All of a sudden there appears to be an exit door from the credit crunch.
The billions of illiquid, underwater mortgagebacked securities that have already bankrupted some of the world’s largest investment banks and choked up the world financial system are about to go away. The US Treasury, in an act of unprecedented charity, will effectively nationalize Wall Street’s most troubled assets and transfer them to the balance sheet of American taxpayers.
What the ultimate cost would be of not intervening will of course never be known. Both the slowing rate of recent housing price declines and vastly improved housing affordability ratios suggest that a trough in US real estate prices is probable within the next six months. But could Washington have waited that long before world financial markets would have totally seized up causing a global meltdown?
While the cost of taking another path will never be known, the cost of the one chosen is clear enough. Higher deficits can only bring higher taxes and higher inflation can only bring higher interest rates. Both are on their way in the American economy.
The big easy in today’s Fed/Treasury policy sets the stage for mean reversion in tomorrow’s policies. The world’s largest financial bailout is sending oil short-sellers to the sidelines. The earlier plunge in energy prices now only sets the stage for even higher inflation rates next year as oil prices rebound to set new highs.
With fears of a financial system meltdown and growth collapse averted, prices for a range of commodities have already seen their lows. The weak OECD backdrop will slow the extent and pace of recovery. Still, the combination of strong emerging market demand and limited new supply should see oil prices average a record-high $ 50/barrel over the second half of next year.
The resulting near-$5/gallon gasoline prices will see CPI energy inflation make a triumphant return, posting no less than a 40% increase from yesterday’s deleveraged prices (Chart ). That, in turn, should see headline US CPI inflation punch through 6% towards the latter half of next year.
