Tuesday, March 04, 2008

Stagflation


You're going to hear a lot about stagflation as the primaries and then the election heat up, yet few people seem to know what stagflation means. That seems to include the politicians. I am not taking sides here, both parties offend me equally. I offer you a modern, working definition that almost anyone of you can use, and immediately know more than the political parties (except for the really good economists that they hire).

Stagflation is when a country's inflation rate exceeds its growth rate.

Plain and simple. Your currency is devaluing faster than your economy is producing goods and services. You are losing two ways. First, inflation is when you produce more money than goods and services. I'm avoiding more classical terms like calling goods and services 'factors of productions'. Technically, they are labor, capitol, land, and entrepreneurial ability. Mix those factors together and they produce goods and services. Each one earns a return, such as wages, rent, interest, a return. So when a factor, or the factors earn a return that exceeds their productivity, you have inflation. Sounds pretty boring, eh.

When you get a real estate bubble, and real estate starts to fall, and mortgages start to get defaulted upon, and capital is destroyed, the Federal Reserve Board, naturally, cuts interest rates. Many of you may not realize it, but cutting interest rates creates money. Entrepreneurs start new businesses. Existing businesses start new projects that becomes feasible at lower interest rates since they borrow money to finance expansions. People refinance their houses, and often take money out and expand or upgrade their existing homes. These are reasons to borrow, and to consume.

People stopped buying houses, and started selling them in droves. This has continued. According to RealtyTrac, as reported by Barry Ritholtz of "The Big Picture" a supurb financial and economic blog, there were 153,745 initial foreclosure notices sent out in the United States in January. During the same period, there were sales of 43,000 total sales of newly built single-family homes, which just so happened to be about half of the total sales which included existing homes and condos. So initial foreclosures are about the same as total sales. Not a lot of room for price increases in the real estate. Our current Chairman of the Federal Reserve, Ben Bernake has recently told Congress that he is prepared to cut rates again. By cutting rates, more money will be made available, and it will produce inflation, partly because the economy is slowing, and partly because the other countries of the world are not cutting interest rates.

There are other little land mines out there to consider in this election year. Foreigners hold about half of this countries debt. If you held a couple of hundred billion of this countries debt, like China does, and you saw our increasing inflation rate, what would you do? Those bonds are denominated in dollars, which are dropping in value in the currency markets to new lows, as compared to let's say one of Glamourpuss' pounds sterling. Gold is closing in on $1000 an oz. China recently gave the Blackstone Group $2 billion dollars to buy into American companies.

Now watch carefully, here's where it gets a little tricky. The economy is slowing down. If you're really smart and market savvy, you have been buying the huge multi-national companies with large foreign sales. Small and medium sized companies, which outperform their enormous cousins in the stock markets typically sell within a country's borders. Small companies grow faster than bigger ones.Small and medium sized American companies are struggling. The Big American international companies like General Electric are coming to life as their huge international sales rev up.

OK, let's summarize here, we're pumping out a lot more money because we have problem with real estate falling, and people defaulting on mortgages. We wrote a piece on option arm mortgages and how they were destroying people when home prices stopped going up. We're paying the piper now. The financial markets have been disrupted because of those mortgages, and constitute several posts all by themself. They have hurt anyone trying to refinance in the last year, and as far away as Europe. The dollar is falling because of the interest rate cuts, and the economy is slowing as we slow our consumption, and unemployment will rise. We are probably either in or about to go into a recession. A recession is defined as two consecutive quarters of negative growth in the economy (as measured by the Gross Domestic Product). The GDP for the 4th Quarter was up 0.6%, just barely positive. Inflation for the same period probably ran a bit over 3%, up from the previous period, higher than the growth rate for the period (hello Richard Nixon, our last period of stagflation before rampant inflation in the 70's). Don't think that the politicians have any silver bullets, or will make things crystal clear, or can repeal the business cycle, which we haven't discused. Notice, I haven't mentioned either political party, or any candidate. We're all in this together. I close with the first exercise in C progromming. Printing out the two words, "Hello World".

