Is It Deja Vu All Over Again?

There has been much talk in the papers, of late, that "Stagflation" may be rearing its ugly head in the U.S. economy. For those of you too young to remember, "stagflation" is a particularly nasty economic phenomenon where both recession and inflation occur simultaneously, a phenomenon we have not seen in the U.S since the 1970s.

As the Wall Street Journal's Greg Ip recently pointed out, "stagflation" is a term coined by British economist/policy-maker who, in 1965, noted that Britain's economy suffered from both stagnation and inflation, a condition he termed "stagflation."

"Stagflation" is highly unusual. That's because, historically, a recession (or economic stagnation) weakens consumer demand for goods and services, bringing prices (or inflationary pressures) down. Hence, a recession is rarely accompanied by inflation.

That was the huge conundrum for, not only the British in 1960s, but Americans in the 1970s, who saw their economies suffer multiple recessions even as inflation rose unexpectedly. Remember the soaring cost of oil, gasoline, food 1971 to 1982? Remember the gas lines in 1979?

My first car loan in 1981, for a 4-door tan, 1979 Chevy Nova (yes, it was an incredible chick magnet!) was 20 and ½ percent. By then, inflation had jumped to 13%, unemployment to 9%, as we suffered through the worst recession since the 1930s and the worst inflation in the history of the country.

While it may only be a semantic argument, because there are many similarities to the 1970s when it comes to the economy, I am going to dub the current economic situation "inCESSION," not "stagflation."

That is a condition where we have the cost of goods and services going up, but recession is the bigger problem of the two, unlike the 1970s, where inflation was the more intractable issue.

The real estate recession and the ensuing credit crisis I have been writing about are highly contractionary events. I believe we are already in a recession and it's likely to get noticeably worse before it gets better. I would also suggest that the rest of the world will weaken with us and this myth of "de-coupling," where the world economy grows while we contract, is nonsense. We have had a nearly unprecedented synchronized, worldwide economic expansion from 2002-2007. There is no way the rest of the world doesn't weaken if we stop growing. With America accounting for 1/3 of global GDP, places like Europe (already weakening,) China and India simply cannot grow without our engine firing on all cylinders.

The "de-coupling" argument, by the way, is being made by brokers who want to keep you invested in emerging market mutual funds, where American investors have been pouring tens of billions of dollars over the last 18 months.

As soon as investors realize the rest of the world is in an equally precarious situation, they will sell their overseas stock market holdings and kill the remaining goose that is giving Wall Street its last golden eggs.

With respect to inflation and/or "stagflation," it is true that commodity prices are skyrocketing ... oil at $100 a barrel, gold at $940 an ounce, platinum over $2,000 an ounce (some women I know are already contemplating hocking their platinum wedding rings to cash in! My wife thought about that at $1,000 an ounce, but that's a story for another day!)

Meantime, the cost of wheat, corn, soybeans and other agricultural products are at prices not seen in about 30 years.

But those prices are not rising because domestic demand for gods and services is red hot ... the typical cause for inflation ... they are rising because investors have lost confidence in the U.S. economy and in the U.S. financial system, which has been plagued by extremely heavy losses on a variety of bad investments, from sub-prime real estate loans to risky leveraged buyout loans.

Hundreds of billions of dollars have been written off by big banks and other financial institutions, weakening our financial system and setting the stage for a protracted economic decline in the U.S. Investors, afraid to hold paper assets, are buying hard assets, like commodities, as a safe haven against the destruction of paper wealth and the devaluation of paper money, particularly our own.

The dollar has plunged as a consequence, putting upward pressure on all types of commodities, particularly oil, which is priced in U.S. currency terms. So, as the dollar declines in value, it costs more to buy a barrel of oil, or an ounce of gold or platinum.

This is not the type of inflation that is usually the result of an overheating economy. With the U.S. economy slowing at a rapid pace (pardon the oxymoron), demand is falling for everything from homes, to home furnishings to vacation houses and consumer goods.

