Stagflation: A condition of slow economic growth and relatively high unemployment - a time of stagnation - accompanied by a rise in prices, or inflation.
The media re-discovered the term this week. There were articles in the NY Times, the Economist, and the Wall Street Journal.
They all acknowledged the validity of the concerns about the return of stagflation, but they all went to great lengths to tell us that today's environment is nothing like the 70's.
They were all wrong. Today is very much like the 70's, with the exception of the polyester and disco.
Give me that ol' time stagflation
"The question is not, will we get inflation, but how much will it cost to stuff the genie back in the bottle. This has the feel of 1970s stagflation."
- John Ryding, economist at Bear Stearns
Most people associate stagflation with the Carter Administration and the peak of inflationary pressure. But the fact is that stagflation had already been a way of American life for seven years before Carter came into office.
On August 15, 1971, President Nixon took the unprecedented step of declaring wage and price controls during peace time to combat runaway inflation, controls that would remain in effect until 1972.
In 1970 unemployment climbed from 3.9% in January to 6.1% in December. The inflation rate was 5.3%.
5.3% inflation may seem somewhat mild today, but in a world that was still functioning on a quasi-gold standard it was extremely high. The average annual inflation rate in the 1960's was 2.5%. It was also the leading cause for Nixon to take America off of the Bretton-Woods gold standard that very same day.
By October 1973 the unemployment rate was back down to 4.6% and the inflation rate even lower. Economic conditions wouldn't be that good again until the late 1980's.
Over the last five months, the consumer price inflation rate (CPI) has been running at an annualized rate of about 5.8%. That may not be comparable to the double-digit peaks in 1974 and 1980, but it does compare to the 1970's average annual inflation rate of 7.4%.
As you might expect, the 1970s weren't a great time for investors. The Standard & Poor's 500 Index ($INX) returned a compound annual 5.9% from 1970 to 1979. With inflation running at an annual 7.4%, an investor in the stock market was losing ground every year to inflation. Bond investors had it even worse: The compound annual return on a long-term U.S. Treasury bond for the decade was just 4.8%, 2.6 percentage points lower than the inflation rate.
Stagflation, here and now
Quite possibly the most memorable trend of the 70's stagflation was how commodities exploded in price while stocks and bonds lost ground after inflation.
In fact, that is exactly what we are witnessing today.
"But the inflation rate is so much lower than the double-digit rates of the 70's" the media tells us.
In fact, the CPI of the 1970's is not the same CPI that we have today. For starters, Reagan changed how its main component - housing, which account for about 30% of the core CPI - was calculated in 1983. Now we have "homeowners equivalent".
If not for this critical adjustment, the CPI of this decade would have looked quite a bit higher than what we were being told.
Of course Reagan was hardly the only one to play with how price inflation was calculated. "Consumer Substitution", hedonic adjustments, and the quality adjustment methods all came into effect in 1990's. They were all designed for one purpose and one purpose alone - to lower the reported inflation rate.
It worked.
If all of these adjustments were rolled back to 1970's standards, today's consumer price inflation rate would look very suspiciously like the 1970's rates.
To make matters worse higher price inflation is on the way.
You see price inflation is a lagging indicator that follows monetary inflation. In order to mitigate a recession, the authorities have been inflating the monetary supply to epic proportions.
Putting the 'stag' in stagflation
On the other side of the equation is a stagnant economy. A recession in 2008 has increasingly become an easy call.
Over the past half century, every U.S. housing downturn as sharp as the current one has translated into a U.S. recession. U.S. house prices are falling at an annual rate of nearly 4% -- an event not seen since the Great Depression -- and the downward trend is accelerating.
I've written many diaries about the credit crunch, including this, this, this, and this. So I won't bother going over the same territory again.
If there is a silver-lining in all this it's that it should help the Democrats in the 2008 election.
In his book The 13 Keys to the Presidency, historian Allan Lichtman notes that all seven times since the Civil War when the economy was in recession in the fall of a presidential election year—1876, 1884, 1896, 1920, 1932, 1960, and 1980—the candidate from the opposition party was elected president.
Heck, sometimes if there's even a whiff in the air of an approaching or recently departed recession—as in 1992 and 2000—that may be enough to eject the incumbent party.
The trick is that the economic problems that afflict this administration are going to carry over to the next administration in spades, just like the stagflation under the Nixon-Ford Administrations afflicted the Carter Administration.