Stagflation

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Something that can and has in the past genuinely led to years of economic struggle or even the outright collapse of entire economic systems. The heart of what makes this so bad is that the treatment of these problems only makes the others worse, in theory anyway. Low interest rates and lots of money printing can pump up market activity and at least on paper make growth look good for a little while, but more money flowing into the economy will, as we've seen first hand, make inflation much worse. Likewise, raising interest rates and taking money out of circulation is also an option. This should fight inflation, but it will also lead to intense economic hardships. Now, the good news is that there are ways to unkind economy from this kind of not, but they require careful, considered, dedicated long-term planning and short-term sacrifices. So anyway, for better or worse, those sacrifices are also probably going to be felt by almost everyone around the world. Yes, the issue of stagnation is getting a lot of attention in the US at the moment, but at least for the immediate future, they have a luxury of exporting a share of that inflation and stagnation out onto everybody else, as the US dollar, is still the world's default reserve currency. This is also not to mention that a lot of other countries are arguably further down this particular rabbit hole already anyway. So, why is stagnation such a big problem? Why has it become such a big problem right now? And finally, what kind of sacrifices are typically needed to unstag and deflate? Every Tuesday, we talk Apple and Mac break weekly. Hi, this is Leo, a reporter inviting you to join Jason Snell, Andy and Ako and our newest panellist, Christina Warren, for a great conversation. We celebrate the 71st birthday of Steve Jobs and talk about what might have been. 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The Central Bank in the USA, as well as most other Central Banks around the world to some extent, have a dual mandate to maintain full employment and stable prices. So perhaps another reason why stagflation is considered so scary by the Fed is that it's failing both of the goals that it give it reason to exist in the first place. But even these simple KPIs need a bit of nuance because honestly, economists have a habit of naming things terribly. Full employment, as the name would not suggest, is not the same thing as zero unemployment. It is instead the lowest rate of unemployment that is considered sustainable. If absolutely nobody in the economy is looking for a job, that can actually cause just as many problems as too many people looking for a job. This will be really important later on, so try and remember it. Likewise, stable prices don't actually mean prices not changing at all. They instead mean prices increasing by a target of 2% per year, a goal that was somewhat arbitrarily set back in 2012 by the Fed. The idea is that a slow increase in prices incentivises people to get out there and put their cash to reduce, either by investing it or just spending it instead of hoarding it because money not doing anything will slowly lose value over time. Now those are the goals to remember while looking at the issue right now, which is that even the Fed itself is quietly sounding the alarm that the economy is on the precipice of major problems with both inflation and unemployment. So what is going on to cause this? Well, for starters the numbers themselves right now actually look okay. The inflation is above the arbitrary 2% target, but it's down considerably from its pandemic peak and likewise, reported unemployment is up from last year, but by historic standards it's actually pretty good. So if inflation and unemployment are both down considerably from where they were say 4 years ago, is this just another case of economists predicting 20 out of the last 3 economic disasters? Well maybe, but those numbers themselves are becoming one of the first major problems. The USA just had its largest job numbers revision ever, revealing that almost a million jobs have been overestimated in the economy. These official numbers are getting more and more questionable over time as fuel businesses and individuals are answering surveys that they rely on because well who answers surveys anymore. On top of that there has of course been some level of political pressure for data producing agencies to make the numbers look good or else. We very often on this channel give a disclaimer looking at national economics statistics from countries like China that they may not be accurate. Chinese economic objectives are set ahead of time and then provincial centres report their results relative to their goals. Bureaucrats have been fired or promoted based on how well their particular area of government is performing, so it's no wonder that many economists suspect that there has been systematic and persistent inaccuracies with their data which could compound over time. But as much as we may not like to admit it, the same kind of pressure could easily have the same kind of results in a country like the USA as well. And then above all of that, even if the data was beyond reproach, it still may not be telling the full story. The employment may look decent as a singular number, but that only measures the number of people not in a job and actively looking for work. It doesn't count labour force participation, which has been trending down to more than two decades and includes a lot of people that have just given up on ever getting a job. It doesn't count under employment for people who can't find a job in line with their skills or experience and so resort to something like gig work and it doesn't count people who aren't getting enough work. To qualify as employed, people only technically need to do an hour of paid work within a week which may make the statistics look good, but clearly isn't going to provide enough for a comfortable life or make