That 70's Feeling
Ben Bernanke may be facing a nasty relic of the disco era. It's called stagflation
Does any of this sound familiar? Today, not only does the economy show slowing growth and rising inflation, but once again it is being hit by dramatically rising energy prices. Job growth during this point in the economic cycle is already less than half that of previous periods. Add in the unwelcome return of guns-and-butter deficit spending by Uncle Sam, and it may seem as if all that is missing for a total '70s flashback is some new ABBA tunes.
So are we in the middle of Stagflation II? Well, "Son of Stagflation" is the preferred term of Ethan Harris, chief U.S. economist at Lehman Brothers. "We are in an economy that is slowing to a little bit below trend growth, and inflation is creeping up," he says. Harris thinks all this is enough of a problem that the Fed should raise interest rates twice more this year. Still, Harris adds, "this is nothing like the stagflation of the 1970s."
He and his clients had better hope not. The stagflation of the 1970s was a catastrophe for financial assets. Adjusted for inflation, stocks lost 13 percent during the decade, while government bonds fell 16 percent. But lately stock prices have been rising, a sign of investor optimism. Yet investors also seem to be hinting at a stagflation call. The yield on 10-year treasury bonds has fallen from 5.23 percent on June 24 to around 4.8 percent last week. That may mean bond investors expect weaker growth. Yet the spread between those bonds and 10-year treasury inflation-protected securities (TIPS) has widened, a sign that investors expect rising inflation. Weaker growth plus rising inflation expectations-that smells a lot like stagflation.
Soft landing? But there's stagflation and then there's stagflation. Richard Berner, chief U.S. economist at Morgan Stanley, thinks Wall Street's worrywarts need to dial it down. "We have just gotten too used to low inflation and solid growth," he says. "Now we're in a period where inflation is higher and growth has slowed." And that slower growth should help bring down inflation, in a soft landing for the economy. While Berner thinks the housing market is headed for a hard tumble, he also expects a booming global economy to cushion the blow.
Fed Chairman Ben Bernanke is another soft-landing guy. When the Fed abstained from raising rates at its August meeting, the move was perceived as a bet by Bernanke that inflation pressures would be relieved by lower energy prices and a slowing economy. No inflation, no stagflation-and no need for more rate hikes. Of course, gambling on lower oil prices has been a sucker's bet in recent years. And those who believe that global oil production has peaked would argue that it will ever be thus. Yet Carl Weinberg of High Frequency Economics thinks the bout of higher prices has begun softening demand, which, in turn, should bring prices down. Indeed, the Organization of Petroleum Exporting Countries, or OPEC, recently cut its forecasts of world oil demand for the rest of this year to 1.3 million barrels per day, 80,000 fewer than it expected a month ago. Weinberg expects a "very sharpbreak in oil prices at some point soon, perhaps after the hurricane season in North America."
But on the other hand ...
advertisement
