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Ardent Listener
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4841 Posts |
 Posted - 07/25/2010 : 16:26:56
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Jayati Ghosh
There is no doubt about it: the US financial structure is crumbling, possibly even collapsing. The collapse of a major Wall Street bank and the enormous bailouts that are being offered to financial institutions in the US by the US Federal Reserve are only symptomatic of the wider crisis created by the unravelling of the real estate boom based on dodgy lending practices.
Everyone knows that what has already come out is only the tip of the iceberg. The financial crisis has clearly spread quite dramatically: from "sub-prime" borrowers to "prime" borrowers; from bad mortgage debt to bad credit card debt; and from banks to hedge funds to insurance companies. There is no doubt that there is much more bad news to come within US markets. And most certainly, given the sheer size of the US system and the complex forms of financial pyramiding and entanglement with other financial structures in different countries, the global financial system will feel the impact.
There is also little doubt that the US economy is heading into, if not already in, a major economic recession. The economic data from the last two quarters is poor, and the prognosis is worse. In the last quarter of 2007, the US economy grew at only 0.6 per cent, and much of that increase was due to higher exports rather than domestic demand. Retail sales have declined in the first two months of 2008 compared to the previous year.
The most recent employment data show that the US lost 63,000 jobs in February 2008, following a fall of 22,000 in January. Initial claims for unemployment have been rising and have already reached levels associated with previous recessions in 1990 and 2001.
Indeed, such figures suggest not a mere recession but even a more substantial depression is in the offing for the US. This is likely to intensify as the effects of the housing foreclosures and worsening financial position of households combine with rising unemployment to create significantly reduced consumption demand. Investment will suffer not only because of the reduced assessments of future market demand but also as the financial crisis makes it harder to access finance for new investment. And so the elements of the downward spiral are all in place.
And here too, the rest of the world will feel the impact, as the large economy whose voracious demand for imports had fuelled the most recent global economic expansion stops being an engine of growth. So there is no doubt that world output growth will be adversely affected, particularly in those countries (such as China) that had been growing rapidly on the basis of rapid increases in exports to the US.
The collapse of the US dollar vis-à-vis other major currencies is not only related to these troubles; it also reinforces them, while simultaneously generating cost-push inflationary pressures within the US by making imports more expensive. Import prices have increased by nearly 14 per cent in the year to January 2008, which is the fastest increase since such data began to be published in the early 1980s. As a result, there is evidence of greater inflationary pressure already at work. The year-on-year producer price index in February rose by 7.4 per cent, making it the biggest increase in more than 26 years. In the past three months, the consumer price index increased at an annual rate of 6.8 per cent.
This combination of stagnant or falling output and rising prices is why more and more economists and analysts in the US have started using the dreaded S-word – stagflation – to forecast the immediate future of the US economy as well as the world economy. This immediately brings to mind analogies with the period of the 1970s, when not only the US but the entire world economy suffered a prolonged period of income stagnation and even decline and increased unemployment, accompanied by rising price levels. At that time, the rise in oil and other commodity prices combined with attempts by workers in developed countries to maintain their real wages in the face of rising costs of living generated inflationary spirals, and economic volatility and depressed investor expectations caused real output and employment to stagnate.
The stagflation hypothesis appears to be reinforced because the current period is also a time when global commodity markets are experiencing some of the highest prices ever. Crude oil prices, at more than $111 a barrel in the middle of March, are higher in real terms than they were at the height of the oil shock of the 1970s. Other commodities such as metals have been showing very high and rising prices for the past year. World wheat prices are also at record highs, hit by falling output (because of acreage shifts in the US to biofuels, along with bad weather conditions in major exporting countries like Australia and Canada).
And now gold prices have hit record highs, crossing $1000 per ounce in early March. This is something that typically happens when inflationary expectations are high, as investors seek safety in real assets rather than financial assets, and gold remains the most convenient of such commodities.
