- The spirit of “stagflation” haunts the US as inflation remains high and economic growth cools.
- Stagflation made the 1970s a drudgery and eventually ended the global economic system after World War II.
- Everyone from investors to everyday consumers is desperate to avoid the problem recurring when the coronavirus recedes.
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The American economy was in full swing during the summer as laid-off workers found new jobs and consumer spending picked up. Wall Street did well too, with major stock indices rising for seven straight months.
But then summer turned into autumn and the economic weather changed. The US labor market has slowed significantly and there are signs that inflation may persist. Now the country is racing towards a situation that was last seen in the economic nightmare of the 1970s: the dreaded “stagflation”.
Now the spirit of stagflation, a brutal mix of stagnant economic growth and high inflation – hence the name – haunts the fragile recovery from the pandemic. The stagflation of the 1970s ultimately transformed the entire economic system, and politicians are desperate to avoid similar disruptions in the wake of the coronavirus crisis.
“Stagflation” mentions in corporate documents are at their highest level since 2008, data firm FactSet noted, even before the third quarter reporting season began. Bank analysts publish research notes on the subject.
If we are really heading towards Stagflation 2.0, this will be bad economic news for years to come.
Memories of the 1970s Canine Economists
Inflation has been above 5% in the US for the past three months and rose to a 13-year high in the euro zone in September. Central banks have spent most of the last year saying that inflation should go away soon, but they have sounded less confident lately.
In addition to “temporary” inflation that looks more permanent, the delta coronavirus wave has slowed the rapid growth from earlier this year. The US job market slowed dramatically in both August and September. Supply shortages have led to soaring energy prices, which has caused some factories in China and Europe to shut down.
Many on Wall Street are chilled by the talk of stagflation and have bad memories of the 1970s.
It is no coincidence that the 70s were the decade that dark movies like “Taxi Driver” and aggressive music like punk rock were born. The economies and societies of the developed world have been rocked this decade by the perfect storm of high unemployment and skyrocketing prices.
It came as a shock to two decades of relative calm and prosperity after World War II, when governments actively managed their economies in an attempt to keep unemployment down. After the deflation of the 1930s and the Great Depression, they gladly tolerated price increases if that meant a healthy labor market.
The US and world economies went through a
when oil prices rose and Richard Nixon changed the rules of international finance by separating the dollar from gold, which had been the bedrock of the financial system since the end of World War II. Despite slowing growth, inflation got out of hand and US price hikes climbed into double digits by the end of the decade. The oil price shock, high government spending and the unions, which drove up wages, were to blame.
The resulting stagflation was a household and business nightmare and shattered old ways of thinking about economics. This ultimately led to new ideas gaining influence, with governments and central banks (particularly in the US and UK) being inspired by economist Milton Friedman to reduce government intervention and focus on controlling inflation. The new system helped revitalize growth but laid the groundwork for a number of new problems, most notably growing inequality and the housing and financial crisis of 2008.
Energy prices could sustain inflation
The return of stagflation threatens to turn the post-pandemic period into a mass fire drill. The signs are mounting: the price of US oil has risen to a seven-year high and natural gas is up more than 500% in Europe.
US stocks fell in September and had a rocky October as investors fear inflation could stay high – and erode their investments – even if growth cools. “Concerns about stagflation seem to have turned from nagging worries to anxiety attacks,” said Susannah Streeter, a market analyst at broker Hargreaves Lansdown.
Still, there are hopeful signs. Analysts indicate that economies around the world will still achieve better growth rates in 2021 and 2022 than they have in years. And unemployment rates in the advanced economies have remained relatively low.
Even so, the markets are nervous and the stagflation debate will continue. Economists and traders will scour every data release for any hint of slowdown in growth or continued price spikes – and pray there is no return to the 1970s. The next decade is at stake.