by Marshall Auerback
Thursday, 16
June 2022
Analysis
16:01

Welcome to the Great Recession 2.0

Brace for a return to Seventies-style stagflation
by Marshall Auerback
He’s worried about his pension fund. Credit: Getty

After inflation rose to 8.6% last week, the US Federal Reserve had no choice but to act aggressively, which they did this week by raising the federal funds rate by three-quarters of a percentage point, the biggest one-off increase in nearly thirty years.

In addition to the rate hike, the Fed Chairman, Jerome Powell, indicated that another three-quarter point hike is possible at the Fed’s next meeting in July, which implicitly concedes that the US central bank is way behind the curve on containing inflation. The elusive soft landing for the US economy also looks imperilled, and a nasty recession therefore almost certainly looms ahead.

Worst of all, the ‘cure’ of higher rates is unlikely to solve today’s economic problems; in fact, they could well make things worse. Thanks to the Ukrainian war  (and the corresponding sanctions imposed in response to the conflict), Americans are suffering on a daily basis, whether it be at the local grocery store, or the gas pump, where gas prices have hit an all-time national high of more than $5.00 a gallon.

Rapid increases in the cost of living have eroded consumer confidence and demand. We can see this in the latest May US retail sales figures: total monthly retail sales growth came in 0.5 percentage points below the consensus expectation. The prior two months were revised down by 0.4 percentage points overall.

Consumer sentiment is also rapidly deteriorating: it fell sharply to record lows earlier this month, well below market forecasts. In full context, this reading is below the level reached during the worst of period in 1980 when inflation was in double digits and the economy was crashing at more than a 10% annual rate. It is also lower than the level reached in the depths of the 2007–09 recession — the worst in three generations.

Even if China were to end its lockdowns and rapidly come back onstream to fill some gaps in the supply chains, it won’t alleviate much of today’s inflation because China is also a major consumer of food and energy (where the price pressures are most acute throughout the world). Hence, we’ll have the worst of all possible worlds: US productive capacity will remain constrained by higher interest rates, while China fills in some supply gaps (but at a cost of further eviscerating what’s left of American manufacturing), all against a backdrop of soaring food and energy price increases.

Even more ominous than the prospect of yet further interest rate hikes are the looming cutbacks in government spending. The US Federal Government budget deficit is forecast to plunge from $2.8 trillion in 2021 to around $1 trillion this year, as most Covid relief programmes expire.

On the surface that might sound good, but the reality is that it constitutes a major economic contraction: the expanded child tax credit ($110 billion) lapsed in December, student loan repayments are likely to restart for tens of millions of Americans, shut-off moratoriums just expired, rents are still rising rapidly, and housing is increasingly unaffordable at a time when many American families are drowning in consumer debt.

All of which means a self-inflicted 1970s-style stagflation cycle lies ahead — a legacy of decades of mistakes made by fiscal and monetary policymakers, now exacerbated by an interventionist foreign policy agenda that risks (literally) blowing everything up.

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Peter B
Peter B
9 days ago

The West has spent the last 30 years living beyond its means and borrowing from its future (and its children and grandchildren). It was obvious even 20 years ago that we were living in a fool’s paradise (Gordon Brown’s “no more boom and bust” was one of many clues).
The necessary corrective recessions were all largely ducked and the debt crisis “fixed” by issuing more debt and printing record amounts of money.
Why is anyone surprised when the bill falls due and the debts must be repaid ? If stagflation is the only corrective medicine to reset things back to sanity, then that is what we must endure.
Or were people expecting a free lunch ?
CAn anyone honestly say they weren’t warned long ago ? Yes, the politicians and media kept pretending everything was fine, but we figured out long ago they don’t know what they’re talking about.

Billy Bob
Billy Bob
9 days ago
Reply to  Peter B

The main problem is that the generations that caused this will largely avoid any of the pain. They’ll be comfortable in their overpriced houses they bought for peanuts while the youngsters will be left with high inflation, decrepit privatised public services in dire need of investment, house prices increasingly out of reach and job losses, stagnant wages and insecure employment

Nicky Samengo-Turner
Nicky Samengo-Turner
8 days ago
Reply to  Peter B

As I have said above, Government debt in bond form is an asset for investors, and has a supply demand safety valve as well as price/ yield cap and collar, which move in different directions

Marshall Auerback
Marshall Auerback
8 days ago

This is very true. But the problem (as I tried to point out) is that fiscal policy is also tightening rapidly, which will slow down the economy even more than most now anticipate. That’s why I think the recession could be particularly nasty

R Wright
R Wright
9 days ago

Living standards will drop and never recover. All part of the west’s managed decline as we prepare for increasing subordination to multinational organisations and technocrats while weak elected politicians take all the blame.

