an ongoing recession. But this scenario is, still, highly unlikely. The most likely scenarios is a slowdown and recession that cools down inflationary pressures (or, at least, does not stoke them further) and forces the Fed to cut the Fed Funds rate. But, as I have persistently argued, even such Fed ease will not prevent the coming recession. The recession boat has left the harbor and there is very little the Fed can do to prevent it. In 2000 the Fed failed to achieve a soft landing; this year we will get the same pattern as in 2000-2001 but a much harder landing than in the previous recession.

Roubini may be too optimistic about avoiding stagflation (the “true nightmare scenario”). What he wrote about it above seems only too likely:
Could this true stagflation (inflation sharply up while growth goes to zero and then negative) occur? It is possible only if geopolitics (tensions with Iran, a worsening security situation in Iraq, a wider Middle East conflict, a worsening civil war in Nigeria, a greater confrontation with Chavez) or “nature” (a major Katrina-style hurricane, even worse pipeline problems in Alaska or somewhere else, another workers’ strike in the North Sea) lead to sharply higher oil prices.

The following piece in the New York Times last week has a sample of views on the “soft landing” issue:
Economy Often Defies Soft Landing

By Edmund L. Andrews

WASHINGTON, Aug. 10 — In the cool and quiet marble corridors of the Federal Reserve, the strategy for taming inflation sounds painless, even soothing: a “soft landing” for the economy after several years of flying high.

As the central bank contended on Tuesday, when it decided to pause in its two-year effort to raise interest rates, inflation is “elevated” right now but will begin to decline because economic growth is poised for a modest slowdown.

Many economists, though, warn that the soft landing may seem anything but soft, and suggest that the Fed is either too rosy about the looming slowdown or naïve about the difficulty of reaching its goal for inflation.

In practice, the Fed has achieved only one true soft landing — in 1994-95, when, under the leadership of Alan Greenspan, it was able to slow the economy enough to cool spending and ease inflation pressure but not so much as to cause a big jump in unemployment. But even Mr. Greenspan, whose ability to fine-tune policy made him famous, presided over two formal recessions, in 1991 and in 2001.

This time, many analysts say that the Fed and its new chairman, Ben S. Bernanke, face considerably tougher challenges. Crude oil, at more than $70 a barrel, is selling at prices that would have been unthinkable in 1995. Productivity growth, which was accelerating in 1995, is slowing these days. The dollar, which was climbing against other major currencies in 1995, is declining against most of them now.

Analysts and other experts say that if Mr. Bernanke is serious about his goals for controlling inflation, at least two million more workers may have to lose their jobs over the next two years.

“The economic slowdown has to be much more substantial than anybody in the Federal Reserve or on Wall Street is expecting,” said Robert J. Gordon, a professor of economics at Northwestern University, who has analyzed the trade-off between inflation and unemployment for the last several decades.

Mr. Bernanke and other Fed officials say they want to keep core inflation, the main measure of retail prices excluding energy and food, below 2 percent a year. But core inflation is already 2.9 percent and almost certain to climb as the cost of oil pushes up prices for items as diverse as air fares and plastics.

Mr. Gordon said the last few decades had shown a grim but consistent trade-off: to reduce inflation by one percentage point, the unemployment rate has to rise by about two percentage points for a full year.

To reduce inflation to the upper limits of what Mr. Bernanke and other Fed officials consider acceptable, more than three million jobs would be lost, a bigger drop than in the recession of 2001.

And that is Mr. Gordon’s relatively upbeat hypothesis, which assumes no other shocks to the economy — no additional increases in energy prices, no collapse in the dollar’s value, no collapse in housing.

“I think the Fed is facing an absolutely classic case of stagflation,” Mr. Gordon said, “a situation in which they cannot win.”

He is not alone. Many other economists contend that inflation is more entrenched and will be more painful to reverse than the Fed thinks. Others predict that inflation will indeed subside, but only because the economy will weaken much more than the Fed is expecting.

The chief forecaster at Decision Economics, Allen Sinai, said unemployment would have to rise to at least 5.5 percent, from 4.8 percent today, putting a million more people out of work, before inflation begins to decline.

The chairman of Roubini Global Economics Monitor, Nouriel Roubini, predicted that the economy would fall into a recession early in 2007 as a result of high energy prices, higher interest rates and a housing collapse.

“Either the Fed does not believe its own inflation forecast, which I don’t think is the case,” Mr. Roubini said, “or the slowdown is going to be greater than what they have been saying. They can’t have it both ways.”

To be sure, economists differ on how weak the economy already is or how severe inflation pressure is. And skepticism abounds on the chances of achieving a true soft landing.

The very idea of such a thing is only about a decade old. It was conceived by Mr. Greenspan, then the Fed chairman, as a way to attack inflation before it started, by shrewdly using the levers of monetary policy to slow the economy just enough to keep it from overheating.

Mr. Greenspan’s greatest success was in the mid-1990’s, when the economy had been expanding for nearly four years. Though inflation was declining and was lower than it is today, the Fed doubled short-term interest rates, to 6 percent from 3 percent, in just over a year.

At the time, the result seemed neither soft nor smooth. Several financial institutions, caught by surprise, found themselves in big trouble. The economy slowed for a while, and unemployment edged up.

But by 1996, the economy was rapidly growing again and the nation enjoyed several years of booming stock markets, falling unemployment and relatively low inflation.

The success, along with Mr. Greenspan’s growing aura as a wizard of monetary nimbleness, prompted the Fed to step in and help soften the blows of the Asian financial crisis of 1997-98, the stock market collapse of 2000, the recession of 2001 and the surge of unemployment that followed.

He failed in preventing the 2001 recession, but the Fed cut interest rates so deeply that this started a boom in housing prices and home refinancing that kept consumers spending even as incomes stagnated and unemployment moved higher.

Laurence H. Meyer, a former Fed governor and now a chief forecaster at Macroeconomic Advisers, said Mr. Bernanke needed to do more than simply duplicate Mr. Greenspan’s one soft landing.

Mr. Greenspan was not trying to reduce inflation, but merely to keep it from going up. Mr. Bernanke, by contrast, is trying to reduce it substantially.

…“Soft landings are much more frequent in forecasts than in real life,” Mr. Meyer said. “With a computer, I can give you a soft landing if you give me 10 or 20 runs. But in real life, you only have one run.”

Uncertainties and disagreement among experts about the economy’s direction are now unusually high.
A big uncertainty is whether the nation is near full employment.

Many economists contend that the country is essentially at full employment, meaning that additional demand for workers will tend to push up wages. Because wages account for more than three-quarters of total production costs, Fed officials view them as inflationary if they rise significantly faster than productivity.

Specialists like Mr. Gordon at Northwestern and Mr. Meyer maintain that the labor market is already very tight and predict that wages will soon start to push up inflation.

But others disagree, arguing that wages over the last five years have lagged behind increases in productivity and have barely kept up with inflation. The bigger risk, according to that school of thought, is to make the situation worse by driving up unemployment.

“We have no clue about labor market tightness right now,” said J. Bradford De Long, a professor of economics at the University of California, Berkeley, who argues that workers still have little bargaining power.

Depending on one’s perspective, Mr. De Long said, the Fed’s attempt at a soft landing is either a display of cool-headed technocracy or murky witchcraft.
Right now, he said, “this is on the witchcraft side.”

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