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The global economy is heading toward another double-dip scare, possibly in the third quarter, in what could be a repeat of summer 2010.
Financial markets may stumble in a few months, and that could prompt the U.S. Federal Reserve to introduce a third round of quantitative easing or an equivalent, which would be another step down the path toward stagflation. In this scenario, China's current monetary tightening policy would be difficult to sustain.
A decline for the U.S. property market is accelerating. It could fall another 20 percent over the next 12 months.
China's economy could slow substantially in the second half due to liquidity constraints for the property industry and local government financing.
These factors contributing to a double-dip scare may push the U.S. Federal Reserve to launch another round of stimulus, although it may not be called QE 3. At the same time, the scare may cause oil prices to dip, easing inflation concerns.
The main aim of a QE 3 would be the same as QE 2 "â?? to support U.S. stock and property markets. While it may succeed in reviving these asset markets, it would also yield surging oil prices and inflation.
A real double dip would occur if either the U.S. Treasury bond market crashes or appreciation expectations for China's currency reverse on expectations of depreciation. The timing for this scenario could be fourth quarter 2012, possibly after the U.S. presidential election and Chinese Communist Party's 18th Congress.
Stagflation Entrenches
This year's first quarter economic data points to a continuation of last year's trend toward stagflation. The most important data were the U.S. annualized GDP growth rate of 1.8 percent for the first three months of this year, compared to 3.1 percent in the fourth quarter 2010, and 3.8 percent inflation for personal consumption expenditures (PCE), up from 1.7 percent for the previous three months.
The Fed pays closest attention to PCE in gauging inflation. Now, while economic growth seems to be stalling, inflation is spreading unambiguously.
Even Fed Chairman Ben Bernanke says the tradeoffs for monetary policy aren't appealing, i.e., the cost of inflation from additional monetary stimulus is probably higher than job creation benefits.
Euro zone inflation continued its march upward to 2.8 percent in April, the highest since October 2008, when oil prices rose above US$ 140 a barrel. The European Union has upgraded the euro zone's GDP growth rate to 1.6 percent for 2011. The first quarter was probably better, possibly showing a 2 percent annual rate.
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