The Ghost of ’70s Inflation and the Ghost of ’30s Deflation Will Scare the Living Daylights Out of Us

People who believe that history repeats itself are asking themselves: Is this a rerun of the ’30s…or a replay of the ’70s. Is it a deflationary recession we’re rehearsing? Or an inflationary recession? How is this story going to turn out?

We look around. We don’t see any breadlines…and people aren’t dressed nearly as well as they were in the ’30s. But now people get their free food through plastic “Independence” cards…proving that they are 100% dependent on the taxpayer for their daily bread. And as for dress…what do we know? If people like wearing flip-flops, pedal pushers, and shirts with reptiles on them, does that change the plot or alter the outcome?

It doesn’t look like the ’70s either. No afro hairdos…no muscle cars…no polyester shirts. (We had one…a brown one with white stitching. It clung to our manly, young body and almost electrocuted us each time we took it off. Elizabeth threw it away the first time our back was turned.)

Still, the economy is beginning to look a little like the ’70s.

“Stagflation fears vexing Bernanke,” says the Chicago Tribune.

“Spectre of inflation returns to global economy,” adds a front-page headline on the Financial Times.

In the following reckoning we don’t disagree. But we add a much-needed nuance. Not only is the spectre of ’70s inflation haunting the economy…so is the spectre of ’30s deflation.

Check out this headline: “Biggest drop in housing since Great Depression.”

Yes, dear reader, get ready for a whiter shade of pale, as the two apparitions join in a ghostly hullabaloo. To the question – which will behave, inflation or deflation? – we have consistently replied, ‘both.’ And la voila – here they are.

But we’re no longer alone in this opinion. Yesterday, the world’s greatest investor and richest man, Warren Buffett, agreed with us.

“Stagflation,” he said, was becoming a bigger and bigger problem. “I think the ‘flation’ part will heat up and the ‘stag’ part will get worse.”

The Financial Times saw its inflation ghost in the huge price increases announced by Dow Chemical and South Korea’s Posco. The former is America’s biggest chemical group; the latter is the world’s fourth biggest steel maker.

Meanwhile, said Mr. Charles Holliday, CEO of Dupont, and not putting too fine a point on it:

“Inflation is here big time.”

You think you’ve seen inflation, said a spokesman for mining giant BHP Billiton. You ain’t seen nothing yet. On Monday another mining group, Rio Tinto announced a price increase of 96.5%. Billiton said that even that would not be enough; it signaled a price increase of over 100%.

“Now,” as Crocodile Dundee might have put it, “that’s inflation.”

“The sustained rise in the price of oil and commodities has hammered industries such as airlines and carmakers, and deepened fears of a global inflationary spiral as producers pass on higher costs to manufacturers and consumers,” the FT figures.

The Reuters CRB index is up 45% in the last 12 months. So far this year oil is up 42%. Natural gas has risen 76%. Corn has popped 58%. Soybeans 26%. Base metals are up about 30%.

Buffett is right…the ‘flation’ part is heating up. You see it in the newspapers, the check lines and, prominently, at the gas station. But what about the ‘stag’ part?

*** We live in a world powered by fossil fuel and designed – particularly in America – for a time when it was cheap and plentiful. Too bad that world no longer exists. Instead of building the world of the future, we built the world of the past. Now, we have to turn our backs on it, move on, and rebuild. This time, we have to build a world designed for oil that is significantly more expensive.

“Our civilization is based on fossil fuel,” writes Martin Wolf in the FT. “But since the end of 2001, the real price of oil has risen some six-fold. Today the real price is higher than since the beginning of the previous century.”

How expensive will it get? We don’t know. Our guess is that it will go down, not up, but still end up about twice as high as the price five years ago. T. Boone Pickens says oil output worldwide is peaking out. And never before have Americans had to compete with so many other people for it. Back in the early 20th century, a roughneck could sink a well in West Texas and have the oil all to himself. Now, there isn’t much oil left in Texas…and what little there is has to be shared with three billion people, many of them with incomes rising a lot faster than ours. If Pickens is right, it stands to reason that the price will probably be higher than it used to be – in real terms.

That prices are rising in nominal terms should come as no surprise either. For many years, central banks have increased money supply faster than the rate of GDP growth – often several times faster. Now that this monetary inflation is turning into consumer price inflation, no one likes it very much. But the only way to stop it is the Volcker way – that is, pushing up rates and forcing a recession. People would like that even less.

Already, the world’s capital markets are deflating. While prices for commodities and oil have risen steeply this year, stocks in Britain and America are down about 11%. Stocks in Europe have fallen even more – about 18%. And in Asia, markets have been beaten up and beaten down. The Shanghai market has lost 44%. Hong Kong is off 18%. And Vietnam has been whacked – down nearly 60% from the peak.

