An Ugly Word Rears Its Head: Stagflation (2008)

First, I would like to thank those reading MONEYTHOUGHTS, as of this morning we reached our 4,000th visitor. I probably accounted for about half those visits because I often return to read my own stuff. After giving it a rest for a few minutes, I come back and reread to make sure the English is correct. I never leave a posting without going over it at least twice.

Second, I would like to thank all my readers from India and other countries that read MONEYTHOUGHTS. I know there are many well written blogs and I appreciate all those who stop by. There are many viewpoints as to what is taking place in the United States today and with the economy. This blog is just one of many, but it is not in New York City nor is it in Washington, D.C. Here, you get my opinion, as I see national and world events unfold through my eyes living in Cincinnati, Ohio. There are certainly much more sophisticated and deeper analysis's of the economic events that are taking place in the world today; however, I try my best to keep it simple. Here in the Midwest we sometimes refer to this as KISS --”keep it simple stupid.”

And third, the purpose of MONEYTHOUGHTS is not to drive a particular political agenda. People need to understand what is happening to their money as well as how government policies effect their money. When enough people sit up and take an interest in how their money is being devalued by inflation, a more level playing field will occur. There are many many issues on the table and money is just one of them, but a very important one. In our economy in the United States, credit, savings and investing all revolve around money. As we have noted before, our money in the United States is made up of Federal Reserve Notes. The Fed is our central bank and as such, has tremendous power over what happens to our money. If our Fed raises interest rates, they can slow the growth of the money supply and in turn the economy. The Fed can also buy US Treasury securities in the open market and inject more money into the economy to facilitate growth. The Fed was created by Congress, and answers to Congress several times a year about the state of the economy. The monetary policies adopted by the Fed have a direct bearing on what happens to the purchasing power of your money. Without purchasing power, your money is worthless. Worthless money is not money as the purpose of money is to make the exchange of goods and services efficient. Where there is no money, there is barter. In our global economy of today, barter is not an option. For us in the United States, our Federal Reserve Notes takes the place of barter.

An old word is starting to creep into our economic discussion here in the United States. It has been a good 30 years since the word stagflation was being knocked about in civil economic discussions. Stagflation is a compound word coming from the words stagnate and inflation. We all know what inflation is, but for purposes of review, inflation is when it takes $4 to buy a gallon of gas instead of $2. The gasoline is the same mixture and essentially it is identical to the $2 gasoline. Because the price has gone up and the product is the same at both prices, we say our money has lost purchasing power.

Commodities are a good vehicle to chart inflation as the item in question essential does not change. When we look at manufactured items such as a car, it is much more difficult to assess the effects of inflation. The car today is not the same car that was produced 30, 20 or even 10 years ago. Technological advances make a strict comparison impossible.

The stag part of stagflation refers to the fact that no economic growth is taking place in the economy. We in the United States experienced stagflation after the first oil embargo in 1973. The oil embargo was just one factor in the stagflation that occurred in the 1970’s. The Vietnam War caused the government to print a lot of money and this helped produce some of the price inflation that the United States experienced.

When the prices of raw materials rise rapidly, companies that provide a product or even a service, such as the airlines, can not maintain profitability without adjusting their prices upward to the consumer. The oil companies, like the airlines, pay more for the raw material from which they make gasoline and diesel, and must charge a higher price. The airlines are paying more for jet fuel and they too need to charge a higher price. If prices go up too rapidly, the consumer must make a choice as to whether they can afford or do without that product or service. A vacation using the airlines may become something people can choose to do without. Gasoline or diesel to get to work is a different story. This is why we say the demand for gas is more inelastic than the demand for airline tickets. We need to buy gas to get to work, we do not need to take a vacation on a jet plane.

When enough companies find their profits margins squeezed because of higher raw material costs and they can not pass them along to the consumer of those products or services, economic growth stops. In fact, if the situation persists, economic growth becomes a negative number and the economists say we are in a recession. If the no-growth lasts two consecutive quarters, then the economy is said to be in a recession.

When it comes to price changes, gradual is better and really slow price changes over several years is still better. Best would be no price changes, neither up or down, but that is never going to happen. Deflation can be as difficult for an economy to handle as rapid inflation. The whole premise for holding stocks is that under conditions of gradual, hopefully very gradual inflation, companies can pass along to the consumer a higher price and thus maintain their profit margins and profitability. Thus the corporation grows its earnings through more sales and a bigger profit margin. When corporations can not pass along their increased costs to the consumer, corporation down size, cut employment, postpone construction projects and try to hang on. When enough corporations are facing this reality, the economy is in big trouble and the stock market is just one indication of our lack of economic growth. This situation coupled with inflation is know as stagflation, and stagflation is not a very pretty picture. Stay tuned.