Friday, February 22, 2008

Guess What? It's Still the Economy, Stupid.

Stagflation seems to be on everybody's mind today with the release of some new and dismal economic figures. I don't usually toot my own horn but I'm going to have to beg a moment's indulgence (promise I'll return to my normal humble self shortly) while I remind readers that I said it first here.

Back on January 6, 2008, here's what I wrote.
The economic news for the 4th quarter of 2007 is in and it is not good. That’s an understatement of massive proportions, by the way. It's actually dire and in ways that we haven't seen since the intractable combination of recession and inflation, known as stagflation in the 1970s...

...Sorry to be repetitive, but the point needs to be made that across the board economists and business writers fear a resurgent threat of inflation. Which means that we could be headed for something not seen since the late 1970s. Stagflation could be rearing its ugly head again.
Since writing that more and more economists, pundits and now journalists are seeing similar parallels and wondering the same thing.

In today's Washington Post, the editorial writer makes the same connection when he says this.
REMEMBER the "misery index"? During the frustrating 1970s, economists used it as a shorthand measure of the pain imposed by simultaneously rising consumer prices and joblessness. Simply adding up the inflation and unemployment rates roughly quantified "stagflation," a phenomenon that defied the economic theory under which inflation and recession were supposed to be mutually exclusive. The misery index averaged 16.27 during President Jimmy Carter's term, peaking at a post-1948 high of 21.98 in the middle of his unsuccessful 1980 reelection campaign. The best index since then was 5.74 in April 1998, under President Bill Clinton. It's been creeping up since, hitting 9.2 in January. The word "stagflation" is once again on the lips of serious economists.
Yup, that ugly word which defines an intractable economic situation where there is a slowdown at the same time as inflation rears its evil head. It's a situation that classical economists once thought to be impossible. Indeed, the cure for recession was to pump money into the economy to stimulate spending and growth. Conversely, the cure for inflation was to tighten monetary policy and credit to slow down the economy.

And that's what makes stagflation so impossibly stubborn to treat. What do you do when you can use neither of these options?

Fortunately, the Washington Post goes on to say the following.
Comparisons with the 1970s should not be overdone. Among the differences between now and then is that labor unions are much weaker today and are thus less able to bargain for higher wages, which companies pass on to consumers. The slowing economy should reduce inflation, in part because falling demand for oil will help moderate its price. Still, the talk of stagflation illustrates what was obvious even before the Fed began using rate cuts to stave off recession: U.S. monetary authorities have relatively little room to maneuver. The worry is that the economy will be sluggish in 2008 -- even though the Fed has pumped in all the cheaper money it could provide consistent with its anti-inflation mission, and maybe a little bit more.
Of course, the Washington Post, being congenitally myopic about free trade and economic matters, always gets something wrong. Interpreting weakened unions and stagnant wages as positive signs for the economy misses the boat entirely. You wonder whom the Misery Index was for? Certainly not for workers who have suffered flat wages for years, which was fine with the Post's business writers.

But if, as the Post claims, the bigger worry is sluggishness, then higher real wages will do more to stimulate growth and get the economy moving than would all the cheap money and tampering that the Fed is trying to do. Ultimately, the way to fight sluggish growth is to put higher wages in the pockets of workers so they can afford to buy things. That's because ours is a consumer based economy. So with a slowdown of consuming, the economy is dead in the water.

Moving on, another columnist, this time Paul Krugman from the New York Times, also weighed in today with a column on stagflation. Here's what he said.
Will the next president be the second coming of Jimmy Carter? Given Thursday’s economic headlines, full of dire warnings about the return of 1970s-style stagflation, you might think so.
But like the Washington Post, he thinks the case for a return to 1970s style stagflation might be overstated. There certainly are some similarities, including the economic slowdown coupled with rising unemployment at the same time as the rise of the inflation rate to 4.3 percent, the highest it's been in 20 years, fueled in large part by rising oil prices, now just over $100 a barrel - also an all time high. But Krugman thinks a more apt comparison might be with the first Bush slowdown in the 1990s.
Realistically, though, the parallels between the problems facing the U.S. economy now and those of the late-1970s aren’t that strong. That’s the good news.

The bad news is that the economy probably will look similar to, but worse than, the economy that undid the first President Bush. And it’s all too easy to see how the next president could suffer a political fate resembling that of both the elder Mr. Bush and Mr. Carter.
According to Krugman, the same conditions that we are seeing today were in play back in the late 80s and early 90s and caused the first Bush economic recession. Those conditions include financial problems at banks, the collapse of the real estate bubble and sluggish consumer spending due to high household debt. Only Krugman thinks it's going to be even worse this time because this real estate bubble is bigger, we have higher debt and much higher oil prices. In fact Krugman predicts that this rough patch will extend into the year 2010, a far less optimistic picture than the Washington Post's prediction that it will go into late 2008.

I'm not sure if anybody has a crystal ball here. But, as Krugman points out, unlike stagflation, for which there are no good solutions, weak spending is definitely treatable. He recommends a serious fiscal stimulus package consisting of public investment and aid to Americans in distress.

