Don’t Worry About a Return to ‘70s Stagflation

Recent months have resurrected a potent economic villain of the past—stagflation.

The U.S. economy is seeing little to no growth, while at the same time inflation has risen to levels not seen in the better part of two decades due in large part to soaring food and energy prices.

How much should we fear stagflation now? Could we be looking at a replay of the pain and suffering of the Ford and Carter years?

While the current environment is trying for many consumers, we don’t see it evolving into outright stagflation due to the relatively low inflation rate (by historic standards) and structural changes in the U.S. economy in recent decades that provide more protection from a damaging spiral.

For one thing, there’s more flexibility in the economy as a result of improved technology, deregulation and increased competition that has resulted in more efficiencies.

A story from Bloomberg this week cites energy use as an example: Economic production in the U.S. in 2007 was 10 times greater than it was in 1973, but the nation’s energy usage has risen by a third over that time period.

A big part of that energy efficiency is the continuing transition from manufacturing to services, which has also helped control inflation by keeping labor costs down.

Goods-producing jobs are now less than 20 percent of the national labor force, down from 34 percent three decades ago (see chart above). At the same time, the service sector has grown to 58 percent of all employment, up from 41 percent in 1978.

The manufacturing sector tends to be more volatile than the service sector because of its cyclical nature.

The history of the domestic car industry is a good example of this. Lower demand creates higher inventories, which leads to layoffs and plant closures as supply is cut back. When demand bounces back, more workers are hired as production is ramped up to increase supply. This works until demand again falls off.

Unionized labor accounted for 20 percent of the U.S. workforce in the early 1980s, but now that membership is down to about 12 percent, according to Bloomberg. And the percentage of unionized workers whose contracts include automatic cost-of-living raises is only 22 percent now, down from 61 percent in the mid-1970s.

In addition to these fundamental changes in the economy, there are other factors that reduce the risk of stagflation.

A big mitigator is the memory of what happened in the late 1970s—a brutal combination of double-digit inflation, double-digit interest rates, rising unemployment and falling output. The awareness of the negative impacts of stagflation will almost certainly lead top policymakers in the White House, at the Federal Reserve and on Capitol Hill to move quickly to head off stagflation, as we’ve already seen with the economic stimulus checks and interest rate cuts.

On top of that, exchange rates are far more flexible than they were several decades ago, and the surplus of worldwide labor will serve to hold down any upward pressure on wages.

Comments

[Dan Walker]

Has it ever occurred to any of you jollies that the reason that 75% of the US economy is in consumer spending because the only US business activity still sourced in this country is retailing, golf courses and strip joints? (I am being a bit facetious, but not much)

Of course goods-producing jobs are now less than 20 percent of the national labor force; we sent it all overseas. What do you suggest when we can no longer afford to import stuff from China? I will be generous and call that happening in 2010. What then?

[buyitcheap]

Agreed Dan. I don't regard the inability to produce goods here as a good thing. Does that manufacturing metric include FDI in plants etc. i.e. Toyota in the southeast US?

[alpinesk8er]

Wage inflation is the result and part of the overall rise inflation expectation. There is and will be surplus labor both nationally and globally. However, China with still healthy supply of laborer (with another 300 million farmers waiting to be converted to factory workers) is experiencing double digit inflation. This is being exported straight back to US, and inflated transportation cost thanks to oil is only going to exacerbate the inflation expectation.

[CLH]

Derrick---I agree with you. I see little if any inflation today. Wages are not going up. Everything must go up for inflation. Watch gold. Its tanking.

[Fiasco]

Your comparison of of 70's inflation to todays is flawed, like comparing apples to oranges. If the BLS used the same rules today the inflation rate would be 11%. Having started the analyses with such flawed data leaves all in doubt, "Garbage in - Garbage out".

[ItsJustMe]

Fiasco is right - inflation is not calculated the same way today that it was in 1975 and the other responders are correct that outsourcing our manufacturing may be a Godzilla that is about to come ashore.

The author does make one point that is pertinent: today's economy is not like 1975's economy. That means tomorrow's problems will be totally unlike yesterday's problems. We're about to find out if that is a good thing...

[Fabien Hug]

That's right we are not in the 70's anymore. But beware of "this time it's different". In the 70's wages were adjusted to a different measure of inflation. The majority of people kept their jobs and could consume. The minority lost their jobs. Now, it seems that wages are not adjusted. People seem to keep their jobs (if unemployment is measured correctly) but they can't consume. This will create another set of problems.

