Stagflation-Plus

by: David Merkel, CFA

I do not agree at all with modern Keynesians who lacked the restraint of Keynes. Deficits are supposed to be temporary not structural. Loose monetary policy is supposed to be temporary, not lingering.

Many policies can “work” when governments have the capacity to take on more debt without harm. We are past that point now. Additional debt builds up a larger problem, that will result in a greater crisis later.

There is no escape. There will be a crisis. Do you want a smaller crisis sooner, or a bigger crisis later? The actions of our government say, “A bigger crisis later, much bigger and later if possible.”

Much of the inflationary pressure we face today is from two sources:

  • Loose monetary policy globally
  • Increased demand for food and energy globally.

We’re a one-world economy, sort of, so demand from growing middle classes in developing countries affects our prices. But they also deflate our wages as they compete with us for transferable work.

Thus stagflation. Our economy does not grow because we have taken on too much debt. Consult Reinhart and Rogoff, but beyond that, know that over-indebted consumers and small businesses are anemic in economic terms.

Now toss into the mix the idea that the Fed won’t raise rates for two years. Inflation has risen over the last several years, what will they do if it rises further? I see inflation rising from here, but not real growth.

This is one reason why I think Ben Bernanke is an intelligent idiot. Intelligent? Of course, he can speak about many things in economics and it satisfies many. Idiot? Well, he is not a critic of his discipline. I would be far more gentle if he were not granted so much power. After all, I don’t care much about what sideline loonies like Paul Krugman think. What, do people read the New York Times? How obscurantist. Newspapers are the past.

If you are not a critic of neoclassical economics, particularly after the 2008 crash, you aren’t thinking. The models did not consider the the effects of a big buildup in debt across the economy. They were debt-neutral, which was a big mistake.

Debt affects the incentives of people and makes them more timid. They don’t want to go broke, and that is far more likely in an indebted economy, where the debts are layered, and the government does not want to take on more costs because they are too indebted already.

Those following simple Keynesian models get things wrong when borrowing parties are over-indebted, because every debt involves a promise to pay that other parties rely on. Over-indebted entities do not buy or borrow freely, because they would endanger their rickety solvency.

Let me boil it down to simple ideas:

  • The world is growing, perhaps more slowly but more rapidly than the US. That forces inflation up.
  • There are many people in the world competing against US laborers, forcing wages down.
  • Developed markets like the US have borrowed too much, and have punk demand as a result. They can’t borrow as much to buy more.

That’s our economy now. We face rising prices for consumption, turgid asset prices at best, and the debt burden holds us back.