stagflation?

a lot of people are thinking about the possibility the US economy is headed for stagflation, high inflation and economic stagnation. in fact, the spike in people thinking and talking about it can be measured, as evidenced by this google trend chart:

i got the idea for using this chart from an article on stagflation over on minyanville. as an aside, i am envious of people who have access to realtime data about web usage and search queries. talk about assymetrical information. i sometimes use google trends as a research tool when i am thinking about buying a stock, sort of like an adjunct indicator to volume of shares traded.

back to stagflation, and a couple links of interest probably to traders or investors only. ticker sense did a quick study of how the stock market has performed during periods of stagflation. first they had to define what constitutes a period of stagflation, as there is no commonly accepted metric. although not directly related to stagflation, bill cara has a good post on his strategies for surviving a market meltdown.

i think my favorite analysis of the present situation and the challenges facing the economy and central bankers comes from brad delong:

What is this most likely scenario? It is of (a) gradual inflation in China and elsewhere (maybe 5% per year for five years), (b) gradual reductions in the value of the dollar (maybe 5% per year for five years), accompanied by (c) gradual interest rate increases in the U.S. so that the dollar decline never turns into a (d) sudden dollar crash.

If that is the case, then–gradually–U.S. housing prices deflate, construction and consumer spending fall, and imports drop. U.S.-made products become more competitive at home, and so manufacturing production and employment for domestic uses rises. The falling real value of the dollar leads to an export boom, which causes export manufacturing to boom as well. Over five years or so, we see a net of eight million jobs (relative to trend) in construction and consumer services (and supporting occupations) vanish, and eight million jobs (relative to trend) in manufacturing (and supporting occupations) appear. If the expanding sectors expand fast enough, we see a tight labor market that brings real wages back to their normal share of production. And moving an average of 1.6 million jobs a year from sector to sector–the U.S. economy can do that without any sort of uproar.

Of course, people are still likely to be unhappy with the process. Rising interest rates and rising import prices will make people feel poor–something in this process has to reduce Americans’ total spending on consumption, investment goods, and government purchases from 107% of income to 100% of income, and whatever it is will crimp spending by making Americans feel poorer. But even so it is a “soft landing.”

As I said, that’s the most likely scenario. But there are other scenarios–the ones that you fear: stagflation, recession, financial crisis, oil shock, global depression, panic, revulsion, and discredit. The other scenarios become more probable every day.

You see, to achieve a soft landing requires that a huge number of people around the world watch the real value of their dollar-denominated assets melt away slowly for half a decade without ever being impelled to sell off the dollar-denominated positions in their portfolios. It could happen. It happened in the late 1980s, thanks to the Japanese central bank and the collected investors of Japan. It will probably happen again. It requires mammoth irrationality on the part of investors, and an extraordinary eagerness on the part of central banks to eat enormous losses on their dollar reserves. It is not a rational-expectations equilibrium. But it will probably happen.

But if it doesn’t happen again–if there comes a day when the world’s central banks and investors all decide that it is time to sell their dollar-denominated assets, then… Well, then we get to see how good a central banker Ben Bernanke really is. There is a really bad global equilibrium out there, which the world economy might jump to at any moment.