Stagflation may be just around the corner

[EJ]

Start saving, a new period of 'stagflation' may be just around the corner
April 6, 2007 (Linda Stern - Boston Globe)

What's more frightening inflation or recession?

The answer, of course, is both. Accelerating prices and a slow- or no-growth economy is a killer combo that's been called "stagflation" since the 1960s.

Folks of a certain age might remember the stagflation which dominated the US economy in the 1970s. It was a gloomy time when energy prices (and gasoline lines) dominated the news; when whole industries slumped at the same time, and when job losses and price hikes seemed to travel in tandem.

AntiSpin: Several members have thoughtfully sent me a few recent notes on stagflation. (Thanks, guys.) iTulip's intrepid Stagflation Godzilla showed up last June:

Stagflation Godzilla Returns, Attacks Finance-Based Economy!

Global Central Banks Send Anti-Inflation King Kong to Fight Back!

Will the Finance-Based Economy Survive or be Destroyed in the Great Battle?

Do a google search of goggle news on the word "stagflation" a year ago and not much turned up. Today, in addition to Linda's excellent report and advice, you'll find the following:

Zook: Stagflation a growing 'possibility'

Five Things You Need to Know About Stagflation

Growing body of indicators raises spectre of stagflation

Federal Reserve trapped in its own game
Stagflation hits Main Street as housing markets slumps and rents start rising rapidly

I've been on this inflation/recession jag for a while. In One Thing Leads to Another in the Bubble Cycle Wonderland in 2004 I concluded: "Like it or not, if the status quo cannot be maintained, we're more than likely heading into a period of inflation."

All of the recent articles that are coming out offer good advice, but don't really get to the heart of what causes stagflation and, therefore, whether or not the inflation part of the program is likely to continue.



Stagflations can happen when one foot of government is on the brake and the other is on the gas, or when Fed and economic policies fail, as they did in the early 1970s. The Fed raised interest rates in 1969 to try to tame inflation by tightening the money supply. Six months later, the Nixon administration undertook trade union policies to increase unemployment in order to slowing consumer demand, believing that this would slow inflation. The theory was that increased unemployment cuts demand by reducing aggregate personal income. Unfortunately, access to consumer credit increased due to deregulation of the credit industry, and credit expanded to fill the gap left by falling incomes, so demand did not decline. What did decline was production, and thus the supply of goods and services available to be purchased with expanded credit. As a result, inflation got worse, even as the economy shrank–stagflation. Paradoxically, what could cure this was to either reduce consumer access to credit or allow an increase in capacity utilization. In the event, neither was done.

That was a unique period in time. The world is never the same in each similar episode. We will experience stagflation–are already experiencing the inflation part, while the recession will not hit until late this year. This stagflation is a different animal altogether, related to the housing bubble and the reliance of dollar demand and cheap imports to keep inflation balanced.

The recession this time around is being triggered by recessions in the housing and automobile segments. We are experiencing high inflation in non-traded goods and services (energy, health care, education) because household credit continues to expand.

Look for continued high inflation in the prices of non-traded goods and services purchased on credit, and continued asset price deflation (especially real estate), rapid in areas of rising unemployment and more gradual elsewhere. Watch for an onset of inflation in traded goods as the US economy slows, dollar demand declines, the dollar depreciates, and traded goods prices rise.

[akrowne]

Re: Stagflation may be just around the corner

This reminds me I must share a photo album pic from my recent trip to Japan with my friends at iTulip:

[wayne]

Re: Stagflation may be just around the corner

One of the big factors in the stagflation of the 1970s - besides the guns-and-butter profligacy of the Johnson administration - was the need to put the baby boom to work. The last thing Nixon and the Republicans needed, after having wrested control from the Democrats, was a Godzilla-sized generation of college graduates and newly minted voters unable to find work to match their elevated expectations. The problem of what to do with the boomers was exacerbated by the rapid entry of baby boom women into the workforce. Given the option of massive unemployment with possible deflation and merely high unemployment with inflation, Nixon and the Fed chose that latter as the lesser of two evils. Fortunately for the boomers and their parents, Nixon, his successors and the Fed were able to attract enough foreign capital through a combination of high interest rates, U.S. economic pre-eminence and dollar hegemony to finance this difficult demographic-driven transition.

The biggest beneficiaries of this policy were probably the boomers' home-owning parents and those lucky leading-edge boomers who managed to glom onto real estate courtesy of negative real-interest mortgages from the beleaguered savings and loan industry (not including me, alas). This effected a massive transfer of wealth from old-school stock and bond investors to the middle class, though eventually the inflation side of the equation got so scary that Carter had to call in the calvary (Paul Volcker) to cool things down.

We could weather this first storm because the boomers were young with their best salary years in front of them, debt levels relative to GDP were still relatively low and U.S. dollar hegemony still pre-eminent, albeit on the wrong side of the bell curve.

The unfolding of this final chapter of the Baby Boom Saga is much scarier. Debt-to-GDP ratios are at levels not seen since the 1920s, with unfunded social-safety-net promises to the boomers clocking in at $50 trillion. Most of the boomers' net worth, meanwhile, is tied up in energy -devouring McMansions in sprawling suburbs the much smaller demographic behind them is not going to want or be able to afford with peak oil right around the corner, if not already here. (This will likely make the housing bust secular rather than cyclical.) The dollar is teetering. It really looks the worst of the 1920s and 1970s. Not a pretty picture.

[jtabeb]

Re: Stagflation may be just around the corner

The dollar is teetering. It really looks the worst of the 1920s and 1970s. Not a pretty picture

You hit the nail on the head my friend!

