I just uttered two of the worst things any economist would ever want to see. And they are together, for good measure. “This time is different” is the first answer you hear when an economist with conservative economic views warns the public about something out of whack in the economy. It happened in 1929 and it happened again in 2000. When the voices of reason warned that the bubbles may burst, those who “got it”, who understood the new economy, answered like a Greek chorus: “This time it is different“. I still remember conversations with friends during the summer of 2005 when I started to get worried about the housing bubble in South Florida, all of them disregarded my worries with unruffled arguments that sustained the dreaded conclusion. So it is not lightly that I dare utter these words.
For those who do not know what stagflation is or why you should care, there is only a simple explanation: imagine that you are out of work and the prices of goods keep rising. That’s the immediate effect of stagflation for you (the last period of stagflation in the United States was during the Carter administration). Without going into too much detail about what produces stagflation (there are a number of theories and you can read a succinct description of them in the above Wikipedia article), let’s just say that when the prices of goods rise beyond the ability of the producers to purchase and transfer the costs to the consumers, they are forced to reduce production and sell to only those consumers who can still buy the stuff. During the 70s, the United States was an industrial economy, and the effects of the rising price of commodities, particularly oil, put a strain in that industrial economy.
Economists who look at the past and the present are right in concluding that a period of stagflation may have a high chance of occurring again in the American Economy. However, this is the part that leads me to think that this time it is different. For one, the American Economy is not as heavily industrial as in the 70s, and thus the effect of rising commodity prices has lest of direct effect on the economy. Besides, during the 70s, consumer credit was not as widely used as today, and even if it was, with Federal Funds rates of 11 and 13% most consumers would not have been able to take loans to supplement their income.
In our current economy if you need an extra $10,000 and you have access to a personal credit line you are better off taking in a loan than working for your money. How come? Easy. We are living in a period of easy money financed by the Chinese economy. They loan us money to buy their goods so they can create and industrial base and an internal market to sustain an economy that is currently absolutely dependent on foreign buyers to subsist.
I do not think this will last forever, and the inflationary spiral may be already out of control. When gold reaches $1,400 an ounce it will be very difficult to produce any goods at a price that the impoverished and indebted American public is able to buy. But we are not there yet so let’s go back to no working.
As I was saying. Any middle class family who wants to be as lavish with their presents in this season as they were last year, have two options: work for the extra money or take a credit card loan at, say, 14% APR. If they go to work for their money, they need to invest the effort now, pay 25% of their money in taxes and get the money after they worked. With the loan, they will receive the whole amount immediately, they will not pay taxes on the extra money, and they will provide work after they enjoy the fruit of their efforts. Provided that this median income family that pays 25% in taxes, has access to a credit line of $10,000 at an APR of 14% pays the debt in less than 3 years, they would not lose money. The society as a whole may, if the taxes are being used responsibly, but they would have paid the same amount to the private lender than they would had the government. As you can imagine, this situation is not sustainable, and our cherished family needs a small bump on the road to dreamland to be in the road to the poorhouse. But that’s not our problem, is it?
Anyway, I guess that’s why they call the present economy a “service” economy, because most of it runs on servicing debt instead of creating wealth.
The simple reason that it is more reasonable to take on further debt than working (at least in the short run) should be enough to dispel any fears of stagflation. However, this economic model is running into big problems. Some things are not different this time, and those are the limitations imposed by the universe we live in. For instance, China can not keep growing at this pace for long without needing to expand its territory and creating a new geopolitical mess. The United States could replace China’s slave labor with that of some other countries, but this will imply pulling the plug from China and creating some sort of monetary crisis that would allow the United States companies to pull out from China without paying the price of it. That would send China into an internal crisis that should not affect the American economy. Either way, the United States needs to secure first access to oil reserves, which still has not been done, or find a real substitute technology that would replace the current dependence on hydrocarbons.
So, next Friday, when you start your Christmas shopping paying with your credit card, feel good about it. Not only will your nephew receive that iPhone, you will be also contributing to the next 20 years of history.
This article is part of the series "Documenting The Hyperinflationary Genesis"
- Bernanke’s creative solution: Let’s do it again
- At a financial crossroads
- How to survive hyperinflation
- Let the party begin. We will be dead tomorrow
- I have $ 100,000,000,000 and yet I can’t retire
- Is the Dow Jones at a new high?
- Stagflation: This Time It Is Different
- The Myth Of Gold as Inflation Hedge
- Is Gold a Hedge Against Excess Liquidity?
- Disposable Personal Income Shows Disturbing Historical Trend
- Things That Go Bump in the Night
- Greenspan: Give Homeowners Financial Aid: Financial News – Yahoo! Finance
- Black Swans, Bell Curves and Stagflation
- The Gold Scam
- And Now They Tell US
- Some Historical Perspective on the Current Recession
- Gold Correction Seems Over
- Gold Chatter
Franklin @ November 18, 2007