I'd add that public investment in the aging infrastructure, exploration of renewable energy alternatives, education, and health care would create jobs, stimulate the economy and also solve several other serious problems we have, not the least of which is global warming.

I agree, though, with Krugman that it will take political courage to withstand the entrenched philosophy of the Republican hard right that shrinking the government, doing nothing and cutting taxes are the only solutions regardless of the problem.

Democrats, to effectively fix the economy, solve our energy problems, strengthen our schools, fix our health care system and stop global warming while stimulating the economy and creating new jobs (in fact, whole new industries) will have to challenge the notion that the government is the problem. There is a role for an effectively run government. If the Republicans can't see that, it's time to tell the public it's because they don't run government effectively to start with.

Then, it's time to challenge the notion that you can't use tax money to further the common good or that it's somehow socialist to do so. There is nothing socialist about public-private partnerships to solve the problems that impact us all.

Indeed, involving private industry in market based solutions to our public problems is something most business people would welcome as much as ordinary wage earners. When the economy is sound and the quality of life is good, everybody benefits.

By the way, it also sounds like a plan to end the class warfare Republicans are fond of deploring while they themselves wage it.


B said...

Interesting post and I think I have a few points to add. Inflation can continue for one simple reason, the dollar is weak. This is why oil, gold and other commodities continue skyward. The entire move up this week in the commodities reflected the comments from the Fed minutes. They have to cut rates 50bp, and that's baked in, but it was revealed that things are far worse than they even assumed in January. Lowering rates hurts the dollar, thus making commodities more expensive and that filters thru to many of the basic needs of our daily lives. That said, they are discussing RAISING rates just as rapidly as they've lowered them to keep inflation in check (their main objective). The Fed truly is in a conundrum that started with the first tech bubble under Greenspan and was allowed to continue with lowering rates leading the the housing bubble. It comes down to this, they have no more tricks up their sleeves, the buck stops here. The Fed can not save this economy and that is what some are beginning to realize, hence the stagflation talk. The truth is when the rest of the street finally understands what this means we may then see capitulation with a major market correction (crash).

The Stock Junkie (

Duck said...

Why do we have inflation? You mention higher oil prices. Why are oil prices so high? One reason is we cannot drill for oil in this country. I love how some people complain about reliance on foreign oil, and those some people prohibit us from drilling for our own oil. Those people also complain that we are just in Iraq because we want to exploit the oil there. I wish that were the case right now! I am all for alternative forms of energy, but until we perfect those other forms, oil is king whether we like it or not.

Should we threaten to bomb the Saudis if they don’t reduce the price of oil? No, can’t have that, as it would be cowboy diplomacy. (OK, I’m not serious here; I just couldn’t resist.)

Nuclear is another way to wean ourselves off oil. France makes great use of nuclear energy, but we can’t build nuclear power plants here in the states because of government regulations. Nuclear is a great way to cut carbon emissions and save the planet too.

Wind mills. Great idea, except no one—including Ted Kennedy—wants those ugly, noisy things in their backyard. Especially not bird lovers cos they tend to kill birds.

Corn-based ethanol is the government’s answer, and the reason why I am paying more for flour, bread, beef, chicken, milk, cheese and so many other food items. Because of ethanol the price of corn has gone up, making all these food items more expensive. The government pays farmers to grow more corn, meaning less wheat is grown, so it is not just corn-based foods that become more expensive.

Corn-based ethanol must be good cos it’s renewable. Unfortunately we are finding out it is bad for the environment in other ways.

So how is government not the problem? Government won’t let us drill for oil or build nuclear power plants, so we have to buy more expensive foreign oil. Government thinks the ridiculously inefficient corn-based ethanol is a good idea, raising the price we pay for food (inflation).

To help stave off inflation, more companies buy goods from China, which eventually translates into fewer jobs here in the states.

Let the free market—not do-gooders in the government—determine some things so we can go back to cheap corn and wheat, and I can at least afford to feed my family. Either that or our fearless leaders need to start making some hard choices. Unfortunately, I don’t see anyone on either side of the aisle willing to make those hard decisions.

AnonymousIsAWoman said...

Thanks, Stock Junkie. All good points. And there are still more. Time and space limits kept me from writing about all of them. After all, this could be the length of a book and nobody would have time to read it.

But the bottom line, as both of us know, is that the economic fundamentals are no longer sound.

In addition to the weak dollar, there is our enormous national debt. We are a debtor nation and our debt is owned by China and countries in the Middle East who are not even reliable friends.

The Chinese peg their yen to our dollar and don't let their currency float to its real market value, thus they have an unfair competitive edge. And we have an enormous trade deficit with them.

I could go on. But again, this can't be book length. Suffice it to say, the Fed is rapidly running out of hat tricks.

We need to get our economy on a stable footing with good, well paying jobs in the USA. That's the only true stimulus for our economy.

And we also have to pay down the debt, end the deficit and insist that China let its currency reach its real value. None of which the Bush administration has succeeded in doing.