by Jim Rickards, Daily Reckoning:
Most economists don’t believe we could have stagflation today. The prevailing view is that recessions are characterized by higher unemployment and reduced spending, and inflation is triggered by full employment and increased spending and therefore they cannot both happen at the same time.
This prevailing view is wrong, as I explain today. Yet it’s a powerful narrative that blinds most analysts to situations where stagnation and inflation are both happening at the same time.
That’s stagflation and it is emerging today.
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The first wing of the stagflation thesis is stagnant growth. This can take the form of an outright recession (two consecutive quarters of declining GDP) or simply slow growth at a rate below the potential growth of a strong economy.
The U.S. economy has grown in recent years, but growth has remained below historical averages.
What growth we have had wasn’t due to monetary policy. It’s been the result of extreme fiscal policy including annual deficits that are now approaching $3 trillion per year. Fiscal policy that involves direct government deficit spending does produce growth that monetary policy cannot. The question is: at what cost?
Basic Keynesian economics holds that government spending at a time of recession or when consumer savings are too high can stimulate growth. If the national debt is moderate, it’s possible to get more than $1.00 of growth for $1.00 of government spending financed by borrowing.
Today, these conditions don’t apply.
The Keynesian Multiplier Is Broken
The national debt-to-GDP ratio is 134%, the highest in U.S. history. Government spending is often directed at non-productive projects such as the Green New Scam and subsidizing illegal immigration.
When debt rises faster than GDP, which it presently is, the debt-to-GDP ratio grows, and the Keynesian multiplier shrinks. You are trying to borrow and spend your way out of a debt crisis, which can only end in default (unnecessary since the U.S. can print dollars) or hyperinflation (likely).
Those extreme outcomes (default or hyperinflation) happen in the endgame, which can be years away. What happens in the meantime is not much better.
Any debt-to-GDP ratio above 90% will produce a Keynesian multiplier of less than 100%. With a debt-to-GDP ratio of 134% the U.S. can only expect more debt and weaker growth from fiscal policy.
This may provide a short-term boost for Biden in an election year, but it’s a long-term drag on growth for the U.S. In the end, the U.S. is now Japan. The Japanese debt-to-GDP ratio is about 300%.
Japan has been in one long depression since 1990 punctuated by nine separate technical recessions. Japan cannot “stimulate” its way to growth. They can only continue deficit spending to prop up nominal growth while making their debt ratio and slow-growth problems worse.
The U.S. (and much of the world) is following the same path. Stagnation in the form of weak growth and occasional recession is the future of the U.S. economy despite recent strong quarters.
The stagflation hypothesis is entirely intact.
Inflation
While the stagnation hypothesis is open to some debate, there is no debate about the persistence of U.S. inflation.
Inflation has been going up for three straight months. In fact, inflation has been in a persistent range centered around 3.3% for 10 months. Inflation is back. In truth, it never went away.
Oil prices are one factor. The price of oil was $68.50 per barrel last Dec. 12. It peaked above $86 in early April and has since pulled back a bit to $78 today. But the trend has been higher.
That oil price surge has not worked its way through the supply chain yet. It’s resulted in some price increases, but more are in the pipeline. It’ll keep inflation at current levels or higher in the months ahead.
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