Saturday, August 25, 2007

Balancing Global Competitive Pressures

The price of gas recently sparked a thought about our interconnectedness around the world. Prior to the Fed's rate cut, the stock market was retreating in face of the ongoing sub prime mortgage debacle. Reduced interest rates, inflation and another decline in the dollar are likely to be the only thing that enables the housing market to stage a recovery without taking a bigger hit than the market has already seen. The Fed is concerned about inflation and the increase in gas prices (which average $1.85 in 2004 and $2.27 in 2005) has had a big impact on inflation and disposable income.

The world view of inflation is that the US pays back its debts in deflated dollars but the alternative is to have the US suffer a major housing meltdown as more sub prime mortgages run into trouble with higher interest rates. A decline in housing values reduces the amount of money Americans can pull from their equity to buy products from countries like China.

If China sells the US less products, they buy fewer raw materials. As oil is a key component in plastics and packaging, a decline in the US housing market hits the oil producers that sell to China. Increasing supply of crude oil to reduce the cost of gas, to relieve inflationary pressure, to encourage the Fed to further reduce rates - could be a good competitive strategy.

Think about that the next time you are at the gas pump.