[rj1]

Re: Stagflation may be just around the corner

One of the big factors in the stagflation of the 1970s - besides the guns-and-butter profligacy of the Johnson administration - was the need to put the baby boom to work. The last thing Nixon and the Republicans needed, after having wrested control from the Democrats, was a Godzilla-sized generation of college graduates and newly minted voters unable to find work to match their elevated expectations. The problem of what to do with the boomers was exacerbated by the rapid entry of baby boom women into the workforce. Given the option of massive unemployment with possible deflation and merely high unemployment with inflation, Nixon and the Fed chose that latter as the lesser of two evils. Fortunately for the boomers and their parents, Nixon, his successors and the Fed were able to attract enough foreign capital through a combination of high interest rates, U.S. economic pre-eminence and dollar hegemony to finance this difficult demographic-driven transition.

The biggest beneficiaries of this policy were probably the boomers' home-owning parents and those lucky leading-edge boomers who managed to glom onto real estate courtesy of negative real-interest mortgages from the beleaguered savings and loan industry (not including me, alas). This effected a massive transfer of wealth from old-school stock and bond investors to the middle class, though eventually the inflation side of the equation got so scary that Carter had to call in the calvary (Paul Volcker) to cool things down.

We could weather this first storm because the boomers were young with their best salary years in front of them, debt levels relative to GDP were still relatively low and U.S. dollar hegemony still pre-eminent, albeit on the wrong side of the bell curve.

The unfolding of this final chapter of the Baby Boom Saga is much scarier. Debt-to-GDP ratios are at levels not seen since the 1920s, with unfunded social-safety-net promises to the boomers clocking in at $50 trillion. Most of the boomers' net worth, meanwhile, is tied up in energy -devouring McMansions in sprawling suburbs the much smaller demographic behind them is not going to want or be able to afford with peak oil right around the corner, if not already here. (This will likely make the housing bust secular rather than cyclical.) The dollar is teetering. It really looks the worst of the 1920s and 1970s. Not a pretty picture.

The thing I do not get is what the government are going to say. No politician ever says "I made a mistake". Everything is always someone else's fault. So what does everyone thinks the Fed and George W. Bush will do that will give them the escape clause of plausible deniability by fooling most of the country into thinking they are right? It's a bit like what I heard a comedian once say about Clinton. Clinton could be standing right in front of you and say "I'm not here" and could make it believable.

[EJ]

Re: Stagflation may be just around the corner

The thing I do not get is what the government are going to say. No politician ever says "I made a mistake". Everything is always someone else's fault. So what does everyone thinks the Fed and George W. Bush will do that will give them the escape clause of plausible deniability by fooling most of the country into thinking they are right? It's a bit like what I heard a comedian once say about Clinton. Clinton could be standing right in front of you and say "I'm not here" and could make it believable.

Bill Clinton knows what every politician knows, that the majority want to be fooled, and he has a special talent for it. His successor has been ham handed and less successful. Greenspan was a master. The jury is still out on Bernanke.

I talk occasionally about the Desperate Optimism of the Invested, the man with half his net worth in Nortel stock at $1,200 (now $28) a share who insists in August 2000 on the fact of the economic New Era, or the owner of several properties bought on spec in late 2005 who insists that housing prices only go up, and depends on the availability of buyers at a higher price to avoid bankruptcy, divorce, or worse.

But there is also the more general assumption of the population that our leaders are not capable, either by incompetence or will, of putting the entire nation's future in jeopardy, to place the investment of generations in blood and treasure on the line for short term political and economic gain. The validity of this assumption may soon be tested.

[wayne]

Re: Stagflation may be just around the corner

George Bernard Shaw famously described democracy as "a device that ensures we shall be governed no better than we deserve." But in times of crisis, we seem to have gotten what we need rather than what we deserve, a Churchill or an FDR, say, leaders who - irrespective of the wisdom of some of their policies - manage to transmit their ferocious will to survive to the body politic. Let's all hope that when our economic house of cards comes crashing down around us, this aspect of our history will rhyme.

Author and alternative spiritualist John Michael Greer, meanwhile, has a dead-on metaphor for the psychology behind the Desperate Optimism of the Invested: the monkey trap. It helps explain why the Mayans failed to switch to a more sustainable crop than corn once they began to deplete their topsoil, preferring instead to make war on their neighbors, and why the poor wretches on Eastern Island, in a frenzy of statue building to appease their gods, accelerated their descent into wretchedness by felling the last of the palms that provided their firewood, habitat for their prey, a sap good for making honey and wine, and the raw material for their canoes. (Ethanol, anyone?)

The monkey trap is gourd anchored to a rope with some delectable monkey food inside. In one end of the gourd is a hole large enough for the monkey to slip an empty hand into but too small for the monkey to extract that same hand while gripping the food. Greer: "You come out of hiding and head toward the monkey with a net, if there’s a market for live monkeys, or with something more deadly if there isn’t. Far more often than not, instead of dropping the food and scampering toward the safety of the nearest tree, the monkey will frantically keep trying to wrestle the food out of the gourd until the net snares it or the club comes whistling down." (Full post at thearchdruidreport.blogspot.com.)

Greer compares the food in the gourd to fossil fuel, but here in the land of optional ARM liar loans, the metaphor works equally well for debt.

[flow5]

Re: Stagflation may be just around the corner

"Given the option of massive unemployment with possible deflation and merely high unemployment with inflation, Nixon and the Fed chose that latter as the lesser of two evils"

No, it's all about arrogance, ignorance & and the dim-witted. Commercial banks create new money when they make loans. They do not loan out savings. Savings impounded within the commercial bankings system have a payments velocity of zero. The stoppage of the flow of savings shrinks aggregate demand, and therefore produces adverse effects on GDP, the level of employment, and on other indicators of the state of our economic health. This is the origin of stagflation.