…what’s next?

The U.S. economy slowed down sharply in the final quarter of the year and GDP clocked in at 0.6% while for all of 2007 GDP came in at 2.2%, the smallest increase in five years.

The annual GDP figure posted its third yearly decline in growth and 2008 could be number four while 2009 could turn out to be number five.

The GDP report showed that inflation, as measured by headline PCE, breached the 4% mark and came in at 4.1% (just shy of a multi-year high of 4.3%) and what may be greater cause for concern is that core PCE came in at 2.7% (the highest reading since the second quarter of 2006).

In addition to the poor GDP report initial jobless claims surged to 373,000 and slowly but surely march their way to the key 400,000 level. Initial jobless claims may be one of the best real-time indicators of economic health available right now and the message the labor markets send is clear. Employment is on a downward trend as claims continue to increase.

Last but not least the U.S. Dollar has hit record lows versus the Euro and continues to loose value due to rate-cuts and the supply of more U.S. Dollars since Bernanke prints money like he needs to win a race. The U.S. Dollar is the most over-supplied currency right now and recent monetary decisions have increased the problem. This translates into the continued decrease of spending power and a real-time loss in equity markets and portfolios in comparison to the global economy.

Let us summarize the above:

The economy slows down and is on a path to hit negative growth (as early as the current quarter), inflation is a huge problem and continues to accelerate while employment continues to decelerate.

That points to stagflation regardless if Bernanke and Friends want to acknowledge the fact. ‘Bernanke Doesn’t See Return of ‘70s Woes’ (Associated Press), at least not yet but if you consider who is at the helm of the Fed it will give you reason to believe that the 1970s will be remembered as not as bad as the 2000s.

Bernanke has chosen to ignore inflation and focus on economic growth but he seems to forget that the economy will not be able to grow with inflation at current levels since the back-bone of the economy, the consumers, will not be able to support the economy as more and more disposable income is required just to cover the basics.

The Fed has taken a dangerous stand on inflation and argues that it is not really a big problem right now and fairly contained. The more inflation is ignored (Bernanke claims that the Fed will keep a close watch on inflation but by the time inflation will show up in inflation figures it is too late; compare it to a story in the newspaper…once it hits the papers it is already too late) the more painful it will be once it does show up.

The weak GDP figure released today along with the continued deterioration of the job market will supply the ammunition Bernanke will use to argue and defend further rate-cuts but the ignorance of a problem will not make it disappear.

When is inflation a problem? Does Bernanke need to see it in double digit territory?

Again, when inflation shows up in different indicators it is too late. The markets have all but e-mailed participants a clear message:

Inflation was a bit of a problem before the rate-cuts and now the little problem has been grown into a big problem. Inflation is heavily embedded into the economic pipeline and a recession is required in order to drive inflation out of the system and bring it down to acceptable levels.

Once inflation starts to go into over-drive, and thanks to Bernanke’s rate cuts it will (maybe already has), there is no quick solution to the problem. The Fed should not only focus on lagging indicators but should be qualified enough to see the problem and understand the markets.

Sure, you can exclude food and energy (and everything else you would like in order to argue that inflation is well contained) but that does not change the fact that consumers are faced with those costs on a day-to-day base.

Bernanke cannot play on two parties (economic growth and inflation) at the same time and decided to fight the slowdown in the economy (which he will drastically and pathetically loose).

Bernanke fights the battle on the wrong front and that will cost him to loose the war.

To be fair, while I think Bernanke is going about the issues wrongly, I think anyone following Greenspan would have been in a similarly awkward position.

Greenspan promoted the era of borrow to spend, and we've already seen in the UK how property was specifically targeted as a growth engine, and there's no reason why that can't be visible in the US economy over the past few years either.

So Bernanke is left overseeing an economy with no momentum left, and no consumer cash left to restart it.

Of course, the actions he is taking can be ridiculed as just plain wrong - but perhaps Bernanke has nothing but a start choice - act in the interests of the short term, or the long-term.

Ideally, the latter would be required - but the danger is that he's essentially a pawn in the political game, and has to be focused on short-term presentation of "doing something" as election year draws on.

2c.

I the economy is in a bad state I do not see the light for a couple of months to come.

Agreed.