any meaningful contributions to the economy. Inflation also has the same kind of measurement problems, which can cause laggy or non-responsive results. Things like shrink flation and shittification and the fact that housing costs are routinely underestimated means that even though on paper the consumer pricing index is only up by 30% over the past five years, actual everyday budgets are routinely being stretched even further. And it also ignores the bigger problem that even if inflation does go back down to the 2% targeted range now, that doesn't reverse the years where it was far higher than it should have been. Now, these limitations are very important to understand, but none of this by itself is anything new. So then why are economists suddenly so worried about stagflation now? Well, for starters, there is a good chance that a lot of this information is only just catching up with us. As you mentioned earlier, a significant revision in jobs creation is a good sign that the real employment number may not be as good as it seems, even ignoring all of the problems of under-employment, which have clearly gotten more widespread over recent years, with the proliferation of the geek economy. Economic growth is also becoming far more dependent on an increasingly narrow set of industries. Again, specifically in the USA, GDP growth has actually looked really good, but that's been propped up by a lot of government spending, a lot of big and probably not very sustainable investments into AI and consumer spending. However, all of those carry with them at significant risks. Obviously, US government spending relies a lot on US government debt, which has arguably been a problem for the last two decades that might really be entering the find-out stage now. New fiscal policy has lowered taxes significantly, while spending has remained roughly the same, even if it has been shifted around by cutting social programs, but increasing spending on things like defense and border security. Now, this isn't a straightforward budget issue, because, of course, the US government can always print more of its own money, but that doesn't mean that people will value it. Sometimes, all of the technicalities of how governments move money around are strapped from the simple supply and demand behind it all. Taxes are the ultimate source of demand for a currency. If people don't collect enough money to pay their taxes, they go to prison. So it's a pretty good demand driver. Lowering taxes naturally lowers that demand, and all other things have been equal. Lower demand equals lower prices. Now, the price of a dollar will always be a dollar, but if the assumption is that there will be a lot more dollars floating around in the future, their actual value of what they can be exchanged for will be lower. Because of this assumption, people who lend money to the government will want more interest to make up for that falling value, or else they'll just go and buy something else right now. This is already happening with major institutions and governments, opting for alternative currencies and even things like gold, the holders reserves, instead of US government bonds, which have an uncertain future. This means that the US government will end up paying higher interest rates for their borrowing, which with so much debt on their books will have a significant impact on the budget. Already, the government is seeing that when it goes to raise money by selling bonds, it's finally getting much more difficult to get enough buyers. In the medium to long term, governments around the world that have been in a similar situation have had to resort to austerity measures, which means drastically lowering spending and raising taxes to start meaningfully paying off debt. This would knock out one major component of GDP, causing slowed or negative growth, and it would also likely come with significant increases in unemployment from late-off government employees and contractors. The US has been able to get away with this for longer than most other economies would have been able to. There's so many other countries use its currency for international trade that it effectively gets free demand from its currency from everybody else, not just its own people. But, big international institutions and governments are not dumb. They are watching a growing budget deficit and erratic international policies and they are reasonably surmising that this could make their reserves less valuable in the future, so it's better to get ahead of it now. Stagflation is normally seen as a failing of the central bank since controlling employment and price stability is their sole reason for existing. But in reality, it takes careful coordination between fiscal policy enacted by the government and monetary policy carried out by the Fed to effectively manage these variables, especially when they are not going in the right direction. Think of it like two synchronized hands been used to play a fine instrument. The central bank can make large changes in the tempo of the economy, but only the government has finer control of the specific aspects of how it's managed. Now, this is always hard because politicians in particular don't want to do anything that could cool down their economy, even if it is in the best long-term interest of the nation, because they run on short-term election cycles. Unfortunately, this could also lead to a situation where one hand is fighting the other. The Fed is trying to rein in inflation while the government is spending record amounts of money. As a hypothetical example. Look, this happens all the time and most central banks are used to dealing with it. They are appointed on much longer terms so they can enact policies that won't be popular on the short-term, which is why it's really important that they stay independent. Unfortunately, that's not really the situation today. Today, the right hand of the Fed is trying to play two different instruments at the same time, while the left hand of