In America, the average stock may be down only a little more than 10%…but some industries have been hit much harder. Airlines, for example, are falling out of the sky. Finance is down about 40%. And homebuilding? Don’t even ask…

So, for now, the Fed isn’t fighting inflation at all; it’s fighting another ghost from the past – deflation. You don’t lend money at less than half the level of consumer price inflation if you’re fighting inflation. You only do when you see the ghost of the ’30s hard on your heels. Yesterday, the Fed must have looked back…seen the spectre of deflation…and decided to leave rates were they were.

*** Little noticed among all the noise and smoke is the way the two ghosts – of ’30s deflation and ’70s inflation – join forces.

As we explained yesterday, expensive energy is destroying the suburbs. That’s not all, as Americans are forced to pay more for fuel, they pay less for other things. The whole retail sector suffers. And much of the hospitality industry; this year Americans are planning on taking ‘stay- cations.’

The Fed tries to jolly things up with more money and credit, but what happens? Oh, cruel, cruel fate! The money feeds into other economies…and into the prices of commodities. Then, as fuel, food, and raw materials bills go up…the extra expenses weigh down the economy like a concrete block tied to a corpse in the East River.

Yes, dear reader, the ghost of ’70s inflation frightens the economy…only to be followed by the ghost of ’30s deflation. Between the two of them, they’re going to scare the living daylights out of us.

Bill Bonner
Markets and Money

Bill Bonner

Bill Bonner

Since founding Agora Inc. in 1979, Bill Bonner has found success and garnered camaraderie in numerous communities and industries. A man of many talents, his entrepreneurial savvy, unique writings, philanthropic undertakings, and preservationist activities have all been recognized and awarded by some of America’s most respected authorities. Along with Addison Wiggin, his friend and colleague, Bill has written two New York Times best-selling books, Financial Reckoning Day and Empire of Debt. Both works have been critically acclaimed internationally. With political journalist Lila Rajiva, he wrote his third New York Times best-selling book, Mobs, Messiahs and Markets, which offers concrete advice on how to avoid the public spectacle of modern finance. Since 1999, Bill has been a daily contributor and the driving force behind Markets and Money.
Bill Bonner

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7 Comments on "The Ghost of ’70s Inflation and the Ghost of ’30s Deflation Will Scare the Living Daylights Out of Us"

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For Australia, if the terms of trade were to change, it is a replay of the 1890’s. Now we have an increasingly desperate treasury saying they will go past the COMECON era barter traded RMBS (Glen prays each night “please God never let our RMBS be rationally risk rated”) to now be proposing to swap bonds issued while we are in surplus for swapping with Australian corporate debt (at least there was deficit when they issued war bonds). That is the supposed backstop funding for use if the threat of foreign local bank branches not recycling the hot money passed… Read more »
Merv Nash

It’s amazing how much clearer rear vision is than foresight.
If the American nation had only foreseen the end of oil while there was plenty of it and everybody thought America was the greatest country on earth and had it encouraged its inventors and genius to develop another source of power in the meantime it would still be loved and admired around the world and would never have needed or even contemplated going to war and would never have been the target of terrorists.

Smack MacDougal
Inflation and Deflation are processes, deliberately undertaken by Central Bankers. Just because each word has a “..flation” part does not mean these words label opposite concepts. Inflation happens when Central Banks cut interest rates in hopes of increasing the Efficiency of Money (ratio of Money in Circulation to New Commercial Credit). Deflation happens when Central Banks raise interest rates in hopes of killing excess, speculative credit. Also, Central Banks change banking rules to restrict credit formation to lauch deflation. Effects of Inflation when Inflation does not increase the Efficiency of Money include: Currency debasement, Rapid price rises in Commodities with… Read more »
Charles Norville

I’m wondering what would happen if the US started to exploit its vast reserves of shale oil. Can anyone including the author Bill Bonner explain my possible uninformed inquiry? Am I missing something, is it just to difficult to switch from crude oil production revenues to shale oil – isn’t shale oil technology highly lucrative at 2000 prices what are we waiting for? Hmm what, high unemployment labour to dig the stuff out with pick and shovel?

Merv Nash
Dear Charles, The problem is building the infrastructure to bring the oil on line, Did you watch the TV prog last week showing the Tar Sands site. Massive equipment working around the clock. Lady truck drivers earning 100kpa. The whole town awash in money. The pristine forest wilderness devastated. Tree huggers broken hearted. But production like never before and its output not even making a dent in the shortage of world demand. I reckon that the producers have hiked the price to pay for setting up the production facilities so they don’t have to borrow any money and beholding to… Read more »
I heard that the north pole is going to disappear soon, which (they said) will allow oil and gas exploration where the polar cap once was. Apparently there are a lot of reserves up there which have remained inaccessible because of the ice. Of course, it depends on how correct scientists are regarding the ice depletion, and how much and how easy the oil is to harvest as to whether this will have any impact on the oil problem. There looks to be plenty of oil lying around – they’re finding new oil all the time, its just that it… Read more »

All these arguments still address oil prices as been predominantly a supply-demand influence. When the price per barrel falls in thenot-too-distant future, the derivatives market will play a substantial role in that engineering process with S-D relationships more or less the same.

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