stagflation or what next?

[ScreamingEagle]

Two excerpts on the topic:

What's causing concern

Three economic indicators are suggesting that slow growth may be converging with rising prices:

-- The consumer price index has jumped from an annual rate of 2.5 percent in June to 3.6 percent in August.

-- Tough talk by Federal Reserve officials suggests a hawkish stance on interest rates. The Fed's short-term benchmark rate is now at 3.75 percent.

-- Wall Street has reacted by driving the Standard & Poor's 500 index down 2.6 percent so far this week.

http://www.sfgate.com/cgi-bin/article.cgi?f=/c/a/2005/10/06/BUGCMF30J31.DTL

Probably the most feared possibility is the dreaded stagflation: rising inflation at the same time as stagnant economic growth. It has happened before, most notably in the 1970s -- also an era of high energy costs, a fact that has not escaped those who take the stagflation threat seriously. It forced up interest rates when the economy can least withstand higher borrowing costs, and spelled death for stocks.

David Rosenberg, chief North American economist for Merrill Lynch in New York, doubts anything like the 1970s is a serious risk. Still, recent U.S. economic indicators do suggest that a mild form of stagflation -- "strictly defined as an environment of slower growth and rising inflation," as Mr. Rosenberg puts it -- may already be upon us.

In a stagflationary environment, cash might be your best investment option. Mr. Rosenberg's research shows that cash holdings matched average returns from equities in the three biggest stagflationary periods of the 1970s and 1980s, but with much less risk. If you insist on holding stocks, you'll want a " defensive portfolio -- health care stocks, consumer staples, utilities, telecom services," he said. "Avoid the cyclicals, especially consumer discretionary stocks."

Most economists doubt stagflation could be anything more than a short-term phenomenon. They figure an energy-fuelled spike in prices would slow consumer demand and put the brakes on economic growth, leading to lower prices. (We could be seeing the beginnings of that now, as energy prices have retreated sharply in light of the prospect of a price-triggered drop in consumption.) That would remove the impetus for central banks to raise interest rates, and, indeed, give them reason to begin cutting rates.

"The slowdown without inflation is the classic 'soft landing,' and the last two -- in the mid-80s and mid-90s -- were very bullish for the equity market," Mr. Rosenberg said. "Tech stocks would scream in this environment, and transports and consumer cyclicals would likely outperform."

There is, however, a third possibility: That the spike in energy prices and resulting economic road bump are temporary phenomena, and that we're in for a period where oil and gas prices stabilize at lower levels and a humming economy. In that case, the central banks will continue to raise interest rates to fight inflationary pressures, but those pressures will be fuelled by healthy expansion, rather than soaring fuel costs. Given yesterday's surprisingly strong U.S. employment numbers -- jobs dipped a mild 35,000 in September, despite the massive displacement caused by two major hurricanes -- it could be that the U.S. economy can emerge from those natural disasters surprisingly well, and with the economic stimulus of a major reconstruction to come.

http://www.theglobeandmail.com/serv...20051008/RTAKINGSTOCK08/TPBusiness/Columnists

 

[Toro]

The Phillips Curve is dead.

 

[ScreamingEagle]

The Phillips Curve is dead.

So you think we are in for a period of stagflation?

 

[Said1]

The Phillips Curve is dead.

Really? You have it figured out, explain.

 

[BaronVonBigmeat]

In a stagflationary environment, cash might be your best investment option. Mr. Rosenberg's research shows that cash holdings matched average returns from equities in the three biggest stagflationary periods of the 1970s and 1980s, but with much less risk. If you insist on holding stocks, you'll want a " defensive portfolio -- health care stocks, consumer staples, utilities, telecom services," he said. "Avoid the cyclicals, especially consumer discretionary stocks."

Surely he means foreign currencies or something. Of course, gold is always an investment option too. If we've got stagflation, then inflation is part of that, and the value of your money is going down. That's not too surprising when the Federal Reserve has been creating money out of thin air at such a brisk pace since just after 9/11.