Indeed, if we look ahead at the financial landscape, I believe that we face many more financial shocks in coming months, from the municipal bond market to the commercial real estate market and on to even more arcane corners of the financial markets, all of which will weaken the economy further.

But as a consequence of these competing economic forces, our Federal Reserve, and other central banks around the world, finds themselves in a box.

Because rising commodity prices have long been a leading indicator of inflation, these central banks may not cut interest rates quickly or deeply enough to keep the recession from getting worse.

Conversely, lower rates have continued to weaken the dollar, making commodity prices rise even faster. It is new conundrum for the Fed, and other policy-makers. They can't fight recession and inflation simultaneously. A recession requires lower interest rates. Inflation requires higher rates to cool off rising prices.

As I said before, this will be an "inCESSION," not "stagflation." The recession will be worse than inflation. The problem for policy-makers is that there is no easy solution to fixing either, which means we may suffer through this experience much longer than usual as the Fed fights a two-front war that could take a very long time to win.

Comments

[ibsteve2u]

"not seen in the U.S since the 1970s"

Sigh - just when GWB was partying his ass off, destroying short- and long-term memory cells.

Would that he could have remembered what happens when trade, tax, economic, and diplomatic policies and events converge to drive energy costs (and oil company profits) skyward.

Assuming he cares.

Oh, and assuming this convergence of energy price drivers is also just a historical coincidence.

(Methinks I doth assume too much.)

[LammertMacroeconomics]

Wednesday 27 February 2008 -the Final High for the CRB and the Final low for the US Dollar?

Over the the last 25 years, GDP growth in the United States has been a function of a debt driven economy. Since NAFTA in the 1990's, the computer-related bubble collapse in 2000, and the emergence of the Asian and Asian subcontinent manufacturers, facilitated debt creation and false asset inflation in the US has been primarily responsible for world growth. Propelled by unregulated lending parameters and standards never experienced before in the history of the word, the US and world money supply has grown through the creation of encumbered money - money borrowed against future wages and earnings. Over the last two years, encumbered and unencumbered peak investment money has rotated from real estate to equities and commodities and from the latter two to currently commodities and debt instruments. The real estate and composite equity peak saturation areas have come and gone. Currently there is only enough investment money to support commodities and debt instruments as encumbered money (and derivative encumbered money) is being sub rosa exponentially destroyed through debt default. By the potential science of valuation fractal analysis, the CRB is within 4 trading days of a saturation high which will likely match the US dollar's weighted value composite low. As on 11 October 2007 for the composite Wilshire, look for a new all time high for the CRB with a opening gap valuation above its previous day's high and ending near the low of the trading day. Look for an all time low in the US dollar weighted average with a reversal pattern ending near the high of the day. Ideally by valuation quantum fractal analysis, this should occur on 27 February 2008. For the CRB this will conclude a 10-11/27/26-27 day maximum saturation growth fractal. Rotation of money will then proceed into tax backed sovereign debt instruments driving interest rates to either record or near record lows. The yield on US treasuries in the 1930's was nearly zero.

[realitytrumpsbull]

Pull your nose out of Biz-Porn Daily, there, for a minute, and consider the Larger Picture.
The money machine is leaving a Big Red Trail,
indicative of some overdue maintenance. This truck needs some quality 'shop time' under the loving attention of caring and skilful fiscal mechanics. But, to DO that, first you gotta park it, and shut it OFF. Pull the stop handle,
and set the brake. Then, get out the clipboard, and be thorough, and find out what's wrong,
and get it fixed. We'll wait, nowhere to go until it's fixed.

[twebster321]

FIRREA blows! Appraisal regulation assists in pushing up the money supply (by way of helping to increase the value of collateral), economic activity (via higher and higher loan amounts in cash out refinancings), and lender profits. As such, regulation is little more than a ruse designed to shift financial liability for losses from the appraisal client (i.e., the lending industry) to the Federal government who is now responsible for appraisal oversight.

