Economists have identified the two principal contributing causes of stagflation. First, stagflation can result when an economy is slowed by an unfavorable supply shock, such as an increase in the price of oil in an oil importing country, which tends to raise prices at the same time that it slows the economy by making production less profitable.
Second, both stagnation, recession and inflation can result from inappropriate macroeconomic policies. For example, central banks can cause inflation by permitting excessive growth of the money supply, and the government can cause stagnation by excessive regulation of goods markets and labor markets.
When combined, the presence of both these factors is more than sufficient to launch an era of stagflation.
Note that “stagflation” actually occurs as the result of three combined forces:
1) a “supply shock”;
2) excessive growth in the money supply;
and, 3) excessive regulation.
Two of those fundamental forces (money supply and regulation) are directly controlled by government and/or Federal Reserve. Thus, stagflation cannot occur based solely on some “supply shock” like the suddenly rising price of Middle East crude oil. If so, stagflation can’t happen unless government and/or the Federal Reserve make it happen and allow it to continue.
For example, policies which promote growth in the money supply to allow consumers to afford higher priced oil contribute as a cause for runaway inflation, even if implemented to fight stagnation or recessions.
The global stagflation of the 1970s is often blamed on both causes: it was started by a huge rise in oil prices, but then continued as central banks used excessively stimulative monetary policy to try to avoid the resulting recession and stagnation, causing a runaway wage-price spiral.”
I doubt that the purpose for the stagflation of the 1970s and its “excessively stimulative monetary policy” was to avoid recession.
As I’ll explain later in this I’ll bet the stagflation of the 1970s was primarily intended to repudiate some significant portion of the global debt.
When did our first dose of stagflation take place? In the 1970s. The dollar had been the world’s reserve currency since WWII. But the dollar abandoned its domestic gold backing in A.D. 1933.
Then the dollar abandoned its domestic silver backing in A.D. 1968. And when did the dollar finally abandon it international gold-backing? August 15th, A.D. 1971. Thus, as of August 15th, A.D. 1971, the dollar was backed by nothing and became a pure fiat currency.
When did the Nixon administration cut a deal with Saudi Arabia to guarantee Saudi security if the Saudi’s guaranteed to sell their oil only for U.S. dollars?
1971. OPEC quickly followed the Saudi lead. Result? If any nation wanted to buy oil on the international market, they first had to have some dollars. Thus, starting in A.D. 1971, the dollar—no longer backed by gold or silver—was effectively “backed” by oil.
Additional result? The price of crude oil rose dramatically, the U.S. economy slowed, and the 1970s were characterized as a period of “stagflation”.
Fast-forward to A.D. 2001 when Saddam Hussein declared that he was going to sell Iraqi oil for euros rather than dollars. If his decision to sell Iraqi crude for euros was allowed to stand, it would strip the U.S. dollar of its only “backing” as the exclusive currency capable of purchasing crude oil. Once that “oil-backing” was compromised, the dollar’s value would plummet and possibly die. Saddam’s decision to sell his oil for euros posed a mortal threat to the American economy.
U.S. forces invaded Iraq in A.D. 2003. Saddam Hussein was hung in A.D. 2006. Unfortunately, that invasion and execution were too little and too late. Seeing the U.S. was mired in Iraq, other countries (Russia, for example) began selling their petroleum products for euros. Japan started paying for its petroleum products with yen. Since just A.D. 2006, the dollar index has fallen from 90 to 71. Without oil’s backing, the dollar’s dying.
The United States—now characterized by rising inflation and slowing economy—appears to have entered a period of stagflation. If so, it’s interesting to compare the current stagflation with the stagflation of the 1970s. In the 1970s, we had a serious bout of stagflation after we abandoned gold-backing. Today, we appear on the brink of stagflation after the dollar lost its exclusive oil-backing.
Interesting coincidence, hmm?
Here’s another coincidence: According to Wickipedia, “John Maynard Keynes wrote in The Economic Consequences of the Peace that governments printing money and using price controls were causing a combination of inflation and economic stagnation [stagflation] in Europe after World War I. Stagflation was also a very serious macroeconomic problem in the 1970s.
Thus, stagflation in Europe followed World War I, and the US stagflation of the 1970s (it actually extended into the 1980s) more or less followed the Viet Nam War which ended in A.D. 1975. Today, here we are again, after about six years of war in Afghanistan and Iraq, apparently entering another era of stagflation. Clearly, if stagflation doesn’t follow every war, it does follow some.
Lessee—what happens in war? Bombs and bullets are bought and exploded or shot. People get killed. Property is destroyed. And, oh yes, huge debts are incurred.
For the past several weeks, I’ve argued in this publication that principle purpose for inflation is to repudiate debts. For example, if you made a one-year loan of $100,000 to the government in A.D. 2007 and there has since been 15% inflation, when the government repays the principal in A.D. 2008, they will repay the nominal sum of 100,000 “dollars”. But, because of 15% inflation, each of those dollars will only be worth 85 cents as compared to their value when you made the loan in A.D. 2007.
Result? By means of 15% inflation, the government will have beat you out of 15% of the value of the money you loaned to the government. By means of 15% inflation, the government will have effectively “repudiated” 15% of their debt to you. If government can sustain a 15% inflation rate for four years, it will thereby repudiate roughly half the value of all debts that existed when that four years of 15% inflation began.