[kevinfmo]

the author is WAY OFF BASE. he suggests that inflation is not high by historic standards but does not acknowledge that the CPI does not accurately reflect the massive inflation across food, energy not to mention healthcare and education among other areas not reflected in the CPI. if someone accurately calcualted inflation and compared it apples to apples, it is very high, possibly double digits. second, he refers to structural changes- the structural change i am aware of is the global nature of food and energy pricing now. that means as our economy softens, it doesnt mean pricing on global commodities necessarily softens to compensate. thus inflation can go on for a long time damaging and softening the economy without a drop off in global demand to slow inflation. thus STAGFLATION. not necessarily the 70s type. probably WORSE. good luck

[iThinkBig]

The world needed the service economy and politicians and megacorporations tripping over themselves to serve emerging markets. What the world needs more of is energy. We want to become competetive again in the next decade we must sell the global consumer what they need. Second, clear out the bums with the global ponzi scams on deravatives based on an inflated and now bursting asset. Selling piles of dung overseas was incredibly short-sighted and destroyed a lot of investor confidence in our financial system. That financials could decline by a total of 80% would not be a bit surprising.

I think this rough patch for the next five years will be worse then the 1970's. We are ignoring the history of the Great Depression or the 1987 market crash and financial pain (real-estate driven, these numbers and malfeasance between lawmakers and i-Banks MUCH BIGGER in scope)

It is the fact that we produce six times the amount of food then the 1930's with only twice as much population and that the U.S. has excellent communications technology why the U.S. will quickly recover from cumulative downward spiral of short-term depression like conditions 2-3 years from now.

Pain in the free market will correct all, but I can't say I approve of the treatment for the stupidity, greed little understanding of fundamentals and lack of honor. I am not particularly looking forward to this time but began preparations in June of 2007. Good luck to you all and on the bright side, there is much money to be made in the worst of times when companies and entire markets conduct firesales.

[flow5]

As long as the dollar's outlook (current account deficit) is negative, there will be a vicious level of stagflation.

[Kevin972]

While inflation is problematic here, it is much greater for China and India. The combination of both rising costs for manufacturing and rising transportation costs, along with ongoing global currency adjustments will, eventually bring manufacturing jobs back on shore. This may take 5-10 years, but it will happen. Cheap oil made the exporting of goods and services possible. Expensive oil favors more local solutions and more jobs in the long run. Currently there is a yet favorable envioronment that allows for this. I don't believe this will hold up in the long run. I don't believe we are in for the large oscillations that both China and India may have to endure, just slower growth. Overall, higher oil prices encourage local solutions and capabilities, which is just what the "creative" side of americans are capable of....even if we don't insist on 4 years of math, chemistry and physics at the high school level.

[Reinko]

Fiasco is in the right; in the artilce it isn't even mentioned if the author is talking about core inflation or about the real inflation that people feel in their wallets.

And then this, quote:

The awareness of the negative impacts of stagflation will almost certainly lead top policymakers in the White House, at the Federal Reserve and on Capitol Hill to move quickly to head off stagflation, as we’ve already seen with the economic stimulus checks and interest rate cuts. Unquote.

Comment: the stimulus package is only a bit more borrowed money and is only 150 to 160 billion US$ in size. As a comparison: In 2005 US house owners withdrew a staggering 750 billion US$ from their home value (in the form of HELOC or second mortgages); most of that was used for consumer spending or large goods but not that much went into decreasing of the house value.

If 750 billion did not do the trick, why whould the stimulus package work now?

And the FED keeping stagnation out of the door? Wake up, it is an election year so from the FED nothing but rethoric...

[flatman]

The service sector is a synonym for low paying low skilled jobs. If anyone thinks that an economy can prosper when that is where the majority are employed - you are nuts.

[ATHELSTAN]

The worse it gets the more I dollar cost average into financials, especially regional banks and S&Ls. What we are all witnessing now is the demise of New York City and Charlotte NC as financial centers.
If the stand alone investment bank is history, and it may be, then the world will be looking for new financial money centers. London? Shanghai? Abu Dhabi?
The short-sigtedness and stupidity of Greenspan and Bernanke are hastening that demise. The latter is now out of control of events and world markets sense it too. The former is left to collect $70,000 a speech talking about the past. What a pathetic sight.
Poor John McCain has been dealt a terrible hand and he's going to take the Republican Party down to the worst defeat since 1932.

