Wednesday, April 16, 2008

Look out! It's a Dinosaur from the 70's!?

No, I wouldn't worry, it's only stagflation, nowhere near as dangerous as a stegosaurus or some other such creature. That's right, stagflation is back and it's not a dinosaur, but it is a bit of flashback fun last experienced for realsies back in the 1970's. Yes, it's economics, and no it has nothing to do with a stag party. However, it could be as nasty and hard to get rid of as something you might wake up with if you get a little too wild at one of those parties.

Not the girl next to you silly, I mean that seemingly incurable rash that she innocently infected you with. Stagflation comes from the combination of stagnation and inflation. The economy grows slowly (or shrinks, recession), unemployment rises, while prices rise. (Wikipedia told me that this type of word is known as a portmanteau, the fusion of two function words) Prior to the 1970's this situation had been thought to be impossible, or next to it. Modern macroeconomic thought, brought to the world by John Maynard Keynes, told us that in times of slow growth, governments should spend us out of our problems, while in times of inflation, a tight monetary policy of high interest rates would cure what ailed the economy. Both happening at the same time caused a dilemma, how could this happen and what can you do?

The general view of events surrounding the last period of stagflation from 1973-1980 lays the blame on the democratic Carter administration. Those left wing bastards spent us into a fix. The ultimate irony will occur if a democrat is once again voted in to the White House come November and the blame once again gets laid at the feet of the wrong party. That way we'll never learn, and keep believing that the fiscally responsible republicans really know how to run the economy. The reason for this is that today's scenario is eerily reminiscent of what happened back in the early 70's. Let's compare. In August 1971, the Nixon administration imposed wage and price controls in an attempt to control inflationary pressure. While this is unlikely to happen today (we've learnt that these things don't work...), the presumptive republican presidential nominee John McCain has suggested a temporary federal fuel tax suspension in order to control the price of gas. Yes, that should help bring down the price of oil as well as the price controls brought down inflation... as the US entered stagflation in 1973. Staying with oil, in that same year of 1973, US aid of Israel in the Yom Kippur War brought the retribution of the Arab world in the form of an oil embargo against the US. As of now, the US has been fighting a war in Iraq for over 5 years, watching oil prices climb above the $114 mark, while at the same time nagging OPEC to open the taps, flood the market with oil. Funny enough, they're not listening.

Of course, today we're facing even more ominous looking signals than we were in the early 70's. I keep reading about how yes, we may be headed towards stagflation, but it'll be nothing compared to then. Do these people not live in the same world as you and me? Oil is over $114, gold went over $1000/oz a while back, and I already went on about food a couple of blogs back. Commodities are all priced in $US to facilitate world trade a fact that is compounding the problems. The greenback has fallen dramatically over the last six years, today $1 is worth less than 63 Euro cents, on this date in 2002, it was over 1.12 Euros! Of course all of these numbers are inter-related. As the dollar falls against other currencies, it becomes more expensive to buy things on the international market. At the same time investors tend to take their money out of dollars and try to find "safer" options, usually things like gold or other commodities, thus driving up their price further. This vicious circle is similar to the dangers of stagflation. Rising prices lead to wage increases which lead to higher prices on the one hand and job losses and lower output on the other.

So, what does this have to do with those of us not living in the lower 48 or Alaska or Hawaii? Well you see, like it or not, the American economy has a larger than life influence on the global economy. I came across an economics word that at least for me was new as I researched this blog, "decoupling". This theory holds that the world's economies have developed to the point that they no longer rely on the US economy for their growth. A quick look at global markets debunks this theory as value is being lost around the world. Calling America's mortgage crisis the biggest financial shock since the great depression, the IMF has recently said that the global economy has a one in four chance of falling into recession. This is an institution that tends to hedge on the side of safety, which makes the real chances far greater. The US still represents about 21% or the global economy, meaning what happens there is felt around the world. To give this context, four of the economies deemed most vulnerable to an American recession, Japan, Britain, Spain and Singapore together only account for 12% or the global economy.

How did we get to this point? The most common explanation for this economic anomaly is the existence of some kind of "supply shock". In the 70's it was oil, and would you look at that, once again it's the price of oil. Hmmm, I wonder how that happened. The second factor is inappropriate macroeconomic policies, which are controlled for the most part by the Federal Reserve in the US of A. Recessions happen for various reasons, many of which are out of the Feds control, but if the experience of the seventies taught us anything, it was that inflation is caused by expansionary monetary policy (low interest rates, see the graph below, notice that long period between 2002 and 2004, can you say loose money, credit crisis waiting to happen?) and can only be brought under control with a strict tightening of policy (raising of interest rates). The most powerful weapon in the Feds arsenal for this fight is interest rates. Quite simply, lowering them causes a growth in money supply and thus inflationary pressure, but hopefully helps to stimulate the economy. It can be argued that the Fed is faced with a unique situation this time around with the implosion of the housing market and the resulting credit crunch along with a slowing economy, leaving them no choice but to lower rates. However, the main cause for this problem in the first place was the low rate policy for the first part of the decade. So lowering rates seems a little like trying to put out a fire with a flamethrower. Another factor is of course the upcoming presidential election. Many argue that one of the Fed's responsibilities is to ensure that the US economy avoids recession until after an election so as not to be an issue. Guess what? It's too late. McBush, Hot Rod and Hope for Change(McCain, Clinton and Obama) have all made it a big deal. Therefore one has to question the logic of Mr.Bernanke (Fed Chairman) and his cohorts.

As usual, the stupid prize goes to George W himself. Having decided to give away free money to every American ($600) they are now running commercials promoting the idea that everyone should run out to the mall immediately to spend it on something useless. Don't save it to pay for the more expensive goods that you'll need to buy when you're unemployed, but use it to exacerbate the inflation problem! Why use it to pay down your debt, the republican White House would never try to decrease their debt, in fact, they'll probably pay your mortgage back for you, or at least provide enough money to the finance company who lent it to you to stay afloat. It's an economic miracle that could only be made in America.