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Mind on Money: The return of stagflation

By: Oak Partners, Inc. Last Updated: July 18, 2022

I will not pretend I was always interested or aware of topics of money, as a 51-year-old child of the Region, however, I have some very distinct economic memories from my childhood involving the time period from the late 1970s to the mid 80s.

I would have been 8 to 13 years old at this time, and like lots of Gen-X kids in Northwest Indiana, my primary interests were spending as much time as possible, unsupervised, roaming the neighborhood and the woods, Star Wars movies and toys and playing a new sport called soccer.

Despite these childhood distractions, my memories of this time period are clear. The Region was hurting. While my dad did not work in steel at that time, many of our friends’ dads did and many of them were losing their jobs. Emerging globalization and the sluggish economy of the 70s had decimated American heavy industry, which dominated the Region.

Some families moved away; my parents talked about moving to Arizona. Our car, which always seemed to be new before, got oldish and junky. For some reason I still don’t understand, everyone seemed to have huge blocks of orange government cheese in their house. People were angry at President Jimmy Carter, and I clearly remember a strange word, “stagflation,” being used by adults.

Beyond these childhood memories, I don’t recall this weird word being part of the lexicon since this period. They didn’t talk about it at Purdue. I haven’t heard it during training and continuing education during my career and I haven’t used it with clients. Until now. Stagflation appears to be back.

Stagflation is a rare economic condition, marked by both a higher-than-average rate of price inflation and at the same time, sluggish economic growth. In a pure supply and demand driven economy, these two conditions should not exist at the same time, as conventional economic wisdom tells us when growth is slow, demand cools off and pricing pressures, aka inflation, are reduced. While this conventional wisdom is based in logic, it doesn’t account for forces unique to a central banking, fiat currency system, which is the type of system used currently in developed economies around the world.

In a fiat currency system, money or currency itself, is also subject to supply and demand forces as central banks such as the Federal Reserve and governments, in an attempt to smooth out the business cycle and effect various political objectives, continually attempt to manipulate the supply of money in the economy through policies such as interest rates, bank reserves, deficit spending and quantitative easing. These manipulative policies have the potential to create dislocations when the supply of money is not driven or justified by the demand for money, which is the problem we have today.

In the late 70s and 80s the world economy, and the United States in particular, was still adjusting to the transition from the gold reserve-based currency system (Bretton Woods system) used prior to 1972 and the modern fiat currency system of today. My analysis of this time period is the transition was clumsy and marked by commodity price spikes and shortages, which when coupled with increasing globalization led to a series of recessions in the United States.

Today, the Federal Reserve’s enormous expansion of the money supply, coupled with massive deficit spending by the federal government due to the COVID crisis, has led to an imbalance between the amount of spending power in the hands of consumers and businesses, and the ability of pandemic disrupted producers and supply chains to deliver goods and services. Inflation has been the result.

At the same time, while the massive government and household spending over the past few years may have kept the COVID-racked economy out of recession or even depression, it likely pulled a lot of demand forward, and economic logic would tell us to expect some type of slowdown in spending, which of course is the hall mark of a recession. Combine the inflation with the potential recession, and stagflation is the outcome.

So how does stagflation get addressed? Well, from a policy perspective, it’s not particularly easy. The very economist who coined the stagflation term, Robert Mundell, prescribed that the policy approach to address it is twofold. First the Fed should restrict access to credit, aka higher interest rates (remember those 13% CDs of the 80s?) and two, the Federal government should reduce taxes to leave more money in the private economy, where it is likely to be “soaked up” by more efficient spending or even saving and investing, aka Reaganomics.

Thus far, while it looks like the Fed is methodically but guardedly attempting to do its part in the formula, I don’t see any Ronald Reagans on the horizon. We live in unique and interesting times indeed.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. Stock investing includes risks, including fluctuating prices and loss of principal. Precious metal investing involves greater fluctuation and potential for losses. Past performance is not a guarantee of future results. Dividend payments are not guaranteed and may be reduced or eliminated at any time by the company. Marc Ruiz is a wealth advisor and partner with Oak Partners and registered representative of LPL Financial. Contact Marc at marc.ruiz@oakpartners.com. Securities offered through LPL Financial, member FINRA/SIPC.