Stagflation has been all the rage lately, but for many (perhaps most) professionals on Wall Street these days, it is beyond their memories. First coined in the 1960s and taken most seriously in the 1970s, it is before the time of many pros, who have experienced periods of high inflation as an adult (if they’re in their early 50s) or periods of continually declining inflation, low inflation, and deflation (under 50s across the board). It’s only the older cohort who have direct experience of what was so awful with stagflation; the rest rely on stories.
And the stories are somewhat unbelievable. Rationing of gas in the United States, a time when pumps would drain empty and cars would be forced to get gas only on certain days. Double-digit price gains for years and years as unemployment remained stubbornly high and people found their buying power crimped despite getting reliable pay hikes and very generous benefits. Some of this seems familiar (higher prices, long-term high unemployment), but some of it seems bizarre (getting continual pay rises? Rationing?). But it makes sense if you look at it just the right way.
At the end of the 1970s stagflation turned into a full-on recession after the Federal Reserve aggressively raised interest rates to stop the stagflation spiral that had gone on for so long. Paul Volcker is largely remembered as an important, serious figure who fixed this problem in the long term by causing a lot of short-term pain: that is, the recession of the dawn of the 1980s. Some recession argues that changes in labor policy may have been more responsible than Volcker, but the point remains that the Fed’s attempt to fix the stagflation spiral with sky-high interest rates (hitting 20% at their peak in 1980) resulted in economic disaster for many.
Because stagflation results in a feedback loop, there’s a sense that aggressive action to tear the loop is the only thing that will work—and a soft landing from that loop is impossible. Thus worries today are so intense and stock market returns are so horrible, with a converge of risk-on assets meaning there’s nowhere to invest and make money. Meanwhile, higher interest rate in Treasuries mean the value of Treasuries fall as well, giving investors nowhere to go.
And at the same time, higher borrowing costs are encouraging less leverage, meaning less money being put to work in investments, again crimping returns. It’s no wonder there’s so much misery out there right now.
But there is a bit of good news, and it comes from the old adage that history doesn’t repeat, but it rhymes.
We are undoubtedly experiencing high inflation, and whether it is technically stagflation or not remains to be seen in GDP growth numbers. At least the first quarter of 2022, which saw negative GDP growth and high inflation, is a strong contender for stagflation—but details complicate the picture (consumer spending and employment income were very high and positive, with inventories causing the big hit to GDP that made it swing negative). But if we are hitting a bout of stagflation, it’s not the same as the 1970s.
The main source of 1970 stagflation was political and geopolitical; while the details are messy and complicated, let’s just say that a lack of oil was the main culprit. This is not something that the Federal Reserve could fix, so its long-term effects are unsurprising.
The main source of 2022’s stagflation (if it exists) is, to put it awkwardly, medical. The COVID-19 pandemic, the shutdown, the restrictions on working conditions, and the lingering response in China and its lower productivity are the main culprits now—and these are things that are either getting fixed (thanks to vaccines and better treatments) or can easily get fixed (China could, for instance, just give its people better vaccines than its own home-brewed ones or foreign companies could disinvest and focus on other countries doing better with growing industrial productivity, or onshore).
So while the problems with the current financial climate aren’t exactly fixed yet—they are much more fixable than what happened in 1970, again because of complex political reasons. But if it does not get fixed soon and a stagflationary cycle is allowed to continue, that possible soft landing could disappear. It may already have—we probably won’t know until it’s too late.
