Recently, a dear friend of mine, an economist in Mexico, made an unpleasant prediction. “It’s back to the 1970s, baby. Stagflation and all that.” Oh goody. I am unfortunately old enough to remember just what that means.
“Highest inflation in forty years,” another friend, and not a partisan of President Biden, announced gleefully to me. Since this person, off to a fine start as a bankruptcy lawyer in New York, is just thirty four years old, I wonder if he realizes what he’s saying. Very likely good news for people in his business. But very bad news for the rest of us.
Why? The just concluded meeting of Central Bankers in Sintra, Portugal, has announced the era of low inflation is over. “The process is highly likely to involve some pain, but the worst pain would be from failing to address this high inflation and allowing it to become persistent,” said Jay Powell, chair of the Federal Reserve. And what “process” would that be. It’s called raising interest rates, which is one of the things central banks can do to fight inflation. Earlier this month, the Federal Reserve raised interest rates, specifically the Federal Funds rate, by 75 basis points. Is that a lot? Well, the Fed’s new “target range” is 1.5 to 1.75 percent. Basically, the Fed Funds rates is what banks charge each other to lend excess loanable funds. Forty years ago—41, to be exact, the rate was over 20 percent. 22.36 percent, to be exact. So if the Fed’s inflation fighting medicine is geared, Holy Smoke, to what was going on 40 years ago, 1.5 percent or so is peanuts, as in Jimmy Carter’s peanuts. You’ll remember President Carter farmed peanuts in Georgia before inflation and Ronald Reagan took him out. We got a long way to go if that’s where things are headed.
There are some uncomfortable similarities to those now-forgotten times. The Russians were in Afghanistan, Ukraine already being part of the Soviet Union. Commodity prices were headed up. The international economy had been disrupted by what economists call “supply shocks,” but these were a consequence of oil prices rising and not a virus like COVID-19. Still, things did get out of control. By 1979, inflation here had hit 13 percent and Jimmy Carter had brought in Paul Volcker to whip inflation now (WIN) (something Carter’s predecessor Gerald Ford had conspicuously failed to do). Mr Volcker put us and much of the world through a wringer, and the 1980s are remembered as a “lost decade” in some parts of the world, where rising interest rates combined with foreign loans delivered an economic knockout punch. It wasn’t pretty. Ask someone from Mexico or Peru, just for starters. Be prepared to hold their hand.
The short story is that rising interest rates kill demand by making the cost of borrowed money higher. So people stop buying things, people get tossed out of work, wage increases stop, production falls. You can overdo this medicine. Like you can cure high blood pressure by strangling the patient, but then there is no game at all. Right? You flatline, you’re dead, and high blood pressure is the least of your worries.
Now, why am I going on about this? Well, turns out that in the 1980s, household debt in America was around 50 percent of GDP. In other words, in total, as much as half of national income, more or less. In 2020, house debt was about 80 percent of GDP, or 60 percent higher. Ok, so what?
Well, two things. Back in those more innocent times, a lot of interest rates were fixed—not sovereign debt, like Mexico’s, they will tell you—so arguably, the full brunt of rising interest payments was somewhat mitigated. It’s complicated, so you’ll have to trust me. I had a student loan at 7 percent, so I was effectively paying minus 6 percent in 1980. The lender was, in effect, paying me.
But bankers learned, alas, and very few consumer rates today are fixed, including credit cards and a lot of mortgages. Which means no more free money if inflation rises. You’re going to feel the increase immediately.
The implication, it seems to me, is that if you thought the 1980s were tough, you ain’t seen nothing yet. Interest payments relative to income are going to be higher this time around, which means that belt-tightening is going to be a lot, well, tighter. You know all those property mavens who took seminars about how to get rich in real estate. They borrowed a lot of money. Ouch.
Like Yogi Berra said, supposedly, forecasting is hard when it involves the future. So I don’t make forecasts. But if I did, I’d say given all our other problems in the United States, what’s on the horizon may be worse than what we’ve seen in the past few years. I’m not an alarmist. But I can count. And I’m worried.
10 thoughts on “Special Edition: Inflation…It’s Baaaaack”
And who benefits from higher interest rates? Investors. That is, the wealthy and perhaps the very upper middle class. And who doesn’t? The poor, and likely most of the middle class. When the smoke clears, the rich are richer, the poor are poorer, or dead, property crime soars. . . . Yes, it is going to get much worse. Very, very worse.
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This is my hunch, but I am an obscure former prof in South Texas. Not a Harvard Big Name
How the Hell can we make the rich richer? And that’s just the tip of the iceberg. I think we’ve really backed ourselves into a corner this time, but, after all, never say gay…….
I know employment is a lagging indicator, but from where I sit, if a thousand legal people showed up tomorrow in the five counties around me, they could all be employed by the end of next week. There’s some skills / market mismatch, but I guess I don’t see stagnation around here, anyway. The 80s I remember were plagued by high unemployment, but we’re at full employment now. The economy is expanding, subject mainly to the limits on finding workers. Obviously there’s inflation but I don’t see the supply shock as permanent — unless the US goes on financing Ukraine’s war with Russia indefinitely.
You’ve put your finger on something that puzzles me. The male labor force in the US has been reduced even as the demand for labor has risen–hence you’d expect to see real wages rising at a faster rate for the first time in years. To raise interest rates is to short circuit that process before it’s had anything like the effect to restore anything like balance between the wages and assets share of national income. You wonder if we aren’t throwing the baby out with the bathwater?
For years I’d be in the car and listening to Marketplace report the unemployment statistic and it was always “unemployment fell but wages are stagnant,” which was ostensibly why the Fed didn’t crank up the interest rates earlier. I get that whatever the inflation rate is this week is not desirable, but yes, I think some wage growth wouldn’t be a bad thing. If all that stuff about free markets is true, then a greater demand for workers should lead to higher wages. Or so I thought. Doesn’t the business cycle imply that workers are supposed to win on an upswing?
Around here, hourly wages for certain kinds of work are up as much as $4-$6. Our participation rate is 5% higher than the national average and more people are working now in this state than have ever worked in the state’s history. Inflation is eating some of that, but hardly all of it.
Well, if that were the case–that business cycles raise real wages inevitably–growing inequality in prosperous countries shouldn’t be a problem. But it is, so draw your own conclusions.
Again, yesterday, listening to NPR, job growth continues, wages continue to rise (just not as fast as prices are rising). Demand for some goods falling. ?
Sure. If coffee gets too expensive, you drink less of it, or switch to something else.
So The Economist published a piece today speculating that the only way around inflation is higher unemployment. (And yet, is it not the explicit task of the Fed to use monetary policy to maximize employment?) I remain puzzled, because what I said before about ability to fill hundreds or thousands of jobs near immediately in my part of this state remains true. Today I placed a green card holder in a manufacturing job — she speaks about twelve words of English, understands another 200 or so, and may in fact me somehow mentally challenged. But they were delighted to have her.
I wonder if the Ukraine situation will calm down in time for the gasoline supply to really affect the result of the midterms.