CourcyInt

COURCYINT SPECIAL BULLETIN

To: All Courcy's Intelligence Service members

Date: 1 July 2004

From: Joe de Courcy, Chief Executive, Courcy's Intelligence Service

Subject: INFLATION

SUMMARY

The Fed's decision to increase interest rates to 1.25% marks a key turning point in the world economic cycle.  Since June 1981, when US interest rates came down from their peak of 19%, each successive cyclical peak in interest rates, and each successive trough, has been lower than the one before.  That cycle has now ended.

ANALYSIS

Since its inception in 1934, Courcy's Intelligence Service has been identifying, tracking, and analysing risks to the free flow of international commerce.  For the most part our principal concern has been with non-economic risk factors, and we have generally left economic crystal-ball gazing to others; but the turning point signalled by the increase in US interest rates is so significant that it warrants special attention.

As attentive subscribers will know, the international economist we follow most closely is Anatole Kaletsky of The Times of London, and his analysis in today's edition cannot be bettered.  He says:

* The Fed should have begun raising interest rates earlier - cutting rates to 1% last June when the economy was already booming was a mistake.

* US interest rates, notwithstanding yesterday's increase, are far below the appropriate level for this stage of the economic cycle and will need to rise much farther and faster than financial markets currently assume.

* Now that the Fed has started raising interest rates, this upward trend has a long way to go.

* The combination of ultra-lax monetary policy with a rapidly falling dollar is reminiscent of the great inflation that started with the expansionary Keynesian and "guns-and-butter" policy in the mid-1960s when the Vietnam war was getting into its stride.

* There are seven trends in the US all pointing to higher inflation: lax monetary policy with a central bank concentrating on job creation rather than stable money; ballooning budget deficits; a depreciating currency; an expensive war paid for by printing money; protectionism; rising oil prices; and a big-spending administration.

* To counter these inflationary pressures, the Fed needs to raise interest rates quickly to at least 5%, but there is no sign that Alan Greenspan has any intention of doing so.  He has already misjudged the inflation outlook by declaring in his annual report to Congress that it would average between 1% and 1.25% this year.  It is now running at 2.5%.

* The problems will be compounded by the costs of caring for an ageing population (the equivalent of the growth in the welfare state in the 1960s) - and, Kaletsky concludes, "if history is any guide, politicians and voters will decide that inflation is the only way to spread the burden of these ever-growing social costs".  This in turn means that interest rates and inflation "will continue to point upwards for years, or even decades".

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