A Touch of Stagflation?
Posted by Stuart Staniford on October 6, 2005 - 9:56pm
Topic: Economics/Finance
Tags: hubbert peak, inflation, oil, peak oil, stagflation [list all tags]
The assembled macro-economists at Econbrowser were hard on this theory, viewing inflation and economic contraction as only possible together due to clueless actions of the government based on long discredited theories. So it was with interest this morning that I read the following in the San Francisco Chronicle that accompanied my omelette: Concern rising over possibility of stagflation. Seasoned market watchers say traders may be overreacting as Dow drops 124 points
Investors and economists are growing increasingly concerned that inflation could be creeping upward even as economic activity slows.Just what the ECP model would predict after a touch of hurricane induced energy loss follows a period of flattening energy supply...The Dow Jones industrial average dropped nearly 124 points, or 1.19 percent, to close at 10,317.36 Wednesday, as Wall Street reacted to a report from the Institute for Supply Management showing that service sector economic activity grew in September, but more slowly than in August, and at the lowest rate since April 2003.
At the same time, the institute, an association of private sector purchasing managers, said its index of prices jumped to the highest level since the measure was devised in 1997.
Given how incredibly wasteful our economy is regarding energy, I have a hard time believing that decreasing energy usage implies a contracting economy. Eventually you would reach a point where this might happen, but there is so much fat in our economy that I cannot see this happening for a while.
There would be some economic pain for those whose role in the economy is to support the wasteful use of energy - those people would feel the pain right away.
Just pronounce some segments of the economy "fat," then when they go, the economy is not really contracting.
Is the recent hikeup hitting energy intensive economies (China) hard? It would make sense.
Fast changes in energy price force consumers to eat the price before any adaptation, reducing other consumption, thus slowing the economy. The more slowly energy costs increase, the more likely we can adapt and still have a good economy.
Henry
Check the CPUC site.
The Wikipedia entry is to me hilarious for all it's careful working around all the possibilities except, to me, the obvious one. Shhhhh. Maybe, just maybe, stagflation, and reverse stagflation in the 90s, has something to do with energy supplies....
As far as stagflation, I go back to chaos theory and the Heidegger environmentalists. Any natural environmental event that you try to change, you inevitable worsen. Monetary policy causes harsher collapses than need be.
One thing that distinguishes "inflation" from an increase in the cost of goods is that in inflation, wages go up along with prices. If wages are not rising then we are not seeing a general inflation of the money supply, but rather goods are getting more costly due to changes in how hard they are to make and get.
But they didn't do the analysis all together. If they did, they would see that the economic slowdown will reduce demand and curtail the amount people are willing to spend, making it difficult or impossible to raise prices. What might end up happening is that some prices will fall, those for which the effects of decreased demand are stronger than the effects of increased costs.
I am not an economist but what I understand is that the stagflation of the Jimmy Carter era is seen as due to bad policies on the part of the central bank. Basically they had this Keynesian model where the bank could choose any point they wanted on a curve trading off unemployment and inflation. But after playing this game for long enough, people began to factor in future inflation, building it into their contracts and such, and as a result inflation no longer had the stimulative effect that it used to. Basically Keynesianism only worked if nobody knew about it. Once people caught on to the con, the jig was up. That bill came due in the stagflation era.
As far as the relation between unemployment and inflation.. I remember the curve you're talking about.. something makes me think it's called the Rule of Seven, where for every point of unemployment gains, you gained 7 points of inflation, although that obviously can't be it.
If there's any economics specialists around..
Which is why I prefer to keep my cash on hand. I don't have an insane fortune of it, so I don't worry too much about security. Also, in the end, keeping it stored at my house doesn't do much for the sudden inflation after a bank run and replaces my run to the bank with a run to my house. But, I figure by saving the frustrations at the banklines, I'll have time to rush home, grab the money, and take the next logical step before anybody else has the chance. I've already located a nearby coin shop and became friendly with the owner, and he has guaranteed me he'll honor an exchange with me. So, while everybody else is sitting with as large a pile of cash they could find for themselves, I'll hopefully be carrying 3 oz of Krugerrand. True, it's not a fortune, but I guarantee it will become an indemand commodity, which should earn me a nice profit as I start leveraging it. Truth be, I don't like alot of aspects of capitalism. But when it comes down to securing limited resources for my family group, I'll probably be ruthless.
And, with that, I feel like a Dostoevsky character.
Those with guns, or land, will do ok, provided they know how to use them. But I guess there are alread plenty of guns in the land.
If fiat currencies become worthless my choice for exchangeable 'currency' would be cigarettes. When the brown organic lumps hit the fan, I'm going to load up the freezer. There are still 25% of adult Americans smoking, many of whom will trade food and guns for smokes. Of course, then we get to that stage there may not be any electricity to power my freezer, so maybe I'll take up smoking myself (cough).
