[R-G] Stagflation May Return as Price, Credit Risks Meet

[Yoshie Furuhashi]

<http://www.bloomberg.com/apps/news?pid=20601085&sid=anXKbWHsXtHc&refer=europe>
Stagflation May Return as Price, Credit Risks Meet (Update1)

By Rich Miller

Dec. 17 (Bloomberg) -- The world economy is facing the risk of both
recession and faster inflation.

Global growth this quarter and next may be the slowest in four years,
while inflation might be the fastest in a decade, say economists at
JPMorgan Chase & Co.

The worst U.S. housing slump in 16 years, coupled with a tightening of
credit by banks, has brought the world's largest economy "close to
stall speed,'' according to former Federal Reserve Chairman Alan
Greenspan. At the same time, rapid growth in China and other emerging
markets is driving energy and food prices higher worldwide.

"What lies ahead is a period of stagflation -- slow or no growth
combined with rising inflation -- in the advanced economies,'' says
Joachim Fels, co-chief global economist at Morgan Stanley in London.

Harvard University economist Martin Feldstein is among those who say
it would be just a mild case of what the world endured in the 1970s
and early 1980s, when a 10-fold increase in oil prices drove both
unemployment and inflation above 10 percent. Still, it poses a dilemma
for the Fed and other central banks as they struggle to decide which
problem they should tackle first.

How they respond will go a long way in determining which danger proves
to be the biggest: a slumping global economy or rising prices
worldwide.

For now, traders in futures markets are betting the Fed will remain
focused on supporting growth, even after the latest government
inflation reading last week showed consumer prices rose in November at
the fastest pace in more than two years.

Another Cut

In today's trading, investors put a 76 percent probability on another
quarter percentage-point cut in the Fed's benchmark overnight rate in
January, down from 100 percent on Dec. 13. Stocks extended their worst
weekly drop in a month on concern the U.S. economy will slow. Treasury
notes advanced.

"Central banks don't have as much flexibility as they'd like, with
inflation rising and demand slowing,'' says David Hensley, director of
global economic coordination at JP Morgan Chase in New York. His team
sees global growth of 2.4 percent this quarter and next and inflation
at 3.5 percent.

That's a far cry from the bad old days more than a generation ago,
when world growth slowed to just 0.7 percent in 1982 while inflation
ran at an annual rate of 13.7 percent, according to data compiled by
the International Monetary Fund.

"The numbers now are very different than what they were then,''
Feldstein said in a Dec. 14 interview. "We are not back to the very
high inflation rates we had in the late 1970s and early 1980s,
fortunately.''

Highest Rate

Even so, no less an authority than Greenspan himself expresses
concern. Speaking on ABC's "This Week'' program aired yesterday, the
former Fed chairman said a period of "remarkable disinflation'' is
ending. "We are beginning to get not stagflation, but the early
symptoms of it,'' he said.

"This is a much tougher monetary-policy environment than anything I
experienced,'' Greenspan told the Wall Street Journal on Dec. 14.
Through the first 11 months of this year, consumer prices rose at an
annual rate of 4.2 percent. That's up from 2.5 percent for all of 2006
and, if maintained in December, would be the highest rate in 17 years.

"The numbers are scary,'' says Stephen Cecchetti, former director of
research at the New York Fed, who's now professor of international
economics at Brandeis University's International Business School in
Waltham, Massachusetts.

It isn't just a U.S. concern. Inflation in Europe last month rose at
its fastest annual pace since May 2001, increasing by 3.1 percent as
food costs soared.

"The oil-price boom and rising food prices have clearly accelerated
inflation developments since summer,'' Austrian central bank Governor
Klaus Liebscher said in Vienna on Dec. 14.

Inflation in China

Surging food prices are also pushing up inflation in China. Consumer
prices in the world's fastest growing major economy rose at a
year-over-year rate of 6.9 percent in November, the quickest in 11
years.

Behind the burst of inflation: rapid growth in emerging markets that
is lifting prices worldwide for everything from oil to gemstones.

Uncut diamonds will get more expensive with "increasing demand from
fast-growing economies such as India and China,'' Gareth Penny,
managing director of De Beers, the world's biggest diamond company,
said on a Nov. 22 conference call from the company's headquarters in
Johannesburg.

That's filtering down to consumers. London-based Signet Group Plc, the
world's largest jewelry-store owner with shops throughout the U.S. and
U.K., plans to increase U.S. prices after Feb. 14, Valentine's Day, to
cover increasing costs of diamonds, gold and platinum, Chief Executive
Officer Terry Burman said on a Nov. 27 conference call.

Limited Success

China and other emerging markets are trying to slow their economies to
keep inflation in check by tightening monetary policy. They've had
limited success, in part because some of them have tied their
currencies -- directly or indirectly -- to the dollar or the euro.

That restricts their ability to raise interest rates to slow growth
because it would probably also lead to an unwanted appreciation of
their currencies.

"Global inflation pressures emanate mainly in the emerging countries,
where growth is strong and monetary policy is relatively
expansionary,'' Fels of Morgan Stanley says.

The same emerging-market nations have also helped stoke inflation by
sheltering their consumers and companies from rising oil prices
through subsidies. That's kept energy demand in China, India and other
countries high because domestic prices are still low.

Pressure to Cut

If the global economy faced only the risk of faster inflation, the
policy prescription would be clear: higher interest rates. Yet with
growth slowing in the U.S. and Europe, central banks remain under
pressure to cut.

The Fed has already reduced its benchmark rate by a full percentage
point in the last four months, while the European Central Bank has
held borrowing costs steady rather than tightening credit as
previously planned.

U.S. growth will slow to 1 percent in the fourth quarter as consumer
spending cools and the housing slump enters its third year, according
to a Bloomberg survey of economists from Dec. 3 to 10. The economy
expanded 4.9 percent in the third quarter.

"I'm not going to put a happy face on the slowing U.S. consumer,''
Jeffrey Immelt, chief executive officer of General Electric Co., told
analysts in New York on Dec. 11. "Our businesses that touch housing in
the U.S. are going to be challenged.'' Fairfield, Connecticut-based GE
is the world's third-biggest company by market value.

Pared Forecasts

In Germany, two institutes that advise the government separately pared
their growth forecasts for Europe's largest economy on Dec. 13, as
rising energy costs sap consumers' spending power and the euro's
appreciation hurts exports.

The Munich-based Ifo institute cut its growth prediction to 1.8
percent in 2008 from a June forecast of 2.5 percent. The Kiel-based
IfW institute reduced its outlook to 1.9 percent from a September
forecast of 2.4 percent. Germany's economy grew 2.9 percent in 2006.

Feldstein, who heads the national bureau that serves as the arbiter of
when U.S. recessions begin and end, says the combination of a stalled
economy and rising inflation could be seen as a form of stagflation.

"It depends on how you want to define it,'' he says. "If you say an
inflation rate of 3.5 percent and a recession is stagflation, then we
could have stagflation.''

To contact the reporter on this story: Rich Miller in Washington at
rmiller28 at bloomberg.net
Last Updated: December 17, 2007 11:00 EST

--
Yoshie
<http://montages.blogspot.com/>