Is Stagflation Back?

It’s BAACKK!! Talking about inflation. Here are the last 12 months of inflation data per the US Bureau of Labor Statistics. We have not seen 5% inflation since the 1980s but here it is again.

Why? Take your pick.

  1. Shortages due to the economic shutdown and pernicious bottlenecks have meant a drop in the available supply of goods while the recovering economy has meant an increase in demand for goods. Lower supply and more demand both push prices higher.
  2. Skyrocketing housing prices have given people money to spend on remodeling or for second mortgages (why let your equity sit there say the commercials) which also goes to spending, so again, more economic demand for goods and services means higher prices for them.
  3. Wages have been going up, especially at the lower end and as labor costs go up, businesses raise prices.
  4. The Federal Reserve has flooded the banking system with money as it has gone from owning a negligible amount of US Treasury securities to being the biggest buyer on the planet, going from owning very little to owning one-third of all US Treasury debt, not to mention all the mortgages it has bought.
  5. Stimulus from an explosion in government spending has increased demand. Who knew the government would send you money for having kids, or send checks for 18 months just in case you were affected by COVID, or would tell your landlord he could not collect your rent for 15 months?

Speaking of housing prices, the median price of a new home has shot up from $325,000 15 months ago to $375,000. That’s a 15% increase in a little over a year. And, housing prices are not even counted in the Consumer Price Index. Rents are, and rents for many people are free on the thinking that so many people are economically hurting from COVID-related job losses. Well, ahem, last time I was out anywhere, name any store, I saw help wanted ads every direction I turned and I have not heard from anyone I know that they are out of work. I’ve even seen restaurants with closed signs due to lack of staffing.

So, Will Inflation Continue?

You could say that bottlenecks due to economic restarts will go away and that the increase in the minimum wage is a one-time event, that the Fed is pulling back on its bond-buying and that eventually housing prices will stall, especially as landlords who lost their stable of homes get foreclosed on and those hit the market and that massive federal spending is very front-loaded at the start of a new president’s term. All those are arguments for inflation settling back down.

But, on the other hand, once you’ve awakened the dragon, it is not wise to turn your back and expect him to lie back down again. Price increases beget prices increase and price increases beget wage increases. If you were alive in the 70s and 80s you remember how that works.

Second, the new theory in Washington is that it literally doesn’t matter how much you spend as long as there is full employment.

Third, prices on an exploding issuance of US Treasuries to finance the spending explosion, 100% of which is borrowed since we were already spending more than incoming revenues, means interest rates almost have to head higher. Since that represents an increased cost for businesses, that will keep pushing prices higher.

CBO Outlook

The Congressional Budget Office (CBO) is your friend. It is an independent part of Congress that examines the effect of taxes and spending. It puts the lie to a lot of financing gimmicks. Unfortunately, the CBO has a big problem. It’s record on forecasting is terrible, probably because it has to use the economic assumptions it is given, which let’s just say are rosier than any pair of Elton John’s spectacles. But it does a good job of looking backwards. So, on the following CBO charts, ignore the “Projected” side and look at the trend up to the present.

The chart above tells you that the percentage of the economy that can be collected as tax revenue pretty much stays around 18%. It is affected much more by recessions (see 2008) than by tax policy. That’s because contrary to optimistic lawmaker forecasts, people change their behavior to avoid taxes and tax revenue actually increases when taxes are lowered as you can see in the late 90s.

As I said, ignore the forecast and just look at the huge spike in spending in 2020 and 2021. It dwarfs everything in the last 50 years.

Now, on the chart below, my question is, “If the Fed pulls back from buying all the new Treasury bonds, how can bond prices fail to go down with the onslaught of new supply to finance all this spending?” It is actually a rhetorical question because the answer is “No one big enough to make a difference, at least at first.” That means interest rates have got to go up, and as I just mentioned, that means higher inflation as well.

Slowing Growth – The Other Side of Stagflation

OK, there is no doubt there is a lot of pent-up spending demand, a lot of stimulus from the federal government and a lot of money to spend from home equity. The first is by definition temporary, the second may be less temporary and the last one is getting out of control and like all other bubbles, eventually pop and come down to earth.

On the other hand, there is a very large stimulus to growth and that is immigration. I think you’ll be very surprised by the following chart, showing that nearly 1 in 7 Americans is a first generation immigrant, up from 1 in 20 in the 1970s.

Source: Migration Policy Institute (MPI) tabulation of data from U.S. Census Bureau, 2010-19 American Community Surveys (ACS), and 1970, 1990, and 2000 decennial census. All other data are from Campbell J. Gibson and Emily Lennon, “Historical Census Statistics on the Foreign-Born Population of the United States: 1850 to 1990” (Working Paper no. 29, U.S. Census Bureau, Washington, DC, 1999).

This is lately much more due to border crossings. See the following chart showing 220,000 crossings a month or 2.6 million per year if continued. This is a huge boost to economic demand that more than offsets the slowing population growth trend of native-born Americans. It also has huge voting implications.

What I showed you above goes counter to what the CBO projects below in terms of the potential labor force. According to their numbers, the labor force is almost not growing at all as people retire and the birth rate is way lower than it used to be. I am concerned about the falling productivity numbers.

So, add it all up – slowing growth as we get farther into the recovery, slowing labor force growth and lower productivity on the negative side. On the positive side, increasing immigration, a growing habit of deficit spending and momentum. While we can’t help but come down from 8% economic growth, I don’t think growth in the foreseeable future will slow enough to put us back into Jimmy Carter-era stagflation.

What I do think is unavoidable is higher inflation and higher interest rates. That’s been my view for a long time and I stick by that.

That’s my take, anyway.