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Source link: http://archive.mises.org/10136/why-i-expect-serious-stagflation/

Why I Expect Serious Stagflation

June 15, 2009 by

When doing interviews for my new book on the Great Depression, a natural question comes up: will the present crisis turn out as bad as the 1930s?

My standard answer is typical for an economist: “yes and no.” On the one hand, there were very specific reasons that unemployment broke 25 percent in 1933, and we don’t have those factors in place today. So I don’t think the official unemployment rate will get anywhere near that catastrophic level, though it could very well come in at the #2 spot in US economic history.

However, even though unemployment rates will not be as severe, I still predict that we are in store for a miserable decade of economic stagnation. FULL ARTICLE

{ 22 comments }

Bogart June 15, 2009 at 7:16 am

Add in Smoot-Hawley and you have yourself one winner of a depression. Ooops, I forgot about this stupid America First program that focuses on purchasing things from American companies that manufacture them in Canada and Mexico.

flix June 15, 2009 at 8:16 am

What is necessary for recovery to actually occur?

-Malinvestments must be liquidated
-Leverage must be unwound
-Production must adjust to reduced demand
-Prices must adjust to reduced demand
-Debt must be repaid or defaulted on
(some overlap…)

Has this happened?
If the answer is NO, talking about recovery is a waste of time or simply propaganda.

I Hate Psychiatrists June 15, 2009 at 8:20 am

Look at the price of gas already !!!

We’re still in a deep recession and look at the price of gas, serious stagflation has already started.

I Hate Psychiatrists June 15, 2009 at 8:22 am

Flix,

“What is necessary for recovery to actually occur?”

answer: FREEDOM !!!!!

We must abolish taxes, uphold private property laws, uphold the 2nd amendment and let the people with their freedoms and private property get out of this mess.

AJ Witoslawski June 15, 2009 at 9:26 am

I still think deflation is possible. There will be two deflationary forces in our economy in the months ahead:
1. The flight to US gov’t bonds. This will drain liquidity away from the private sector and slow inflation as money will be diverted away from efficient, market operations and towards inefficient, government ones.
2. The collapse of the financial system. Since financial institutions with non-performing assets and big liabilities have not been allowed to go bankrupt and restructure, those bad assets and liabilities will continue to slow lending. More defaults of Alt-A loans and the like will also have deflationary effects as banks will be forced to increase reserves. Because of the riskiness of putting money in banks, I expect people to increase their own cash reserves as well.

Ultimately, nearly every action the government will take will propagate price deflation.

fundamentalist June 15, 2009 at 10:17 am

I completely agree with Roberts analysis and outlook, but I think the inflation over the near term will take place in assets and commodities as businesses use the excess money and low interest rates to speculate with. I can’t imagine why cpi would increase until the vast pile of unused resources gets eaten. That may take a couple of years. Then cpi will take off.

So for the short term, libertarians can and should make a lot of money from the feds’ foolishness. Borrow as much as you can at these low rates and invest in a basket of assets and commodities, though not bonds. The next depression should be like 1981 when the feds raised rates to stop cpi increases in the double digits. Long rates should be high by then, so before the feds raise short rates, get out of the other assets and into bonds. With bonds, you’ll lock in high interest rates and enjoy principle appreciation as long rates decline.

Lucas M. Engelhardt June 15, 2009 at 10:30 am

I think Murphy is right here.

The fundamental structure of the economy still has the same problems that it has had, and the Administration is trying to keep it from changing like it needs to.

Meanwhile, the money supply is growing like mad and I think there’s little evidence that the demand for money holding has increased sufficiently to offset the growing money supply. For example, if what was happening was just that banks wanted to hold more reserves, then we should see the monetary base increase, but M1 and M2 should not. Instead, M1 and M2 have increased by 9.5% in the past 6 months. This is significantly faster than usual. If people just wanted to hold more actual cash, then we shouldn’t see M1 and M2 grow this quickly either. Now, it might be that these effects exist (banks holding excess reserves and people carrying more actual cash), but it’s clear that Bernanke has overshot. Not only that, but he’s hinted at providing another trillion dollars. So, he’s committed to overshooting any actual increase in the demand for holding dollars.

So, we’re going to have lots of money, but not a lot of “other stuff”. Prices will go up and the economy will languish.

matt June 15, 2009 at 10:40 am

AJ, quick question:
“1. The flight to US gov’t bonds. This will drain liquidity away from the private sector and slow inflation as money will be diverted away from efficient, market operations and towards inefficient, government ones.”

the bond market over the last month looks like investors are fleeing US debt. do you think that will change?