So does all this suggest that not only the US but the entire world economy is heading towards stagflation? The answer may well be yes, but not for the reasons that are generally being offered by many analysts. Several economists have offered an essentially monetarist analysis of stagflation, whereby it is brought about by central banks trying too hard to prevent recession, and thereby keeping interest rates too low and monetary policy too loose. According to them, this creates an excess of money supply, which then generates higher inflation. Instead, they argue that if the Fed holds its nerve and simply tightens its monetary policy in the face of rising price levels, then inflation will be brought down even at the cost of some temporary pain in the form of a recession.
Remember that the essence of stagflation is a prolonged combination of stagnant income and rising prices, rather than a stagnation that has a temporary rise in inflation followed by a more widespread deflation. While there is no question that aggregate world incomes will grow more slowly than they have in the recent past, whether or not there will also be rising inflation depends not upon monetary policies and the attempt to control money supply, but on the ability of different groups in the economy to maintain their distributive shares.
That is because inflation in modern economies is essentially about two forces: the fight over distributive shares in national income by different groups, and the role of expectations about inflation. Thus, if there is a rise in commodity prices (that would increase the relative income share of commodity producers) then this will only lead to a rise in the general price level if capitalists insist on maintaining their margins over costs at the same level. If they are unable to do so for any reason, then the rise in commodity prices need not translate into a generalised inflation.
Similarly, if the initial rise in prices pushes down real wages and workers are not in a position to demand increases in nominal wages that would maintain their real wages, then the inflation is controlled. Tight monetary policies are usually a way of enforcing this by allowing greater unemployment, so they work indirectly rather than directly to control inflation. So inflation reflects a wider fight over income distribution.
Expectations add another dimension to this, by making different agents behave in ways that are determined by their anticipation of future inflation. If higher prices are anticipated, producers and retailers will set their prices higher to absorb such expected effects, and workers will scale up their demand for nominal wages. In this way, the expectations become self-fulfilling and create an inflationary spiral that becomes hard to break.
Therefore, whether or not there will be stagflation depends ultimately on international political economy and the relative strength of different groups in the world economy. It may be argued that working classes and peasants have been so weakened by the onslaught of neoliberal policies of the past two decades that they are in no position to fight to maintain even their already significantly diminished shares of income. If this is true, then the likelihood for the immediate future is an economic recession with worsened conditions of living and higher unemployment across the world, albeit with lower rates of aggregate inflation.
But if the world has changed in other ways that make further attacks on people's livelihood more difficult in most countries, then the current crisis may well become an opportunity. A period of stagflation and generalised capitalist crisis could augur a different global political economy and more creative approach to economic policy making, in which rapacious profit making is restrained and ensuring better material conditions for the majority becomes instead the basic policy priority.
This is not as far-fetched as it may sound. The 1970s may be remembered with fear and loathing by finance capital, but they were also a period in which several developing countries began the industrialisation process that culminated in the "success stories" of east Asia and elsewhere. And surely the destructive tendencies of the most recent phase of capitalism require a shift in economic strategy in a more democratic direction, which can only be enabled by the clear collapse of the existing strategy.
April 8, 2008.
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Ardent Listener
Administrator
USA
4841 Posts |
Posted - 07/25/2010 : 16:42:55
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Jubak's Journal7/4/2006 12:00 AM ET
Stagflation: A new peril for stocks
Stagflation is what happens when you have little economic growth but a good bit of inflation. It's an awful environment for stocks, and it could come back. Here's why.
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Great. Something more for investors to worry about.
There are inflation worries, of course. The financial markets are worried that inflation is running so hot that the world's central banks will raise interest rates again and again and again to fight it. That wouldn't be good for either stock or bond prices.
There are slow-growth worries, of course. The concern here is that the central banks will overshoot and raise interest rates so high in their battle with inflation that they'll either slow or stop economic growth. That certainly wouldn't be good for stocks and if growth slowed enough, rising bad debt could take a bite out of some sectors of the bond market.