The federales claim that the total national debt is about $9 trillion.
USA Today has recently calculated that, under Generally Accepted Accounting Practices, the government’s real total debt is about $57 trillion. Add in the debts of state and local governments, plus private debt of the American people, and it appears that the total US debt is at least $75 trillion. Divide by the population (300 million), and you’ll see that the average “fair share” of the total American debt for every man, woman and child is about $250,000. Each.
No way all that can be paid. No way.
What can’t be paid, won’t be paid. That means the enormous unpayable debt must be “enormously” repudiated. There are only three ways to repudiate unpayable debts:
1) declare bankruptcy;
or 3) kill the creditors.
Government will not admit the truth (that it’s bankrupt). Therefore, it will inflate to escape the unpayable debt. Incidentally, by means of inflation, government and central banks will also kill millions of “creditors” (poor people who’ve worked for mere paper promises to pay rather than real payments—gold or silver or something tangible) by inflating the price of food to the point that the poor can’t afford to buy and must starve or kill each other to survive. We’ve already had food riots in over 30 countries this year. I’m betting that at least millions (primarily in Asia and Africa) will die in the coming food price inflations. The number of fatalities will probably be in the tens of millions; they could go into the hundreds of millions.
What is stagflation?
It is a maximized, hyper-efficient form of debt repudiation. Stagflation is characterized by
1) inflation and
2) a stagnant economy.
In simple, free market, supply-and-demand economic theory, stagflation should not be possible.
When the economy is slow, prices should decline. But during stagflation, prices rise at the same time the economy falls. That can’t happen in a truly free market. It can only happen by means of intentional manipulation of the economy.
Ohh, the government and Federal Reserve will blame stagflation (economic slowdown and inflated prices) on the rising price of oil. As in the 1970s, we’ll be invited to once again blame OPEC (the villains we love to hate) for our economic problems.
But I believe crude oil is merely a convenient and even contrived scapegoat . Remember how Wickipedia described stagflation? As a condition caused by a combination of three forces: 1) supply price shock (oil); 2) high inflation (Federal Reserve); and 3) excessive regulation (government)?
Why do we have high oil prices today?
One reason is that government regulation since the 1970s has inhibited the discovery and production of domestic crude oil. Truth is, there’s plenty of oil in the USA. Government knows it. But they regulate to inhibit significant domestic oil discoveries and production. As a result of that regulation, we now have an “oil shortage”.
And why do we have high inflation? First, because the dollar—stripped of its oil backing—is now a pure fiat currency and is falling slowly to its death. Second, anyone who bothers to read knows that the Federal Reserve is causing significant inflation by printing fresh “helicopters-full” of legal tender to be blown about like autumn leaves.
And why do we have an economic slowdown?
Ultimately, because government wants it that way. Why? Because when the economy is slow, interest rates are also low. Right now, government claims inflation is only about 4%. That’s more or less the same as the interest rates. So long as interest rates and the inflation rates are about equal, the inflation doesn’t repudiate much debt.
But if the government can hold down interest rates to say, 5% (supposedly because of the slowing economy) at the same time the real inflation rate is 15%, the government will repudiate 10% of the existing debt for every year that scenario persists. (If there’s really about $75 trillion in total U.S. debt, and if the inflation rate is really about 15%, then our government is currently wiping out about $7 or $8 trillion dollars in debt per year.)
However, once the people realize that the real inflation rate is 15% (maybe more), creditors increase the interest rate until it matches and then exceeds the inflation rate.
Once the interest rate goes into double digits and begins to match the inflation rate, stagflation’s effectiveness as a means of repudiating debt will be diminished.
What happens then? I’ll bet that if we studied stagflation of the 1970s, we’d see that stagflation began to end when creditors finally started loaning their money at an interest rate that matched or exceeded the rate of inflation. (If the inflation rate is 15%, the creditors will want 18% interest on their loans.) But for now, so long as the people are content to believe government’s claim that inflation is only 4%, stagflation (complete will double digit inflation) will continue to repudiate the value of existing debts.
I can’t give prophecy, but I’ll bet that stagflation continues for at least another two years, and maybe five. By the time stagflation ends, I’ll bet that the real value of the current total U.S. debt ($75 trillion) will be cut at least by half, and perhaps by eighty percent.
If I’m right, people holding paper promises to pay (debt instruments; stocks, bonds, federal reserve notes, pension funds, retirement funds, etc.) are, on average, going to see the value of their debt instruments depreciated by fifty to eighty percent. When people
1) realize that what can’t be paid, won’t be paid;
2) realize that 80% of the world’s existing debt can’t be paid;
3) that 80% of the value of the world’s debt instruments (paper promises to pay) will be repudiated; then
4) we are going to enter a period of hyper inflation wherein the only paper promises that will have value will be the ones that promise to be “extra soft and absorbent”.
Everyone is going to dump their paper promises for anything they can get.
If the previous analysis is roughly correct, prudent people will get out of the paper promises to pay, and get into actual payments—gold or silver coins, land, food, property. And they’ll do so as quick as they can.