The Vise, or stag-double-flation

[JG55]

/ Utah News From The Daily Herald Newspaper / Utah And World News - The Daily Herald / Opinion / Outside Observer With Jim Tynen

The Vise, or stag-double-flation

Posted: Friday, June 17, 2011 10:00 am | (2) Comments

The more I sift through the economic news, the more anxious I grow.

It's not one piece; it's when they all start to fit together. Are we in an economic vise, with both deflationary and inflationary pressures squeezing us ... until we break?

I'm no genius. But going through sites such as Instapundit, RealClearPolitics, National Review Online, and other well-known sites, and disquieting facts suggest themselves.

First, many worry about the prospects of inflation or deflation. But what if both are not only possible, but inevitable? Stag-double-flation?

To stick with inflation, as the above observer notes, "When the banks start lending again, it will unleash the reserves that the Fed has pumped into the economy and there will be big inflation."

That isn't the half of it. I've been reading "This Time Is Different" by two noted economists. They outline how virtually every country in the world has defaulted on its debt at some point. The scary part: sometimes they do it by inflating the currency.

After reading this, you may join me in thinking that the government of the United States will choose to do this, partially because it's swept along by the ongoing inflation, but also because the politicians would rather infuriate the bondholders than the voters. The voters will get hammered, of course, but further down the road, and indirectly. And our current leaders love to kick the can down the road.

Some say we can grow our way out of this. But whether you are a capitalist or a socialist, you are faced with growth engines that are tapped out.

As one investor newsletter shows, not only have government stimulus programs have failed, the U.S. government is so tapped out, it couldn't do much anyway. Things are so bad, that one group floats the possibility that the Federal Reserve itself is just another bad bank -- another zombie bank with no real assets, floating along because no has the courage to face the facts.

So that's stagflation: a comatose economy, even as prices rise, destroying the value of savings.

But what if the "flation" also includes deflationary pressure of overwhelming force?

As one report puts it,

"'We believe a large proportion of today's high unemployment is structural in nature, resulting from a huge skill mismatch between the jobs being created and the existing skill sets of jobseekers,' says Wells Fargo economist Mark Vitner. The pressure from globalization is a driving factor. U.S. labor has become relatively more expensive compared with overseas labor, capital equipment, and computer software."

I was in China last year. There's 1.3 billion people there, and by and large they are hard-working, tough, aggressive, smart and, when they want to be, charming. They work more cheaply, too. Throw in India, the rest of Asia, Mexico, etc.

In other words, the U.S. is in a price war with the rest of the world.

That's deflation.

Plus, the continued impact of reality on the economy. Having recovered from the Great Hallucination of, say, 1998 to 2006, we are seeing the real worth of things. Housing is one sign. The nation built a lot of McMansions and strip malls and office buildings that aren't needed. So ... "The housing crisis that began in 2006 and has recently entered a double dip is now worse than the Great Depression."

in other words homeowners are in a price war with each other.

Ditto in other spheres that have experienced bubbles that are deflating, or have popped. That could include the higher education bubble: as grads fight for jobs, they in effect are in a price war with other grads.

Now, at best, I would suggest, that's a bad equilibrium: Two negative forces somewhat counteracting each other. But as noted above, that means a zombie economy for a long time.

What if, however, this underlying deflation and coming inflation reinforce each other?

As economists note, deflation magnifies the debt burden. You have to pay back loans with dollars that are worth less, making the debt relatively more expensive.

So picture a college grad. She suffers the effects of virtual deflation, as a lousy job market drives down wages. But inflation affects her to: as U.S. wages rise, the relative cost of having someone in Shanghai or Mumbai drops. She gets lower wages, or no job at all.

That's what happens if the U.S. dollar becomes inflated, making our wages and products even more costly on the market, even as deflation hammers those with debts. And virtually everyone is in hock. Inflation won't give you even a nominally higher salary, if your job has been outsourced overseas.

Meanwhile, you may still have your mortgage, car payment, student loan, etc., to pay. Perhaps its relative cost is less, as you pay with inflated dollars. But if you don't have even that, the debt remains a burden.

Also, what about real value? In a stagnant economy, that art history degree has less value by any standards. A poor economy can't afford a lot of art analysis. How much else has less value in a stagnant society?

As above, the government can't ride to the rescue. They're like Custer, surrounded and running out of bullets.

So the economy may not be of stagnation, but of being squeezed in a vice. Maybe till it shatters.

And what happens then? Is our society so stable that it can endure such a long period of frustration and ennui?

Doubtful.

All this isn't even counting the reality that other countries face the same trap.

I'm just an amateur. But I can't help think of this weather explanation:

"Tornado outbreaks are caused by the same forces that form individual tornadoes — the meeting of hot and cold. Typically, cold air coming in from Canada hits warm, moist air from the Gulf. When the cold air meets the warm air, they tumble over one another and create the vortexes called tornadoes"

So what happens when deflation and inflation collide in just the right way? Do we get an economic tornado?

I hope we don't find out.