Dollar, Fed and Global inflation

The recent decision of the US Federal Reserve (Fed) to cut their interest rates by 50 basis points in response to the sub prime crisis may lead to new problems. Global inflation which has been unusually benign for the last decade or so because of the surge in globalization seems all set to make a dramatic come back. Oil is past 80$ to a barrel and gold has climbed to 28 year highs threatening to go past 800$ an ounce. Food inflation is already running between 5 and 15% in most countries with a combination of environmental disasters and diversion of crops to bio-fuels adding to shortages. Whether it is wheat, corn or some other cereals globally or shortages of pork in China, or tortillas in Mexico, food inflation is going to be both politically and economically a major issue in the coming months. In such a scenario, the Fed has cut interest rates and it sure had its reasons, what with the R word being bandied out by every other economist. But this cut, which effectively will add a new global flood of liquidity will probably create another asset bubble to add to the global stock and housing bubbles. This new bubble according to economists might be in emerging markets. Most of these markets are already at or close to their life time highs. How long this emerging market party will last will again ironically depend on inflation. If the dollar continues to fall and global inflation makes a comeback piggyriding on oil, commodities and food, the Fed will have to go back to increasing rates and Alan Greenspan's prophecy of 10% interest rates may not be that far. This will almost surely stall the global economy if not bring out a full blown recession. Asset markets whether property or stocks worldover will take a massive knock. Globalization has made sure that economic booms and crises will now be global. The assets to own in the event of such a crisis will surely be Gold and ironically the dollar. Once the Fed starts raising rates, the dollar will start to make a massive comeback both against emerging market currencies as well as the euro and the yen. If all this is beginning to sound scary, it actually is. This has to be one of the worst times to predict where the asset markets are headed. All we can hope is that inflation continues to somehow remain benign and the Fed can pull the US economy and the world out of this current mess.