And now there are stagflation worries to add to the list.
Concerns that we could see a rerun of stagflation, that dreadful mix of slow-to-no growth and high inflation that made a good part of the 1970s such a bad time for investors, have been on the rise this year. But until recently, I hadn't seen a convincing explanation for why this monster should rear its ugly head now. However, the Bank for International Settlements, based in Basel, Switzerland, the bank for the world's central banks, warns in its most recent annual report that global stagflation is a real possibility. I find the bank's logic convincing, and I think investors need to factor the possibility of stagflation into their thinking.
Why you should be thinking about stagflation
Most of the time, we associate high inflation with periods of fast economic growth, based on Keynesian economic theory, named after the great English economist John Maynard Keynes. (Keynes is, to the best of my knowledge, the only great economist who was also a masterful investor: He managed the Kings College, Cambridge, portfolio to an average annual return of 13.2% from 1928-1945.)
According to Keynes, fast growth in demand leads to bottlenecks that prevent supply from keeping up with demand. That leads to rising prices for goods and services. At some point an inflationary psychology sets in -- the price-wage spiral -- as higher prices cause workers to demand higher wages to keep up, which in turn produces higher prices.
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This is exactly the kind of inflation that the Federal Reserve seems determined to fight with its current set of interest-rate increases. Higher interest rates should, the theory goes, depress growth in demand, which should lead to lower prices.
But as the 1970s proved, this theory of inflation with its focus on supply and demand doesn't explain all instances of inflation. According to Keynesian economics, it should be impossible to produce inflation during a period of slow growth and high unemployment. Slow growth and high unemployment should depress demand, leading to lower prices.
The 70s: A rotten time for investors
However, in the 1970s, despite Keynesian theory, the economy went into a nose dive and inflation soared. Real GDP actually fell in the United States from 1973 through 1975. From 1973 through 1977, real GDP grew at an annual compounded rate of just 1.3% a year. But from 1973 through 1979, inflation averaged an annual 8.8% a year.
As you'd imagine, this wasn't a great period for the stock market. According to Ibbotson Associates, the S&P 500 ($INX) showed an average compounded rate of return of just 3.2% from 1973-1979. Long-term government bonds didn't do a whole lot better, with a 3.5% compounded annual return for the same period.
Mind you, those were the nominal rates of return for the period, i.e., before inflation. Figure in inflation and investors lost money during these years.
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Jubak's Journal7/4/2006 12:00 AM ET
Stagflation: A new peril for stocks
Continued from page 1
This Economists who focus on the money supply -- known as monetarists -- have an explanation for what happened in the 1970s. An expansion of the money supply can cause inflation just by itself, even if demand isn't strong enough to push up prices. When the supply of money is larger than the demand for money, monetarists argue, inflation is the result. "Inflation is always and everywhere a monetary phenomenon," argued Milton Friedman in "Monetary History of the United States," the book he co-authored with Anna Jacobson Schwartz.
The central banks don't get globalization
The arguments among the Keynesians, monetarists, neo-Keynesians, and neo-monetarists are by no means over, but it looks like stagflation, whatever your theory of inflation, could be set to ride again, thanks to a basic misunderstanding of the global economy by the world's central banks. You don't have to take my word for it this time. (See my June 23 column, "The worst-case scenario is not about us.") This time, it's the Bank for International Settlements that is raising the alarm.
The bank, an international organization of central banks based in Basel, Switzerland, argues that central banks from the Federal Reserve to the European Central Bank have misunderstood the effects of globalization on inflation. (You can read the bank's discussion here.) Globalization, the bank says, kept inflation low in the world's developed economies. Low-priced overseas goods replaced higher priced domestically produced goods, lowering prices. Competition with low-cost overseas producers forced domestic producers to lower prices, as well. That also acted to damp inflation.