There's a lot to ponder here, hence Rodin's "Thinker" to help you mull things over. A little art always helps a lot, hence, the following recommendations!

For better writing, I'd personally read Open Grove Claudia, Hearts, and James Burnett. For different and unique there The Phoenix Hearse and Odat, as usual. And for pure, unrivaled joy, there's always my friend, buddy, pals WnG, Glamourpuss, Frankie and Amytree. M@ is at the Doc's so.........

15 comments:

AmyTree said...
This comment has been removed by the author.
AmyTree said...

And here I was wishing that Stagflation would have something to do with a big balloon of Bambi on a string...
We are certainly feeling it over here!! The housing market sucks, and it still seems the only way I will ever be able to afford to buy a house again is if it falls right through the floor. But then if that happens everyone else will be thinking the dame thing, and all us vultures will descend...
A real-life lesson in global economics - I'll say this - it certainly keeps my attention better then any classroom lecture ever did!

(That deleted post was mine, too - had to take it away when I noticed all those little typos...) :-)

Glamourpuss said...

So... the American economy is knackered?

Puss

The CEO said...

Amy, there are more foreclosures coming, so prices will go lower.

Puss, knackered isn't the right word. We're probably in a recession, working off the 'excesses' of huge runups, this time, in the real estate market. Watch the American stock market. It could rally, or start back toward new highs later this summer. Note bene, this is a guess on my part, not a known fact.

PhoenixHearse said...

The word "stagflation" conjures up images (or odors) that I must endure every day to and from work as I pass the feed lot full of cows.

Open Grove Claudia said...

Boy, you know I hear "stagflation" and I remember the 15% CD my high school boyfriend put his cocaine money into.... Sigh. Not this time.

It's scary and the news is even scarier. I supposed we got through it once??

I saw Steve Forbes speak a couple years ago. He said we would suffer for the errors of a new Fed chief - but that it would turn around in 5 years - 3 more years to go?

We've cut our spending and increased our saving. Decreased our use of any credit to hold out and whether the storm. What solutions would you advise??

Great post! Thank you so much for sharing your wisdom.

Open Grove Claudia said...

Oh, I just gave you an award! :)

Alison said...

Thanks for this post.

M@ said...

I've definitely cut my spending. Unfortunately, my personal economy is a microcosm of the federal government's reckless fiscal and financial picture.

WanderingGirl said...

It's so good I have you to explain things to me.

heartinsanfrancisco said...

Thank you for the generous compliment, Monty.

So "stagflation" isn't a blow-up toy with horns...? Seriously, thank you for the explanation of something that affects all of us but is not understood by many.

bloggablogga said...

after my kids and I giggled at the term stagflation, I read through your post.

It was simply stated and easy to understand. Thank you for that.

Odat said...

Could you say all that in one sentence??? hehe.

Thanks, my friend, for the shout out!
Peace

The CEO said...

Heather, you'd scrape the stagflation off your boots, and you'd never let your dog near it if you could keep her away from it.

O. G. Claudia, those were the days of runaway inflation in the late 70's when you were a mere child. That's when the word disintermediation became tres popular financially. Thank you for the very generous award.

Alison, you're welcome.

M@, we need to go out for some beer and chili and to flirt with waitresses.

Tiff, I am always available to you.

Susan, I marvel when I read any piece on your site. I'm glad when I can write some that makes a useful contribution. Thank you.

bloggablogga, it's nice meeting you, I'm glad you liked the post.

Odat, I couldn't say it in a sentence, I need to breathe more than that. I still love and appreciate your blog. Thank you.

skinnylittleblonde said...

Lol, well I won't tell you what I imagined 'stagflation' to mean, but it certainly did not involve the economy! ;) I am perplexed by how we think band-aids can heal broken bones... I don't know how the housing market was up there, but here, several years ago, people were able to buy houses who couldn't qualify to rent furniture. It just didn't make sense.