Inflation is generally associated with a fast rising economy. Much of the rise may be nominal, not real, because price indices are rising faster than the real economy. But at least there’s some real growth underneath the froth.
Deflation is the opposite. Deflation is associated with declining prices, recession and depression. According to economists’ pet theories such as the Phillips Curve, one thing that should not happen is inflation and recession at the same time. But, it does happen contrary to economists’ assumptions. It even has a name: “Stagflation.”
That name is meant to capture a combination of stagnant growth and high inflation. This happened in the U.S. in 1979 – 1982, when we had two back-to-back recessions, including the worst since the Great Depression. It was also a period of near record inflation with annual price increases hitting 13%, the Fed discount rate at 20% and interest rates on long-term Treasury bonds at 15%.
The reason for this combination of declining growth and high inflation is that inflation has nothing to do with growth, interest rates or money supply. It has to do with investor confidence in the dollar. Now we’re returning to that unpleasant combination of low growth and high inflation.
The low growth today is caused by excessive government debt despite Fed money printing from 2008 to 2015. Higher inflation is coming from lost confidence in the dollar as a result of out-of-control government spending.
Perhaps the Fed will put a lid on this with tightening, but that tightening might just cause a recession and reduce confidence in the dollar even further. Stagflation may be in the cards, according to this article.
If so, it will be a return to the late 1970s when the “misery index” was created to describe the stagflation combination of high interest rates and high unemployment at the same time. The best performing asset class in stagflation is gold.
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