Manufacturing overcapacity push prices lower
During this period, the prices of overseas goods weren't just lower than those produced by domestic competitors, they were also falling over time. Thanks to massive overcapacity in manufacturing centers, such as China and India, overseas producers were forced to compete with themselves and to repeatedly lower prices to keep the business of price-sensitive retailers, such as Wal-Mart Stores (WMT, news, msgs), in the developed economies.
Intervention in the currency markets by national governments kept the prices of overseas goods from rising as well. Most obviously, the refusal of the Chinese government to let the yuan freely rise in value to reflect China's huge trade surpluses kept the price of Chinese goods low and forced other overseas manufacturing nations to intervene in the currency markets, as well, in order to prevent their own goods from being priced out of the world market.
Low and falling global prices masked the effects of an expanding money supply in the developed world. Interest rates that fell as low as 0% in Japan and 1% in the United States provided a huge boost to the global money supply, especially as investment funds borrowed money at these rates to leverage their capital assets. The huge increase in the price of oil put massive numbers of U.S. dollars in the hands of oil producers, who then sought to recycle them by making investments in assets such as U.S. Treasury bonds and mortgage-backed securities, based on a booming U.S. real estate market.
Under other circumstances, an increase in money supply of these dimensions should have produced measurable global price inflation. But it didn't. Traditional measures of domestic inflation in the developed economies didn't show rising prices. With inflation measures showing inflation still contained, the Bank for International Settlements argues, the world's central banks kept the money supply spigots wide open for longer than they should have. That has built up considerable inflationary pressure around the world.
Bidding for workers in China
And now that global inflationary pressure is in the process of being turned into actual, measurable inflation because prices for goods produced by overseas manufacturers in China, India and elsewhere have stopped falling.
In China, for example, some regional manufacturing centers have developed labor shortages. Chinese companies are paying larger bonuses to attract workers from outside their own areas or relocating work to areas with still-abundant cheap -- on China's wage scale -- labor. Rising raw materials costs have cut into profit margins again and again until a significant portion of companies in such sectors as steel and chemicals are not profitable. Thanks to the willingness of Chinese banks, despite government policy, to lend more money to unprofitable companies, these money-losing enterprises aren't going out of business. But they are certainly no longer able to significantly lower their prices. For foreign customers, the small increases in the value of the yuan against the dollar also make Chinese goods more expensive.
These changes -- in Chinese wages and in the yuan-dollar exchange rate -- may seem very small. Indeed they are. But as the Bank for International Settlements points out, it's not necessary for prices of Chinese goods to rise significantly in order to increase the measured rate of inflation in the developed economies that are big consumers of offshore goods. If prices simply stop going down, that alone is enough to push measured inflation significantly higher in the future.
Higher rates ahead?
If the Bank for International Settlements is right, the global economy has built up significant inflationary momentum because global central banks, which did not see inflation in their usual measures, kept the money supply growing too fast for too long. That has created exactly the kind of inflationary situation described by monetarists in which too much money supply faces too little demand for money.Get the latest from Jim Jubak. Sign up to receive his free weekly newsletter.
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HTMLPlain TextLearn more about newslettersTo unwind that monetary imbalance, central banks will have to tighten by reducing money supply growth and by raising interest rates to levels that are well above current rates and quite possibly well above the levels that are compatible with solid economic growth.
At the same time, because significant global inflationary pressures are just now starting to show themselves -- and because managing prices for Chinese and Indian goods by raising U.S. and European interest rates in order to damp U.S. and European consumer demand is likely to take a while -- inflation rates are likely to rise to higher levels than central banks in developed economies find comfortable.
So, according to the Bank for International Settlements, we could be headed for slow growth and high inflation for a while -- even if everything goes well in the effort to slow inflation by raising interest rates.
Stagflation isn't a certainty. But for the first time I can see a plausible scenario that gets us to that very uncomfortable position.