While it's great to have more service sector jobs, you can't export them. Most high tech within 15 years will come from India, eastern europe, Israel, and the middle east . Our high tech centers, Raleigh-Durham, northern Virginia, Boston area, the west coast, are living on borrowed time. They are not price competitive and never were.
Like Dorothy in "The Wizard of Oz" ,we'll all wake up from our dream to discover our real roots as an economy now lie in Kansas, or some other agricultural setting.

[BrunoT]

I can't believe some people have the gall to write columns as if they're experts when they lack a grasp of some pretty basic stuff.

Just one example:

The reason we use less energy per unit of GDP is that we don't MAKE as much STUFF as before! We IMPORT IT! So it doesn't show up as us using oil but instead in the cost of things we import, because the costs of the people manufacturing it overseas are going up!

And the whole premise of the column...."don't worry, we sell insurance, mow lawns, and give haircuts to each other" is scarily missing the point.

[chrism1962]

Is stagflation possible in a service dominated economy? .. of course it is.

If anything it may be easier to cut payrolls from service jobs, as they do not tend to be linked to high capital cost equipment (factories). Reducing 2 or 3 burger flippers is easy, cashiering 10% of your bank staff (expensive, but an opportunity to remove the dead wood).

The only jobs safe in the short term would probably be the public sector, as the Government would not want to be seen to be influencing the voting intentions before an election.

[tuckfinitee]

Not only are we in stagflation(see above)we are seeing the beginning of a massive revaluation of wealth. The US doesn't produce as great a percentage of things that people want. Think Great Britain and the first half of the 20th century.

[Wefwef]

Calculated the way it was calculated before 1983, US current inflation is 11.3-11.8%. Don't believe me, find it out yourself.

US bond yields are a joke.

[User 30121]

To CLH: ANOTHER bit of your wisdom, huh? Gold tanking! JesusHCrist! What is it about PM that has you so turned off and tuned out? Can you actually read? If so, try looking at PM starting with 1933 to present. Never mind the 5000 YEARS before that! If you can't see the forest because the trees are in the way, well, just QUIT making stupid comments WITHOUT so much as a scintilla of FACTS to base your hatred for PM's.

[E.D. Hart]

I usually refrain from depreciating remarks--but I hope the author doesn't have a degree in economics, because if he does, he has wasted a lot of money.

I agree with the others that 1) inflation is double digits, don't believe the government numbers, and 2) the fact that wages are not rising is not evidence of the lack of inflation, but rather the powerful forces of globalization.

Moreover, the following quote is absurd:
"A big mitigator is the memory of what happened in the late 1970s—a brutal combination of double-digit inflation, double-digit interest rates, rising unemployment and falling output. The awareness of the negative impacts of stagflation will almost certainly lead top policymakers in the White House, at the Federal Reserve and on Capitol Hill to move quickly to head off stagflation, as we’ve already seen with the economic stimulus checks and interest rate cuts.

On top of that, exchange rates are far more flexible than they were several decades ago, and the surplus of worldwide labor will serve to hold down any upward pressure on wages."

We currently have double digit inflation, unemployment is understated and rising, interest rates have no where to go but up, and are poised to raise considerably after the fall election.

The fact that wages are held down by surplus wages is irrelevant to inflation. Inflation results from the government(s) creating money, and credit globally faster that economic growth. Prices rise in such an environment, and wages can actually fall in the face of rising prices. The authors analysis gets cause and effect wrong, and has waaaaaaayyy too much confidence in the politicians.

economic stimulus checks are more than offset by the rising cost of energy, and falling interest rates are a very temporary phenomenon that must reverse. Please take off your rose colored glasses.

[Did U Think The Ponzi Scheme Would Last?]

This time it's really different just like the great moderation is a product of financial "innovation" (cough, cough).

There will be twists and turns, but it's really no different than any other boom bust cycle. Unfortunately, some of those twists could be really bad for the USA including removing the USD as the world's reserve currency and petrodollar, hyperinflation due to foreign gov'ts dumping dollar denominated assets to avoid losing their wealth through our inflation, etc. A big difference this time is that we have standing armies in place to physically threaten anyone who resists our monetary shenanigans. Wow, it feels just great to be an American these days. And hey, those higher taxes on the horizon sure bode well for those entering retirement, huh?