The Dow finally breaks above 9,000 for the first time since January. Is this just a bear market rally? Despite positive earnings announcements from corporate America and the announcement of 3.6 percent gains in existing home sales, there seems to be an army of analysts who would say the 34 percent gain from the Dow low in March it will not continue.
Some analysts indicate that there is a high risk that corrections in the market are inevitable and that history would show that reversals of one third to two thirds could come.
While many would say that the US is showing signs of recovery, some are calling for a plan to counteract the effects of inflation that is expected to continue at the end of this recession. Without an effective plan, fears of inflation could have a negative effect on the markets in the future. Inflation has a direct impact on Credit and Credit rates.
The Federal Reserve sets monetary policies which are the main tools to control inflation. One policy is to fight inflation by setting higher interest rates (slowing down the increase in the money supply). Maintaining a balance in interest rates is a complicated issue. Keeping interest rates too low results in deflation which many economists believe is a problem for our modern economy due to the danger called a deflationary spiral. One of the worst economic disasters in history is tied to a deflationary spiral, and that was the Great Depression.
The Great Depression, or Black Tuesday, the day of the great stock market crash, October 29, 1929. The Dow Jones Average quintupled through September 1929, after which, for six weeks, the Dow Jones fell sharply, which resulted in nearly 13 million shares being sold as investors lost faith in the Stock Market and panicked in an effort to salvage what little was left of their investments. An incredible $30 billion was lost in that one week in October alone.
By mid-1932, the Dow Jones was down a staggering 89 percent, all because of the Federal Reserve’s policy of trying to lower interest rates to revive growth. Today, while most Americans rejoice at the news of the interest rate drop, there is quiet fear among the few who can remember the devastation of that unforgiving time in history.
Since December 2007, the core inflation rate in the United States has fallen to less than 1 percent compared to the Great Depression, when core interest rates fell as much as 10 percent annually. The Federal Reserve admits that while this is a good sign of a recovering economy, they still need to be very vigilant and watch closely for signs of deflation. However, due to some of the measures taken to combat the current credit crunch, especially with mortgage-backed securities, current inflation risks are quite different from any previous recession.
For now, lending interest rates are holding steady and may rise slightly in the future to account for subdued inflation. Recent studies have indicated that the number of American households behind on debt payments is declining and that a turning point in the economy is approaching.
While there are no easy options for the Fed to act now, with unemployment as high as 9 percent and foreclosures raging, a plan must be put in place to contain inflation if necessary.