Sonic Ninja Kitty June 15, 2009 at 10:54 am

Fundamentalist, When you said “I can’t imagine why cpi would increase until the vast pile of unused resources gets eaten” are you referring to the low capacity utilization (manufacturing) number we have these days?

I have an ongoing discussion with a friend who insists that we cannot have inflation until after this number goes up. My inflation argument hinges solely on money supply. We’ve agreed that we seem to be discussing a timing issue, here, although I can’t quite wrap my head around why low capacity utilization would necessarily prevent inflation from taking off.

Any comments would be greatly appreciated!

Mike Barnett June 15, 2009 at 11:04 am

According to shadowstats.com, real unemployment is already over 20%. If it weren’t for so many people being on the government payrolls, I expect we’d be at 25% already. (http://www.shadowstats.com/imgs/sgs-emp.gif). This collapse is going to make the 30s look like the golden era.

fundamentalist June 15, 2009 at 11:22 am

Sonic Ninja Kitty: “…are you referring to the low capacity utilization…”

Nice handle, btw. Capacity and inventories for the most part. Remember that the quantity theory of money goes both ways. If the money supply stays constant and the supply of goods increases, prices will fall.

Hayek was fond of saying that the biggest mistake mainstream econ could make would be to ignore the quantity theory of money, which they do completely. The second biggest mistake would be to take it too literally, which monetarists do.

All other things being equal, an increase in money will cause prices to rise without a doubt. But they never are equal. Productivity increases can mask the effects of monetary increases just as the excess supply of labor and capital goods that exist after a depression will do. Also, changes in velocity will have the same effect as changes in the money supply even though the money supply doesn’t change. Finally, new money at the beginning of a recovery often goes into assets, such as the stock market, rather than the purchase of goods and services, so we can see asset price inflation without cpi increases. My bet this time around is on asset price inflation first, then cpi increases.

Lucas M. Engelhardt June 15, 2009 at 11:23 am

Sonic Ninja Kitty,

I think the argument comes from a simple erroneous assumption. You friend seems to be assuming that “capacity” (or, nearly equivalently, “capital”) is basically homogeneous. So, as spending starts to go up (perhaps because of an increased money supply as you claime), production will increase toward capacity. Since production is increasing, prices won’t increase very much.

However, if capacity is not homogeneous, then we can run into a situation where capacity utilization stays low, but prices go up. If the increased spending is primarily in a sector that has hit capacity (or is near capacity), then prices in that sector will go up, even if another sector is still below (maybe far below) capacity.

For example, suppose that we have two sectors of equal size both operating at 75% of capacity in the boom, and where both sectors have an “L-shaped” short-run marginal cost curve. That is – marginal cost is flat until you hit capacity, at which point it is vertical. Then, suppose that one sector sees a 2/3 drop in demand. In that case, it would cut back to 25% of capacity, but prices would stay roughly the same. The other sector sees a 50% increase in demand. So, they hit 100% capacity, and prices start going up – since demand at the original price would require 112.5% of capacity. In this example, we have an increase in the price index despite the fact that “capacity utilization” fell from 75% to 62.5%. If we believe (as I do) that economic restructuring is largely what a recession is, then it’s very possible to have capacity utilization fall while inflation hits at the same time.

8 June 15, 2009 at 11:26 am

There’s a difference between inflation and commodity price increases. Most of the CPI increase is China demand and Goldman Sachs speculation.

If you follow many of the long-wave theories and some of the industrial cycle theories, there are some good reasons why inflation stayed low during the expansion of the past 25 years as inflation was funneled into capital assets such as factories in China. Now, we have a temporary deflation caused by the destruction of credit in the economy, and under-utilization of resources. However, the long-wave theories argue that we’ve maximized productivity in many industries, for instance raw material prices are an increasing portion of manufactured goods prices. Therefore, once the utilization numbers climb back to the peak, there won’t be any place to gain. Wages will be bid up, as better workers will be one of the few ways to gain an advantage over competitors. Supply/demand issues will emerge in commodities, and the Fed will be unable to hide inflation in assets or cheap Chinese labor.

We are moving from a world of supply shocks: neo-liberalism, fall of communism, and huge commodity supply, to a world of demand shocks: neo-socialism, aging workforce, and huge commodity demand.

Curious June 15, 2009 at 12:57 pm

Government employee = welfare recipient (unemployed individual), so I agree with Mike Barnett, the real unemployment rate is at least 25%.

