2007 December 16 Sunday
United States Headed For Stagflation?

We can not move from running a huge yearly trade deficit of 5+% of GDP to a balance or surplus without a decline in living standards. The day of reckoning has to come sooner or later. Either living standards stagnate for several years or the correction is severe enough to cause a decline in purchasing power. Well, the decline in the dollar and rise in fuel, food, and imports (due to the dollar decline) are starting to cause noticeable inflationary effects. Alan Greenspan fears stagflation.

"Because of the tremendous geopolitical shifts that occurred at the end of the Cold War, we've had a period of remarkable disinflation," he said. "That period is now coming to an end, and the evidence is clearly there in rising export prices coming out of China. It's showing up in a slowed rate of productivity growth in the United States and elsewhere, and we are beginning to get not 'stagflation,' but the early symptoms of it."

Do I seem distracted from the topics I typically cover? Well, I see lots of storm clouds gathering. Many long running bad economic and demographic trends are starting to catch up with us. We might go through a period of rising unemployment and rising inflation. Just like the 70s. So then are people going to get back into wearing polyester?

Greenspan observes higher inflation in consumer and producer prices.

"Core inflation is up. Wholesale prices had their highest increase I think in a generation. That raises the specter of stagflation again," said Greenspan, referring to a simultaneous stagnant economy and upward pressure on prices.

Greenspan has been worrying about the return of inflation for a while. He saw this coming before it started to show up in the most visible statistics.

An inflation rate of 4.3% put us in territory we haven't been in for a long time.

US inflation hit a two-year high of 4.3 per cent in November, underlining the problems facing the Federal Reserve as it fights to free the economy from the grip of the credit crisis.

Rising inflation could delay further cuts in interest rates as the headline US CPI rate has more than doubled in just over a year, rising from a four-year low of 1.3 per cent in October 2006.

Pricing pressures on food and energy costs show no signs of slackening.

The data showed the continued pressure on prices from high food and energy costs and highlighted the risk the economy will face at least a brief period of "stagflation" as growth slows and inflation rises.

Policymakers worry that persistently high prices could unsettle inflation expectations, leading workers and businesses to factor higher inflation into their wage and price-setting decisions.

"The pick-up in prices may not only be sustained next year, but we could see even higher rates of inflation," said Conrad DeQuadros, economist at Bear Stearns. "In an environment where monetary policy is going to become easier, it's going to give businesses the chance to pass on higher prices to consumers."

The cost increases show up in many categories.

Boosting the rate, not surprisingly, was energy, up a huge 5.7% after a 1.4% push in October. Gasoline prices climbed 9.3% and are up 37.1% year-over-year. Transportation costs were up 2.9%. Housing costs rose 0.4%, with a 0.3% increase in owners' equivalent rents and a 1.5% gain in fuels and utilities.

Rounding out the ugly picture, apparel prices were up 0.8%, food rose 0.3%, and education increased 0.1%.

On a year-over-year basis, the headline rate accelerated to 4.3% from a 3.5% rate in October. The core rate was up 2.3% from 2.2%, and above the Fed's implicit 2% ceiling for inflation.

Wholesale prices increased the most since 1973? Wow.

And costs may only go up. Wholesale prices, which are passed on to consumers, rose last month at their fastest rate in 34 years. Import prices recorded their biggest monthly gain since 1990.

The stagflation of the 1970s was not fun. If oil production stays on a plateau then we might be living with stagflation for years to come.

Not everyone sees inflation as the biggest risk however. Some see big deflationary forces emanating out from the credit crisis. For example, Mike "Mish" Shedlock thinks bank losses, real estate price declines, and declines in value of commercial debt instruments mean that deflation is the far bigger risk. We might go through a period of a mix of deflation in real estate and inflation in manufactured goods, energy, and food. We import a much larger fraction of our manufactured goods and the US dollar is declining due to the trade deficit. Rising Asian demand for food and US government engineered demand for corn ethanol are both pushing up the price of food. Plus, oil production constraints are pushing up energy prices. So a mix of rising and falling prices seems quite possible.

Share |      By Randall Parker at 2007 December 16 05:45 PM  Economics Business Cycle


Comments
John S Bolton said at December 16, 2007 9:01 PM:

If the bankers who might otherwise put everything into being the swiftest to foreclose on subprime mortgages, see inflation picking up, they will actually want to delay, since rising prices cover bad loans.

Kenelm Digby said at December 17, 2007 3:54 AM:

Well China is definitely NOT 'stagflating', although Chinese prices have risen by some 6.9% this year, it must be remebered oif course,that China's GDP grows by some 11% per annum and Chinese incomes grow at 15-20%, so in that context talk of 'harmful inflation' is really overblown.

OkieJimbo said at December 17, 2007 7:01 AM:

ParaPundit....very good stuff here. I was turned on to you by a friend. I looked for some bio stuff on your home page but didn't find anything. Can you oblige me with your bio info?

Randall Parker said at December 17, 2007 6:36 PM:

OkieJimbo,

I can't think of anything biographically interesting about me. I'm a software developer (mostly embedded Linux right now) in Santa Barbara with a degree in biology who reads a lot. From the East Coast. Tried assorted ideologies such as Objectivism and libertarianism and found them all wanting. Am intellectually closest to the evolutionary conservatives who are, in turn, closest to the paleocons for the most part. I think my history of posts is more interesting than anything I've done.

You could try reading my FuturePundit site as well.

HellKaiserRyo said at December 17, 2007 8:05 PM:

Randall, I respect your stance on illegal immigration and drug policy, which as a liberal, you have influenced my views on.

I most certain appreciate your ability to understand the effects of technology more than your political views.


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