Tweet
By Neville Bennett
Everyone is feeling the effect of inflation. Dairy foods seem to have doubled in price. Coffee seems dearer and filling with petrol is a heart-stopping experience. The world shares our problem, and we could see a return to that toxic combination of recession and inflation: a condition from the 1970s called stagflation.
When it happened from 1973 to 1980 most economists who were Keynesians through it was theoretically impossible. They thought stagnation would be cured by easy money through monetary and tax policy, and inflation would be restrained by tight monetary and fiscal policy. How could an economy be stagnant and have inflation?
We know that stagflation came in the 70’s because of two things. The first was a supply shock: a massive increase in the price of oil. This was very disruptive to industry and also hit consumers very hard. In New Zealand. The Government forced economies in the use of petrol by a policy of car-less days. We could drive only on even or odd-dated days. As so much expenditure went upon increased travel costs (and later on plastics, fertilizers and other products derived from oil) demand for other goods fell, and unemployment crept up.
The second cause of the 1970’s stagflation was government policy in the USA and Europe. The Federal Reserve has an obligation to maintain high employment, and it increased liquidity and lowered interest rates. Inflation duly occurred because there was too much money chasing too few goods.
When the process kicked off, it did not seem too bad for most people. They felt good because house prices were increasing. Most wage and salary earners got good income increases, but it was a fool’s paradise.
Before long, interest rates rose, and paying the mortgage became tough. Employment fell. All imports got dearer. Life was harder. It is important to remember that stagflation lasted for years and created many economic distortions. What was worse was the cure. Interest rates were hiked sky- high in the 1980’s, and paying off a mortgage at 20%+ is cruel.
The time is right now for another bout of stagflation. The first cause is a supply shock. We have that with the price of oil. A year ago, it was US$60 a barrel. By mid-March it had hit US$108 a barrel.
In the 70’s the shock was oil. Now it is oil, gold, copper, steel and coal and any material used in manufacturing. However, it is also most foodstuffs. Wheat prices have doubled, and spaghetti –loving Italians have rioted. Expect bread, cakes etc to increase sharply in New Zealand. The best commodity price index (Reuter/Jefferies CRB) showed prices moved upwards in February by 14%, the biggest monthly rise since July 1974.
Price shocks are coming. Their impact has been a bit muted so far, for two reasons. The first is that importers got contracts for lower prices. Air New Zealand was paying only US$80 for oil recently. However, the hedges will run out, and our importers will have to pay the full price eventually. Prices have been lower than expected because our dollar has been at record highs. Most economists expect it to decline. If so, imported inflation will be fierce.
Central Banks in the US, UK and Europe are increasing the supply of money to mitigate the effect of the credit crunch by ensuring ample liquidity. They have lowered interest rates aggressively too. New Zealand and Australia are the odd-men-out to be tightening or leaving rates on hold. Therefore, the conditions suit stagflation.
Ben Bernanke says it will not happen. Bernanke is determined to keep lowering interest rates to ensure that there is no recession. He may be too late.
The US economy went into a tailspin recently because of the collapsing housing market. The economy showed some growth, but that was export-led growth based on a very weak dollar. Unemployment is also rising: jobless claims rose to an unexpected 375,000. This is the first January for many years to show a steep fall in employment.
US monetary and fiscal policies (there are huge tax cuts and help for mortgagees in the pipeline) mean that the US dollar is getting weaker by the day. The Euro has hit US$1.50. This will increase the price of commodities. It is obvious in the case of gold, a hedge against inflation, and a hedge against a weak dollar.
The weak US dollar is imposing weakness on other economies. The EU is losing export orders because the Euro seems overvalued. Even New Zealand’s economic activity is diminishing because of the high NZ$. The point needs little expansion, but the fishing industry is the latest complainant.
Inflation is compounded by the activities of speculators. For many years, there has been a flood of money surging around the world in search of yield. It has been invested in a variety of asset classes, but developments have skewed it towards commodities. Last year began with a lot of buy/outs or takeovers. But the market got saturated with the Boots takeover in UK and Chrysler in America. That closed one venue. Housing turned down in most markets, so there was no money in property.
How about shares? The Dow was at 14,000 in July 2007, it is struggling to stay above 12,000 now. You would need you head read if you went into CDO, SIV’s or any clever vehicle today. How about hedge funds?
Very few specialise in good areas. Many are suspected of holding leveraged subprimes. Money has gone into commodities as the frontier of opportunity. Speculative activity is driving the commodity market, and it will not lessen until prices fall.
I think economic growth will falter globally, and the US will swamp the world in a flood of money. I do not see how stagflation can be stopped.
