Economy Headed Towards Stagflation

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The latest news tells us that the economy really is softening – as predicted. Unemployment is now up to 5%. Nothing to get too worried about, but heading in the wrong direction.

“Unemployment sounds warning on the economy,” says a New York Times headline.

It’s the “latest omen of recession,” adds the LA Times .

The New Year has been uncorked. We take a sniff. Pretty much what we expected…a slight odor of rot. Hey wait. There’s a faint smell of rice wine…yes…it’s Sushi Funk…the vintage produced in Japan between ’90 and ’07!

Hold on…we’ll explain.

In America, 2008 is beginning as a year of $100 oil…$850 gold…falling stock prices…5% unemployment…and a dollar worth barely one and a half euros (EUR).

The little countries of Malta and Cyprus chose to go with the euro. Investors all over the world, drug dealers, and central bankers seem to be making the same choice.

And did we mention? Stocks fell 256 points on the Dow on Friday. The index is now below 13,000.

What do we make of this?

First, we’d say that it appears that the economy is headed towards the dreaded synthesis of inflation and deflation known as ‘stagflation.’ Commodity prices are rising . Gold is rising. Oil has already risen. Up…up…up…and yet, the economy can barely get out of bed in the morning. Consumers are running out of money to spend. And financial assets – the kind of assets people like to see go up in price – are going down instead.

Second, we’d point out that this is not the first time the United States has suffered stagflation. The first time was in the ’70s. Inflation rose while the economy slumped. Realizing that looser monetary policies would merely cause more inflation, big Paul Volcker was called in. He raised reserve requirements…drove short-term lending rates to 20%…and stopped inflation.

That was then. This is now. Back then, the United States had much less debt that it does today. And now, it is not inflation that the feds fear – it is deflation. They’ve had the Japan example to watch for the last 18 years. The last thing they want to see is a Japan-style deflationary slump. America’s high debt, current account deficit, consumer credit economy couldn’t bear it. So they’re doing all they can to avoid it. When it comes to stagflation, they don’t mind the ‘flation’ part; it’s the stag that worries them.

And so, third, you can probably expect more efforts on the part of the feds to weaken the dollar …which will almost certainly have the effect of driving up oil, commodity, gold…and consumer prices. This is not the path followed by Volcker. Instead, it is the path followed by, are you ready for this, the Japanese!

Yes, dear reader, in our unrelenting efforts to keep you ahead of the news, we have pulled out a chicken…looked at its entrails…and what we see is a slimy mess. The one thing the feds fear most is a Japan-like slump. But it is the policies of the Bank of Japan and the Japanese Treasury that they are following…not the policies of the Volcker Fed in the late ’70s and early ’80s. Instead of crushing inflation, they are pumping it up. Instead of bringing on recession…they are trying to hold it off. Instead of protecting the dollar, they are trying to destroy it.

If they sow as the Japanese sowed, what harvest will they reap?

We don’t know, but we can barely wait to find out…

Until tomorrow,

Bill Bonner
The Daily Reckoning Australia

Bill Bonner

Bill Bonner

Best-selling investment author Bill Bonner is the founder and president of Agora Publishing, one of the world's most successful consumer newsletter companies. Owner of both Fleet Street Publications and MoneyWeek magazine in the UK, he is also author of the free daily e-mail The Daily Reckoning.
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2 Comments on "Economy Headed Towards Stagflation"

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I sometimes think that that the word ‘inflation’ is a misleading term to describe the phenomenon. Could it be a cunning mis-application of a word that leads the lay-man to presume and believe that ‘stuff’, and those that make and sell it, are at fault for needing more currency to buy the stuff, i.e. rather than central bankers being at fault for needing more of their currency to by stuff. Perhaps it would be valuable to re-label the phenomenon that we presently call ‘inflation’ with a less misleading word? Perhaps: dilution, or deterioration or maybe peculation, or emasculation. Or even… Read more »
Kokopelli
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I think most of the US has been in a Stagflationary state for a while now. At least for those people who live below the 90% income percentile. Energy, food, health care, taxes have all gone up while incomes have been stagnant to down. And for over a year, house prices have been declining so net worth for this group is also down and cost of living is up. This is Stagflation. Has been for over a year now. This will only change when there is enough demand destruction world wide to dramatically increase stores of resources to lower their… Read more »
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