Walt D. June 15, 2009 at 1:29 pm

I also agree with Mike Barnett. All that shadowstats is doing is using the original methodology. When the government sees changes in the time series that it does not like, it changes the methodology. It is not only the unemployment statistics that are altered to make things appear more rosy, but also GDP, CPI etc. If you look at GNP, we have been in a recession for a very long time. So what Robert Murphy is predicting has already started to take place.

M June 15, 2009 at 2:05 pm

This analysis seems optimistic to me. Nowhere in this article did Murphy include the effects of Social Security going broke during your decade. Nowhere did Murphy include the effects of Medicare going broke in a similar time frame. When those paychecks stop arriving, things have to get dramatically worse.

Eric June 15, 2009 at 2:46 pm

The one silver lining behind the clouds to come is that we may escape the hardship of the 30′s because we have 80 years of progress and technology on our side.

Imagine what it would be like if we had to pay $4 to $10 a gallon for gas and all we had were fords and chevy’s getting 10-12 mpg.

Imagine if we didn’t have world trade? In the 30′s we had no toyota’s honda’s, etc. And we didn’t have all that neat stuff at the dollar store coming from China (though it’s more like the $1.50 store nowadays).

Oh, and don’t forget the advances in computers and medical care – in the 30′s you’d likely die from an infection.

Sometimes I wonder if having 50% stolen from me today is really comparable to 50% stolen in the 30′s. With all the advances in technology today, perhaps we can live as well on half the (real) income as compared to the 30′s.

Sonic Ninja Kitty June 15, 2009 at 6:02 pm

Fundamentalist and Lucas M. Engelhardt, Thank you both very much for your insights! They are much appreciated!

Emil Suric June 15, 2009 at 8:55 pm

Shadowstats has the unemployment rate at around 21%, and the CPI at 7%. Deflation is a myth, you don’t have long drawn-out deflationary periods anymore. The FED simply doesn’t allow for deflation to act as a natural market correcting mechanism. In 2006 our current account deficit was 7% of GDP; since then it’s fallen to 3% (still too high). Add in the trillions of dollars printed by the FED, along with the very real possibility of the U.S losing vehicle currency status, and hyperinflation seems more than just possible. Not to mention that the FED continues downward pressure on interest rates, creating and expanding more bubbles.

Som June 15, 2009 at 10:34 pm

Bogart

“Add in Smoot-Hawley and you have yourself one winner of a depression. Ooops, I forgot about this stupid America First program that focuses on purchasing things from American companies that manufacture them in Canada and Mexico.”

Agreed! I was thankful for the past few months that the state hasn’t totally screwed up free trade this time (yet) Plus an upside is that this time around we also have a whole new instrument for “free” trade. The internet and its e-commerce.

ed smith June 16, 2009 at 8:27 am

The good thing is that as the monetary supply increases the minimum wage will effectively decrease making it easier for people to hire workers. Of course the assumption is that the government will not dramatically increase the minimum wage.

Dick Fox June 16, 2009 at 1:08 pm

Robert Murphy wrote:

there were very specific reasons that unemployment broke 25 percent in 1933, and we don’t have those factors in place today. So I don’t think the official unemployment rate will get anywhere near that catastrophic level, though it could very well come in at the #2 spot in US economic history.

I agree with Murphy in general concerning his article but here he seems to have a misunderstanding. There is a very strong possibility that we will have unemployment as severe are during the Great Depression. While there has not been a sumit such as Hoover had to ask businessmen to artificially hold wage rates high the government is doing virtually the same thing.

First evidence is the takeover of GM. Government motors will not reduce union wages but will use tax revenue or deficit spending (future taxes) to support wages. What is the difference between this and what Hoover did? Additionally congress is increasing unemployment benefits as unemployment increases. Once again wages remain high as workers go on unemployment but taxes or deficits (future taxes) is also artificially keeping wage costs artificially high. Add to this the fact that the government intends to create “green” jobs with the result of destroying 2.2 jobs per “green” job and the situation gets worse.

I believe that Murphy may be fooled by Keynesian bond illusion. If the Keynesians borrowed (bond illusion) to lower tax rates then as with the Kennedy/Johnson tax cuts we could see increased production but this is not what the Keynesian bond illusion is being used for. The bond illusion is being used almost directly to prop up wages.

If the President, Congress, and the FED do as they are promising we could actually have higher unemployment than during the Great Depression.

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