Greenspan Gets One Right: Here Comes Stagflation
In a recent interview, former U.S. Federal Reserve Chairman Alan Greenspan (the “Maestro”) warned that the economy was experiencing, “the early signs of stagflation.” This is a very rare occasion where Mr. Greenspan and I are actually in agreement. I also warned of this in my “Time to Invest for Stagflation” commentary published several months ago.
In fact, the U.S. economy-and indeed the entire developed world-is in the beginning stages of an unprecedented breakout of stagflation. The number one reason for this can be summed up in a single word… debt. Debt not only steers an economy towards low growth but it also mires the nation with inflation.
Public and private debt as a percentage of the economy had been 150% for decades prior to going off the gold standard in 1971–a standard of money that Greenspan himself advocated before becoming Fed chairman. That ratio of total debt to Gross Domestic Product shot up 350% before the great recession of 2007-9 and it remains near that level today. And now, the annual level of red ink has started to rise sharply. The fiscal 2016 deficit is projected to rise to $600 billion, up more than 35% since fiscal 2015.
In fact, global debt as a whole has increased to $230 trillion, up $60 trillion since 2007, nearly three times the size of the entire global economy. All this debt engenders the stag part of stagflation because it is difficult to invest for growth in an economy under such high debt burdens. The baneful part of this worldwide debt buildup is that it didn’t lead to the accumulation of capital goods for the purpose of expanding productivity. Instead, it was spawned for the fruitless Keynesian ruse of what amounts to not much more than hole digging and filling.
While it is true that debt service payments are currently at historic lows, it is also true that debt levels are at a record high both in nominal terms and as a percentage of the economy. Therefore, low-interest payments are the direct result of an unprecedented bubble in the bond market. Individuals are intuitively aware of this unstable rate environment and must prepare their balance sheets for rising carry costs.
Most importantly, a debt saturated economy can’t function properly because it is marred by capital imbalances and asset bubbles that must be unwound for the credit and savings channel to work efficiently. But our economic leaders seem intent on obduracy.
A perfect example of this condition is Japan. The nation is now set to take its 26th trip down this deficit spending road to nowhere since its property, and equity bubble crashed back in 1990. And despite multiple recessions and lost decades, the government is still clinging to the deluded fantasy that a debt to GDP ratio greater than 240% is needed to jump start the economy.
But, the effects of this unproductive debt pile aren’t just evident in Japan. U.S. GDP averaged just 2.1 percent since 2010. And that anemic growth rate is headed even lower; up just 1.2 percent over the past year and only 1 percent for the first half of 2016.
Indeed, the International Monetary Fund (IMF) recently lowered its 2016 forecast for the entire global economy to just 3.1 percent.
So where does the inflation part of stagflation come from?
If there is one thing that all central bankers foolishly agree on it’s that a 2 percent inflation goal is now mandatory for growth. According to Haver Analytics, the balance sheets of the Fed, European Central Bank, Bank of England, Bank of Japan, and People’s Bank of China have soared to $17.2 trillion, from $6.5 trillion over the past eight years.
In pursuit of this fatuous task, ECB and BOJ balance sheets are ascending at the blistering pace of a combined $180 billion per month of newly created fiat credit. And now the Bank of England just stepped up its asset purchase scheme to a total of $570 billion. But unlike what most Keynesians will tell you, inflation doesn’t come from a low unemployment rate but rather from too much money chasing too few goods.
Therefore, it would be silly to assume that central banks can achieve their 2 percent inflation targets with precision. Reckless deficit spending, surging debt to GDP ratios and an unmanageable increase in central banks’ balance sheets will eventually erode the confidence of central bankers to maintain the purchasing power of fiat money. Therefore, inflation won’t just magically stop at 2 percent; it will eclipse that level and continue to rise.
This return of inflation will cause a mass exodus from the bond market, just as short sellers begin to pile on top. The bond market will respond in violent fashion-taking yields up 100’s of basis points rather quickly-as bond bids from yield-agnostic central bankers are supplanted by a genuine market that will justifiably demand higher rates. And of course, the inevitable surging debt service payments will subsequently render debt-saturated governments completely insolvent.
An unprecedented accumulation of unproductive government debt that is fueled by a massive increase in the global base money supply is a perfect recipe for worldwide stagflation. But the truth is that stagflation isn’t something on the horizon, it has already arrived.
The hallmark of a healthy economy is to have its real growth rate to be double the pace of inflation. Today, this sign of prosperity has been turned completely upside down. The core Consumer Price Index is up 2.3 percent year over year while real GDP has grown just 1.2 percent. Inflation is now running at twice the rate of real economic growth!
Stagflation is not an economic peril we only need to fear in the future; but rather it is something consumers are forced to deal with right now. The former “Maestro” is perhaps getting better with age. Investors should prepare their portfolios for a protracted period of rising prices and slowing growth.
Originally posted on Pentoport.