Now that the Nation is experiencing another serious financial 'adjustment' just like the S&L Crisis, lenders and GSEs will be able to point to Federally mandated appraisal regulation as their free pass to escape a Congressional inquisition (where property valuations may be called into question). They will have the appearance of having done everything according to 'the book'. The investor groups suffering damages from having purchased loan packages (with this designer gift wrap) will have to seek a bail out from the government - the ultimate underwriter and overseer of lending and appraisal regulation. The government will not accept blame, but it will go looking for a villain. Guess whom they will find? -from "The Fraud of Appraisal Regulation" by Larry Levy 2004.

[Rockyman]

Whatever you call our fiscal future it looks ugly! The housing appreciation-cycle and the equity pulled out gave us a false sense of prosperity. We "partied" and now the dust is settling and burying many in unpayable debt. With the price of goods rising due to energy-costs and with a "strapped" consumer you have a confluence that wil be with us for many years. Time to learn how to adapt to less abundance here, certainly among the middle and lower classes.

[Barrack69]

I had a 76 4-door Nova witha straight 6. A f'n lemon. Detroit died in the 70's.
Anybody that beleives the economic numbers that come from Washington is an imbecile.
In the northeast inflation has been around 10% for the last 10 years.
The only industry in the US is the credit industry, and it has been going strong for the last 20 years. If intrest rates were where they are supposed to be, 8-9% the US economy would cease to exist. Its only a matter of time.

Look at corporate management. They know. They are and have been taking massive amounts of compensation, cause they know whats coming.

I've been in Gold Bug/amex since 2002. Everything. They said I was nuts. Sold my house in 2004. Put it in gold. Been putting every cent in since. Its the only solid investment to beat inflation

[Sumocat]

I disagree; I think "recessiflation" sounds better.

[WIpatriot]

I agree, Sumo, but since we all get to make up words, I'll throw in "FINANCIFICATION" which means "the result of illegally privatizing a country's wealth while socalizing the entire impact of total economic collapse."

[joebhed]

The Refinacification Movement

where the "other" people say to those private-wealthians holding all that debt to fugetaboutit.

Didn't he say something about the destruction of paper wealth?
I thought that was what I read.

The creation of money (US$) in this country is carried out by issuing debt, much of it to foreign governments and corporations.
Those debts are payable in US dollars.
Those debts grow two to three times while they are held by these groups before they are paid off by our grandchildren.

All growth in the economy is supported by the issuance of debt(increasing the money supply) in order to fuel that growth.
The owners and the traders of that debt are the wealthy elite of international finance.
Fugetaboutit.
Only the economy of the US can actually generate US dollar value.
Ultimately it is the people and the taxpayers who are responsible for paying all that debt.
Maybe from the depths of the coming collapse people can begin to seek out a new means to create and utilize money.
And we start over. Putting the people in charge of their money.
Monetary nationalism.
It responds to the socialization of the cost of the collapse.
As if people mattered more than capital.
Rising up.

[Herrington]

I like the term "inCESSION", but we are all going to hate it before long. And the re-characterization versus "stagflation" is a very good insight into the cause. Whereas the oil shocks that caused the 1970s stagflation were geopolitical, the inCESSION is caused by the inability of the overall economy to absorb the dollars chasing a decent return. I would even go further and call it a wealth affect.

The 2000 stock bubble burst. The housing bubble burst. Now the commodities bubble is upon us. Wealth is chasing profits and is distorting the economy in the process. The Fed is helpless to stop it.

Nixon at least had enough sense to determine that a geopolitical problem required and political solution. We got the 55mph speed limit and wage price controls. The Fed solution alone, massively high interest rates, would have tended to stifle economic expansion. Energy conservation measures and wage supports keep the economy going long enough for the crisis to pass, a political resolution in the middle east.