fiscal policy is busy punching itself in the dick. Only inflation side inconsistent and let's be honest, reckless trade negotiations have made long-term supply chain management incredibly difficult, which is hurting prices not only from the demand side but also from the supply side too. If there are less goods that make it to shelves, naturally prices for those goods will rise, and that's discounting the eventual inevitability that tariff costs will be passed along to consumers as well. Cutting taxes, especially for the highest incomeers, is also likely to have long-term consequences because at the moment they're the only group driving consumption grows. Expansion is the largest component of GDP in the USA, and half of that consumer spending is now done by just 10% of households. If they pay significantly less taxes, they can have more money to spend at driving up inflation in very narrow markets. Now, beyond the immediate social issues of already high income earners getting tax breaks at the expense of 90% of the population, there are pragmatic economic problems as well. Lots of people spending money requires lots of employed people to process those sales, and if only a small share of the population is spending most of the money, then naturally fuel will need to be employed to serve those consumers. Again, this isn't new by itself. We actually made a video on the K-shaped recovery where wealthy people will do really well, and everybody else will do really badly, and the problems that could cause over five years ago now. The problem is that instead of managing those risks, current fiscal policy is just turbocharging them. This puts the Fed between a rock and a hard place even more than they would be when facing stagnation, because different policies are going to have different impacts on different parts of the wealth spectrum, and at the further they drift apart, the harder those differences are going to be to manage. For wealthy people and high income earners, the biggest impact that lower interest rates will have is increased asset prices. There are two general mechanisms that make this happen. If interest rates are lower, it's easier to borrow money to invest, and simultaneously more rewarding. Imagine a company that makes a profit of $10 million per year, but is worth $100 million. Assuming no capital gains, that's a return on investment of 10%, which is pretty decent. If interest rates were 5%, and an investor could get returns twice as high by making a risk year investment into this company, compared to just keeping their money in a savings account paying the nominal interest rate. If however interest rates dropped to 2.5%, but the company was still making $10 million per year, it could be worth $200 million, while still providing twice the rate of return of a secured savings account. Now this is of course an incredibly oversimplified example, but it's how these investment decisions are made. Nobody is going to invest into a risky business when they could get better returns in risk free savings or bonds, and the lower the interest return is, the more people are willing to invest in other forms of income. Increasing asset prices primarily help wealthy people who own most of the assets and gives them more money to spend, which as we've already seen is not a problem since they are doing half of the spending in the economy already. For less wealthy households that don't have a stockpile of investable assets, rising prices can make it harder for them to catch up, especially in areas like housing. The lower interest rates will help them a little bit, but consumer debt tends to be overall less sensitive to baseline interest rate changes anyway. Imagine loan or a mortgage going from 5% to 2.5% halves the interest expense. A credit card going from 2.5% to 20% might help a little bit, but not to the same degree. And again, this isn't just a moral problem. Crushing the majority for the benefit of asset owners can lower productivity. That company from earlier that jumped from $100 million to $200 million may have been great for existing investors, but it was still producing the same total output. So high prices and lower employment, that is stagflation. And there's a good chance that the US is already there, but changes in the nature of the economy mean that they just haven't realised it yet. So then the question is, why is this such a course of panic? There are plenty of advanced economies with higher unemployment rates, higher inflation, and lower growth in the USA. In fact, most advanced economies fall into this category. So why is it a headline worthy problem for the US and not for a country like the UK? Well, for starters, nobody wants to be like the UK right now. They are more of an indication of where the US might be headed, which is scary enough by itself. The other thing is that the world relies on the US, so them struggling with stagflation will probably hurt a lot of other countries as well, even those that are already hurting. If the stability of the US dollar evaporates over a short time frame, that alone is a global crisis. And then, of course, domestically, there is the problem that there are less safety nets in the US for people that are impacted by these economic variables, converging on their household budgets. Now, we've made an entire compilation of all of the problems these European countries are facing as a point of comparison. That same kind of situation in the US would have far deeper and wider consequences. But you should be able to click that video on your screen now. Thanks for watching, mate. Bye. Have you ever wondered how inbred the Habsburgs really were? Did women in the past used for birth control or what Queen Victoria's nine children got up to? On the History T-Time podcast, I profile remarkable Queens and LGBTQ+ royals, explore royal family trees, and delve into women's medical history and other fascinating topics. Join me every Tuesday for History T-Time, wherever fine podcasts are enjoyed.