If I had the physical possibility I'd also have made a personal reserve of gasoline. Just in case of course.
I know that modern infrastructure is very sensitive for disturbances but i believe that people can handle more then they can imagine. But bad preparations as in civil defence, grid redundancy, etc can mean that quite a lot of people can die during emergencies while other people figure out how to keep things running.
Having a few disasters helps the preparations for worse disasters but it is a horrible thing to wish for.
For instance. Sweden were very lucky during the first world war but had civil hardship due to trade disturbances. We vere even more lucky during the second world war and in manny ways the civil hardship were less due to lessons learned during the first world war on how to handle rationing etc. We were then very well prepared to be as lucky in the thirld world war untill the end of the cold war. ;-)
Of course you have to be careful what type of mortage you pick in case you choose real estate. Or simply do what everyone else is doing - spend and get in debt. I've been through this twice, and I can say that at least in my lifetime debtors have always been the winners in this game.
The middle class has seen no real dollar wage gains in half a decade now (median family income in the U.S. is the same as in 1999 according to the NY Times). Corporate profits and upper class incomes have soared. Since the middle class makes up the bulk of consumer spending, it is the driving force for long-term economic growth. High inflation would hurt, but it would also correct the growing gap between the middle class and the rich: the rich are investors which indirectly hold much of the middle class' debt.
Just trying to find a silver lining...
Put another way, yeah it may feel good to you that now your mortgage payment is only 5 or 10% of your take-home pay, but does that really mean anything when spending on essentials such as food, gas, electricity is now closer to 70%? You certainly won't feel any "richer" than you did before, indeed you'll probably feel vastly poorer, since you'll realize that after paying the bills for essentials, you don't have a lot left over for discretionary purchases (movies, dining out, luxury goods; i.e. the things that make one feel "rich").
And the problem with private debt has never really revolved around fixed-rate, secured instruments, but rather with above-one's-means spending on consumer goods on variable-rate unsecured credit lines, whose rates WILL GO UP DRAMATICALLY with inflation. With the new changes to the bankruptcy bill, creditors still make you pay it all off, essentially committing you to a life of wage slavery. So instead of wiping out your bad debts and getting to keep your home, you'll be forced to liquidate your home and assests at fire-sale prices (due to collapse of new mortgage market from high interest rates), only to become what is essentially a modern-day sharecropper (to use Warren Buffett's term).
If U.S. consumers are primarily holding variable rate debt, then you are absolutely correct and we're toast.
However, if the debt is primarily fixed, then I think we may benefit as long as workers get cost-of-living increases that match inflation fairly well. Real dollar wages would not increase, but the amount or real dollar debt would plummet. My scenario is based on the idea that variable rate debt is a much smaller amount than fixed. (Most debt is house + cars, a little is credit card).
If the debt is variable (lots of credit card debt), though, the interest payments will, indeed, reduce much of the middle class to sharecroppers.
In any case, if you have variable rate debt you better shed it NOW. It doesn't hurt to be rid of it -- but having it may be a disaster in the making.
100% agreed, but my take is that variable rate debt is a bigger chunk of the debt market than you think, and right now it's the fastest growing form of debt (witness the rise of ARM's and even negative amortization mortgages in areas with ridiculous housing prices). I don't have the numbers to back that up right now, I will go look them up though.
My other point, which I guess we could quibble on, is the impact of stagflation. When I hear stagflation, to me that means that since there is no economic growth, employers will not have the wherewithal to both a)increase wages to at least keep pace with COLA due to inflation and b)promise a real (inflation-adjusted) rate of return to their investors. That means something's gotta give. My bet is it will be wages. There will be wage freezes, and maybe even outright layoffs and cutbacks (witness the labor concessions we've been seeing in the airline industry). In which case, average middle-class Joe will see cost-of-living consume an ever larger chunk of his take-home income, thus making him feel "poorer" regardless of how his debt's been eroded as per my analysis from my previous post.
In such a situation, it also logically follows that unsecured, variable-rate debt usage will skyrocket, as families make tough decisions between putting bread on the table and getting even deeper into debt. Now, maybe the credit companies will finally wake up and realize that they're making a bad situation horribly worse by lending to folks with little to no ability to pay them back, but now that they've got the protections from the bankruptcy bill, I think they will continue with impunity.
But who knows? It all depends on how spectacular the inflation is and how much the economy slows down. Might not be as bad as we think.
(ps the other potential silver lining is that interest rates on savings accounts will also increase, providing a bit more income, though I expect this to be a minor effect)