New developments on past columns
When this market bounces, sell: The stock market rallied strongly on Thursday, June 29, after the Federal Reserve raised short-term interest rates another quarter of a percentage point and indicated that it sees more likelihood that the economy is slowing. Investors who had bid the odds of another quarter-point rate increase at the Federal Reserve's Aug. 8 meeting up to 90% before the meeting rushed to buy stocks after concluding from the Federal Reserve's June 29 press release that an August increase was now less likely. The Dow Jones Industrial Average ($INDU) closed up 217 points, or 2% for the day. The optimism hung on a relatively minor change in the Fed's press release: Instead of saying, as it did in May, that the Fed's Open Market Committee "sees growth as likely to moderate to a more sustainable pace," on June 29 the Fed said "indicators suggest that economic growth is moderating." I think the June 29 move in stocks continues the bounce that began on June 13, and it could well run for the first half of July as investors react with relief to the chance that the Fed won't raise interest rates in August. But it is still likely that when investors start to worry about an August rate increase again, this bounce will peter out with a July retest of the May high on the Dow industrials at 11,642, about 4% above the close for the June 29 post-Fed-meeting move. I'd still treat this bounce as an opportunity to sell selectively and position your portfolio for buying at an August or September low.
3 picks for the dog days of summer: Now that it has paid off the money that it borrowed from the government during Japan's banking crisis in the 1990s, Mitsubishi UFJ Financial Group (MTU, news, msgs) wants a bigger piece of the global banking pie. The company, the world's biggest bank by assets, has opened negotiations with the U.S. Federal Reserve about obtaining financial holding company status in the United States. That would allow Mitsubishi Financial to expand into the U.S. insurance, underwriting and investment-banking markets. The company already has 13 bank offices in the United States and owns 62% of UnionBanCal (UB, news, msgs), the 21st largest bank in the United States. But without holding company status, Mitsubishi Financial can't consolidate its operations with UnionBanCal, acquire other U.S. financial holding companies or compete in the lucrative insurance and investment banking sectors. Right now, more than 80% of Mitsubishi Financial's profits come from its home market in Japan.
3 ways to invest in Europe's revival: On June 19, Nestle (NSRGY, news, msgs) purchased weight-management company Jenny Craig from a group of private investors. Jenny Craig sells branded weight-management foods and runs weight-management classes in the United States, Canada, Australia and New Zealand. Sales for the last 12 months were more than $400 million, and Jenny Craig showed double-digit organic revenue growth. Nestle paid approximately $600 million for Jenny Craig. The acquired business will help Nestle's Nutrition group expand its presence in the United States, the world's largest nutrition and weight-management market.
Editor's Note: A new Jubak's Journal is posted every Tuesday, Wednesday and Friday. Please note that Jubak's Picks recommendations are for a 12-to-18 month time horizon. See Jubak's CNBC Picks for shorter six month recommendations. For suggestions to help navigate the treacherous interest-rate environment see Jim's new portfolio Dividend stocks for income investors. For picks with a truly long-term perspective see Jubak's 50 best stocks in the world or Future Fantastic 50 Portfolio.
E-mail Jim Jubak at jjmail@microsoft.com.
At the time of publication, Jim Jubak owned or controlled shares of the following equities mentioned in this column: Mitsubishi UFJ Financial Group. He does not own short positions in any stock mentioned in this column.
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All posts either by the members, moderators, and the administration of http://realcent.forumco.com are for your edification and amusement only. It is not the intent of realcent.forumco.com or its host to provide investment, medical, matrimonial, legal, security or tax advice and nothing posted here should be considered to be so. All rights reserved.
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copperhead57
Penny Collector Member
USA
255 Posts |
Posted - 07/28/2010 : 20:12:50
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There was "STAGFLATION" back in the 1970's, but I think this time it will be much worse.
I'm beginning to look at the late 1970's as the good old days. |
copperhead57 |
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Beau
Penny Pincher Member
216 Posts |
Posted - 07/30/2010 : 23:03:29
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the late 70`s were hardly felt here.
the only thing I remember about them were long Gas lines and the Gas was high.
everyone that wanted a job and would work had one. |
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Global Stagflation?
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