Brendan O'Leary
Brendan O'Leary
9 days ago

“a self-inflicted 1970s-style stagflation cycle ” is probably the best we can hope for, given current governments’ fear of even short-term political pain.

Nicky Samengo-Turner
Nicky Samengo-Turner
8 days ago

Lack of understanding of global bond markets, associated derivatives and the advent of electronic markets makes so much comment on this subject at best erroneous. The days of banks being able to simply raise interest rates at a whim due to simplistic economic ( mainly industrial output/employment/wage demands) is long gone, as interest rates are effectively governed by long government bond pricing/yields, so central banks have to react to out of kilter supply/demand pricing.

Perhaps the most worrying ignorance is the ” man in the street” complaint about government borrowing/ debt, not actually knowing that the majority of his pension and life insurance is invested in the debt… precisely because government bonds are actually an asset.
I am also pretty sure that most politicians and Ministers have not a clue about any aspects of economics, let alone capital markets

Paul MacDonnell
Paul MacDonnell
9 days ago

This article is all over the place. The problem with the 70s wasn’t too little government spending but too much.

The solution begins with the need to increase interest rates and drastically. It is wasteful government spending that has caused the problem. It also must be cut so that economic resources can be allocated by the market (i.e. the people) and not by politicians.

Brendan O'Leary
Brendan O'Leary
8 days ago

No current government, “conservative” or otherwise, has the guts to increase interest rates drastically.

And media drumbeat, insisting that raising interests rates would be disastrous , has become a cacophony.

So to save inevitable short term pain, and political unpopularity, we and our children and our children’s children are being condemned to long term disaster.

Nicky Samengo-Turner
Nicky Samengo-Turner
8 days ago

as I have said above, Governments cannot simply raise interest rates, as in past times, and modern economics are NOT the same as the 1970s,

J Bryant
J Bryant
9 days ago

This article captures our economic situation quite accurately, imo. There are plenty of similar articles out there all busily diagnosing the problem. What about solutions? How do we crawl out of this hole? Clearly higher interest rates are now necessary despite the economic pain they’ll cause. But what else can we do for long-term, stable economic growth? I can find few articles addressing that question.

Steve Jolly
Steve Jolly
9 days ago
Reply to  J Bryant

I believe the reason people aren’t proposing solutions is because nobody has any.

R Wright
R Wright
9 days ago
Reply to  J Bryant

The solution is the crash. It can’t be alleviated because QE, the ‘fix’ last time is now no longer available since we’ve been addicted to it ever since

Bernard Hill
Bernard Hill
9 days ago
Reply to  J Bryant

…we’re in a social and economic governance interregnum across what is now a technologically joined up and economically integrated world.
The governance model of nation state representative democracy, is losing its status as the default format, because it does not/cannot intrinsically map current and foreseeable social and economic realities on the ground and in the ether. (Notwithstanding the reprise in still-to-catch-up Eastern Europe right now).
And the likely way ahead is not nation states being overtaken by centralized world wide or even EU style regional geographic governance. That model too is at odds with the centrifugal effects of a technologically joined up world, in which human and productive capacity and capital are mobile (digitally if not physically) and incentivized, cross culturally, to seek the best returns.
Sovereignty and governance may become detached from strictly geographic divisions, into smaller aggregations, something more akin to the old Hanseatic trading league, the medieval Knights of Malta etc., the old Southern European and current Asian/Middle Eastern city states, as well as new community formats based around digital communications and finance.
In other words, a diverse “market” for governance and sovereignty, in which the participation franchise will comprise voting with your physical and or digital footprint, and in the occasional Swiss style referendum.
The emergent chaos has a long way to run but.

Hardee Hodges
Hardee Hodges
7 days ago

As we watch interest rates rise, we will also see government outlays to service that debt must increase else the government faces default and currency collapse. Given all the major nations have rather huge debts so they will face higher servicing costs. Most governments can extract revenue to a point but really are at some limits even now. What will happen to those people who have become dependent on government transfer payments?
We might see great unrest and anger at past squandering and resource misuse. Very choppy waters ahead.

trevor fitzgerald
trevor fitzgerald
7 days ago

Weren’t we told inflation was a good thing and central bankers should be happy that they have finally dug us out of our deflation hole and all that debt will be inflated away?