Carry Trade, Inflation and Market Forces

Dear Readers,

So we have this news - US Fed chairman Bernake 'softened' his tone and 'vowed' exceptionally low interest rates for extended period owing particularly to the situation in Europe. This is quite opposite to what I thought some time back when several Fed members opened their mouth against low interest regime. I thought that was the start of changed stance by 'Fed Group' and would lead to unwinding of carry trade world over. So, do I change my views? NO. Bernake said what he was compelled to say and markets somehow do understand that this 'renewed dovish stance' is just a camouflage and interest rates are poised to go up sooner than later. Let me make myself clear hear - Fed DOES NOT DECIDE RATES, IT JUST DOES WHAT IT IS FORCED TO DO BY MARKETS. Fed guys are also helpless when facing actual market forces. However, I guess Bernake is right in his thinking that it is deflation that is going to be near term threat than inflation.

When it comes to investing and markets, small guys look toward news and policy decisions by govt. My neighbor told me yesterday why Indian markets will go up now. He said it was inflation and esp food price inflation that was worrying govt. According to him, this coming year India is going to have one of the best agriculture production thanks to good monsoon and that will drive down food prices which will eventually result in high stock prices. He was so convinced about this that he refused to hear anything against this 'sound' logic. I asked him anyway - what will happen to the rural people who are directly dependent on agriculture? Won't they be in a better state and have more disposable income? Won't they buy a lot more goods and services with the extra income they would have as a result of good harvest? This is where common people stop thinking. A good monsoon is good for Indian economy and then it actually drives up inflation. RBI (Indian Central Bank) is uncomfortable and governor Subbarao has already expressed his feelings. I guess a good monsoon is going to create more troubles for Indian govt as well as RBI.

Milton Friedman said inflation is always and everywhere a monetary phenomenon and I agree partially. Inflation is indeed a monetary phenomenon but not always. We can see it today - even zero interest rates and 'monetizing debt' haven't been able to lift Japan's inflation and the same is happening in US as well. Bernake can't stop market forces, he can only do what he is told by market forces to do. And, despite deflation being the actual threat, interest rates will have to rise in coming days. In India its a little different - monetary inflation and its threat will force RBI to raise interest rates which will eventually result in deflation.