Now you literally have investors playing OPEC with the full range of global commodities, not just oil. If anything, this will be far worse than the seventies. The Fed, as mentioned, is useless. No tinkering with interest rates will fix this. A political, legal, remedy is called for again, to counter the economic distortions caused by massive speculation in commodities. Middle east peace will not fix it this time.

One solution would be to target commodity speculation with the tax code. The other, longer term solution is to reverse the phenomenon that has caused it, ever increasing concentration of wealth and that fallow wealth devaluing because of the two tiered nature of the economy.

We will do neither of this things, the commodity bubble will burst. The wealth invested there will be lost, but only after the global economy has been ravaged enough to steeply curtail the demand for bread.

Interestingly though, raising interest rates might chase some money back into traditional investments and would certainly help the dollar.

[Idytme]

What you are missing in this is that commodities for perhaps the first time are now in limited supplies. The planet is getting to the limit of what it can supply for our population. There are already a bunch of stories about how this year will be the first year that China will become a net importer of commodities like corn. It may also have to start importing large amounts of pork. China has driven up the price of copper with its building boom. Like oil, the planet only has limited amounts of certain stuff but the demand keeps going higher.
While bubbles in commodities prices certainly can happen, it is a whole different entity than, for example housing markets.

[Herrington]

You make a good point Idytime. How close the horizons for global shortages is debatable. But on that same horizon looms the prospect that global resources, now subject of speculation, will become either private property or global public resource. Either way, near term speculative inflation of prices is not conducive to either the global economy or global peace.

[Craig]

One thing that might work is to protect the value of the dollar, primarily by having a flat import tariff (adjusted periodocally and tied to a basket of currencies) to maintain a constant dollar. If we can remove the dollar variable then dollar-based commodity bubbles won't materialize, business leader will be able to make better overseas investments decisiona, etc.

[Herrington]

I'm all for tariffs. But the dollar decline only exacerbates the impact of speculation caused inflation on Americans. Can't cause a bubble on its own.

I knew that the government would have to try and inflate its way out of the national debt. I don't think they could foresee investors being chased into commodities and compounding the effects of their currency policy.

[joebaggadonuts]

The only things I know of which cuts the demand for "bread" is less people, or them shifting to something else like rice as the staple in their diets. A person has to eat.

From this I can only conclude that what you are predicting, Stephen, is massive die off of the human population due to wealth shifting to ownership of commodities, making it impossible for many humans to eat because the wealth owners refuse to distribute their wealth.

Seems to me that there will be a better path. I don't know what it is though.

Generally, with the nit that Idytme being a minor and possibly transitory exception, I agree with your analysis and that of Ron Insana's here. Ron does put a clearer frame on things than I had before reading his article.

[Herrington]

Exactly Joe. Fewer people. Makes you wonder if the U.S. or any other nation is thinking at all about their letting speculators screw around with inciting global warfare.

[nowaterboardUSA]

I think that already happened. Much of our economy has been floating on Chinese money for years.

[Henry]

In the 70s at the fine universities, the Phillips Curve was taught to young business people and econ majors. The curve, juxtaposed inflation to unemployment. It was a priori correct right to the point that the empirics of stagflation blew it out of the water.
It seems that we are always on the learning curve of economics. Our latest chapter was the academic proposition that securitiations neutralize risk by bundling large numbers. Ooops, the invisible hand once again rejects.

[WIpatriot]

...and gives us the invisible finger.

[joebaggadonuts]

Black Swan should be required reading for any econ major.

[desmirl]

As the value of the dollar continues to sink--thanks entirely to the insanely incompetent economic policies of the Bush Administration--the economy will continue to get worse. Prices are rising because 1) energy costs are escalating and 2) too much of what we are buying comes from overseas where the dollar buys less. Jobs are disappearing because business are seeing fewer customers coming through their doors, so they are laying people off, which means fewer customers for other stores, which resonates back to the first store and... It's time for a change--or it's time to just close the doors and put a FOR SALE sign on the USA.