Everyone is feeling the effect of inflation. Dairy foods seem to have doubled in price. Coffee seems dearer and filling with petrol is a heart-stopping experience. The world shares our problem, and we could see a return to that toxic combination of recession and inflation: a condition from the 1970s called stagflation.
When it happened from 1973 to 1980 most economists who were Keynesians through it was theoretically impossible. They thought stagnation would be cured by easy money through monetary and tax policy, and inflation would be restrained by tight monetary and fiscal policy. How could an economy be stagnant and have inflation?
We know that stagflation came in the 70’s because of two things. The first was a supply shock: a massive increase in the price of oil. This was very disruptive to industry and also hit consumers very hard. In New Zealand. The Government forced economies in the use of petrol by a policy of car-less days. We could drive only on even or odd-dated days. As so much expenditure went upon increased travel costs (and later on plastics, fertilizers and other products derived from oil) demand for other goods fell, and unemployment crept up.
The second cause of the 1970’s stagflation was government policy in the USA and Europe. The Federal Reserve has an obligation to maintain high employment, and it increased liquidity and lowered interest rates. Inflation duly occurred because there was too much money chasing too few goods.
When the process kicked off, it did not seem too bad for most people. They felt good because house prices were increasing. Most wage and salary earners got good income increases, but it was a fool’s paradise.
Before long, interest rates rose, and paying the mortgage became tough. Employment fell. All imports got dearer. Life was harder. It is important to remember that stagflation lasted for years and created many economic distortions. What was worse was the cure. Interest rates were hiked sky- high in the 1980’s, and paying off a mortgage at 20%+ is cruel.
The time is right now for another bout of stagflation. The first cause is a supply shock. We have that with the price of oil. A year ago, it was US$60 a barrel. By mid-March it had hit US$108 a barrel.
In the 70’s the shock was oil. Now it is oil, gold, copper, steel and coal and any material used in manufacturing. However, it is also most foodstuffs. Wheat prices have doubled, and spaghetti –loving Italians have rioted. Expect bread, cakes etc to increase sharply in New Zealand. The best commodity price index (Reuter/Jefferies CRB) showed prices moved upwards in February by 14%, the biggest monthly rise since July 1974.
Price shocks are coming. Their impact has been a bit muted so far, for two reasons. The first is that importers got contracts for lower prices. Air New Zealand was paying only US$80 for oil recently. However, the hedges will run out, and our importers will have to pay the full price eventually. Prices have been lower than expected because our dollar has been at record highs. Most economists expect it to decline. If so, imported inflation will be fierce.
Central Banks in the US, UK and Europe are increasing the supply of money to mitigate the effect of the credit crunch by ensuring ample liquidity. They have lowered interest rates aggressively too. New Zealand and Australia are the odd-men-out to be tightening or leaving rates on hold. Therefore, the conditions suit stagflation.
Ben Bernanke says it will not happen. Bernanke is determined to keep lowering interest rates to ensure that there is no recession. He may be too late.
The US economy went into a tailspin recently because of the collapsing housing market. The economy showed some growth, but that was export-led growth based on a very weak dollar. Unemployment is also rising: jobless claims rose to an unexpected 375,000. This is the first January for many years to show a steep fall in employment.
US monetary and fiscal policies (there are huge tax cuts and help for mortgagees in the pipeline) mean that the US dollar is getting weaker by the day. The Euro has hit US$1.50. This will increase the price of commodities. It is obvious in the case of gold, a hedge against inflation, and a hedge against a weak dollar.
The weak US dollar is imposing weakness on other economies. The EU is losing export orders because the Euro seems overvalued. Even New Zealand’s economic activity is diminishing because of the high NZ$. The point needs little expansion, but the fishing industry is the latest complainant.
Inflation is compounded by the activities of speculators. For many years, there has been a flood of money surging around the world in search of yield. It has been invested in a variety of asset classes, but developments have skewed it towards commodities. Last year began with a lot of buy/outs or takeovers. But the market got saturated with the Boots takeover in UK and Chrysler in America. That closed one venue. Housing turned down in most markets, so there was no money in property.
How about shares? The Dow was at 14,000 in July 2007, it is struggling to stay above 12,000 now. You would need you head read if you went into CDO, SIV’s or any clever vehicle today. How about hedge funds?
Very few specialise in good areas. Many are suspected of holding leveraged subprimes. Money has gone into commodities as the frontier of opportunity. Speculative activity is driving the commodity market, and it will not lessen until prices fall.
I think economic growth will falter globally, and the US will swamp the world in a flood of money. I do not see how stagflation can be stopped.
Comment