Fun fact: unless I have read wrong, the rise in housing prices--the most expensive purchase you will probably ever make--is not included in inflation numbers! So the inflation rate of "only" 3.1% or whatever is actually higher. Also, they don't count it as inflation when a company reduces the quality or quantity of their products while holding the price steady (I've noticed that some brands of ice cream have quietly dropped the "1 US GALLON" note, while others have raised prices and put "STILL 1 GALLON" notes on the front).

Moral of the Story: Taxes are only one way for the government to rape your wallet. Borrowing and inflation by the Fed are the other way, except they're worse because inflation is a stealth tax, and people will blame "greedy capitalists" for the higher prices. Don't be too impressed if your local Republican congressman brags about tax cuts, but isn't interested in spending cuts.

 

[Toro]

So you think we are in for a period of stagflation?

No, not like we saw back in the 1970s. Stagflation is persistent high unemployment and high inflation. Currently, inflation is rising, which means interest rates are going up, which means the economy slow, which means unemployment will rise. When inflation starts to slow, the Fed will start easing, the economy will pick up and employment will start rising again. For true stagflation, we would need to see inflation at 7-9%, which isn't going to happen.

 

[Toro]

Surely he means foreign currencies or something. Of course, gold is always an investment option too. If we've got stagflation, then inflation is part of that, and the value of your money is going down. That's not too surprising when the Federal Reserve has been creating money out of thin air at such a brisk pace since just after 9/11.

Gold did very well in the 1970s.

Fun fact: unless I have read wrong, the rise in housing prices--the most expensive purchase you will probably ever make--is not included in inflation numbers! So the inflation rate of "only" 3.1% or whatever is actually higher.

This is true. But rent is included. Rent is 23% of the CPI calculation. And 15% is something known as "owner's implied rent," a fancy-dancy calculation that econometricians make that "implies" how much rent would be imputed in the average house if the average home owner rented his/her house instead of living in it. So, soaring housing prices have not caused the CPI to move up because rents, and implied rents, have not. This is known as "heuristics" in economics.

Also, they don't count it as inflation when a company reduces the quality or quantity of their products while holding the price steady

I think they do. Over half the CPI are heuristical adjustments, which tries to factor out both the improvement in the product and changes to unit size. So, for example, if your computer was worth $600 two years ago, and if you wanted to buy another one today and it cost $600 but the processing power doubled, the statisticians make the adjustment for the increase in processing power. Thus, in two years, according to their calculations, the cost per MPU has gone down 50%. This adjustment is reflected in the statistics.

 

[ScreamingEagle]

No, not like we saw back in the 1970s. Stagflation is persistent high unemployment and high inflation. Currently, inflation is rising, which means interest rates are going up, which means the economy slow, which means unemployment will rise. When inflation starts to slow, the Fed will start easing, the economy will pick up and employment will start rising again. For true stagflation, we would need to see inflation at 7-9%, which isn't going to happen.

I've heard we have been actually experiencing anywhere from 12 to 15% "hidden" inflation. If we take into account your explanation of hueristics and "owner's implied rent" and the fact that inflated housing prices are not really included in the CPI figures, that would seem realistic.

 

[Annie]

I've heard we have been actually experiencing anywhere from 12 to 15% "hidden" inflation. If we take into account your explanation of hueristics and "owner's implied rent" and the fact that inflated housing prices are not really included in the CPI figures, that would seem realistic.

Me too. Something about looking at 'oil' as a replacement for 'gold standard.' If one adjusts the prices at 1980 prices-then figures how much oil it would take to buy X, inflation running about 12%, which DOES include housing prices.

 

[BaronVonBigmeat]

The bit about house prices vs. rent prices is interesting...but I'm afraid I don't understand the logic behind it.

Another thing occurred to me too. Let's say you correct your numbers for reduced sizes, ie a smaller bag of potato chips for the same price. That ought to be easy enough to figure, it's straight and simple.

But what if you're talking about something which would have gone down in price otherwise? Production techniques are contrantly improving as a whole (leaping upwards for some industries), so we should see the price of a bag of potato chips go slightly down from year to year. (This is exactly what used to happen--production increases, the gold supply stays nearly the same, so prices drop slowly over a number of years.) So if the price of potato chips stays the same when it should have been falling...is that counted as inflation?