Stagflation is a term that became common in the US in the 1970s when inflation was rising significantly while economic growth was slow. As best we can tell the term stagflation was first used in Britain in 1965. It was first used in the US when President Nixon imposed wage and price controls in August 1971 and again in 1973 during the oil crisis. The term was widely used in the late 1970s during the Carter administration.
Expect to hear more references to stagflation in the days and weeks just ahead. Earlier this month, we learned that the US economy is growing at a very anemic rate of only 0.4% in the 1Q and 1.3% in the 2Q, both well below most economists’ expectations. Unemployment remains above 9%. With the latest meltdown in the stock markets, most forecasters now believe the economy won’t grow much above 2% in the second half of this year, if that.
Meanwhile, inflation is creeping higher. “Creeping” may not be the appropriate description since wholesale prices are actually soaring as I will discuss below. The Consumer Price Index rose more than expected in July, up 0.5%, versus the pre-report consensus for an increase of just 0.2%. For the 12 months ended in July, the CPI rose 3.6%. This is well above the Fed’s target of around 2%.
Wholesale prices have jumped by twice that amount over the last year. The Producer Price Index rose 0.2% in July, about in line with expectations. However, the PPI jumped a whopping 7.2% over the last 12 months. Increases in wholesale prices lead to subsequent increases in consumer prices. The increases this year have been most notable in energy and food prices.
Note: The chart shown does not include the latest CPI data for July which shows consumer prices rising at an annual rate of 3.6% as noted above.
As the chart illustrates, wholesale and consumer prices have risen rather dramatically since the end of the recession (shaded area). Yet most economists believe that the US remains in a deflationary period overall, what with the continued deleveraging in the housing markets and high unemployment. What they really mean is that credit remains very tight.
On one hand, rising prices are bad news for consumers; on the other hand, this may actually be good news for the Fed. The Fed implemented QE1 and QE2 in an effort to head off deflation.The recent increase in the producer and consumer price indexes may be an indication that the Federal Reserve policies are starting to work. However, the lack of economic growth at a time when inflation is increasing is not what the Federal Reserve wanted. They wanted both economic growth and higher prices, but what they are getting is higher prices and very little growth.
It remains to be seen if the Fed has plans for another round of “quantitative easing” (QE3). Keep in mind that the Fed holds an Economic Symposium every August in Jackson Hole, Wyoming. Fed Chairman Ben Bernanke will speak at the symposium on Friday, August 26. You may recall that Bernanke hinted at this same symposium last year that the Fed was about to embark on another round of quantitative easing – QE2. QE2, which ended in late June of this year, consisted of purchases of apprx. $600 billion in Treasury securities.
So, will Ben announce QE3 on August 26? If the stock markets continue to tank, I would think the answer is a definite YES. You might recall that Bernanke already hinted at QE3 on July 13, shortly after the end of QE2, but recanted the next day telling lawmakers that the Fed “…isn’t prepared ‘at this point’ to enact more stimulus.” We’ll see about that.
A year ago, when Bernanke announced QE2, rumors were that he wanted to buy up to $2 trillion in Treasury securities, but the more conservative members of the FOMC reportedly forced him to scale it back to only $600 billion. Some now feel that the $1.4 trillion difference ($2 trillion less $600 billion = $1.4 trillion) could still be on the table.
Personally, I hope the Fed doesn’t do it. That would push the Fed’s securities portfolio over $3 trillion. Plus, there are questions as to how well QE2 worked. I would say, not very well. But they may do it anyway. President Obama and Treasury Secretary Geithner met with Bernanke last Wednesday, just one day after the Fed downgraded its view on the economy. Hmmm.
If Bernanke hints at another large round of quantitative easing, QE3 on August 26, that should be quite bullish for stocks – especially if it’s a trillion dollars or more. Of course, who knows where the stock markets will be by August 26.