Friday, December 05, 2008

Back to the 70s: Stagflation

Here was the problem: In order to fight inflation, policy makers raised taxes. In order to fight unemployment, economists pressured the Fed to rapidly expand the money supply. It wasn’t until Milton Friedman weighed in that people realized the core of the problem: Too much money was chasing too few goods...Back to the 70s? Lawrence Kudlow, 1/17/2008

In the days referenced, the early 1970s, almost 40 years ago,the economy went on a years-long downward spiral, culminating in two steps: a bear market that lasted from 1973 through 1974; and the inflation that lasted from 1973 to late 1981, after Reagan took office. The principal causes of the decline were easy to identify: a speculative marketplace that became something of a casino in the late Sixties; government Great Society (read "socialist") programs; and a war in Vietnam that Congress and the White House had decided were best funded by future generations. The market said "ha!" to these delusions; the bottom fell out. The economy shrank. Politicians, unable to manage simple concepts like supply and demand, God help us, responded with policy.

When Nixon unhinged the dollar from gold (Bretton Woods, 1972), there was no governor on the U.S. money supply. This monetary expansion substantially increased aggregate demand. And yes, the economy would periodically get a short-term spurt. The problem was that higher tax rates, either through legislation or inflation, stifled producers and investors. So the supply of goods and services was held down while the demand for them was increased. This stagflation raised unemployment and inflation at the same time...Sound familiar? (Back to the 70s..., cont'd)

Sure does. And remember, Kudlow wrote this a year ago, months before even Bear Sterns fell off the cliff. Hell, the several-months, 7% drop in the market he mentions is by today's standard's nothing. We've lost that much a day on several occasions in the last month. But, he saw, with uncanny precision, what we ought to be looking at.

What we’re hearing from Washington is cause for Ben Bernanke to gun the money supply and drop interest rates more. At the same time, Congress wants to spend more (either through temporary tax rebates or more spending, or both) and pay for it all with a tax hike at some later date. That tax hike could mean overturning the Bush tax cuts, or new surtaxes on high-end producers and successful earners...(Back to the 70s..., cont'd)

Remember, that was written on January 17th, 2008. Since then, the Chairman of the Federal Reserve and Congress have injected two trillion dollars into the economy. The Office of the President-elect, the new Congress, and the EPA have plans to take trillions more in taxes and fees from those who actually earn a living. When the productive are taxed, the economy goes down and people (half a million last month) lose jobs. But not to worry, the Office of the President-elect and Congress promise that everybody will have a bailout, or "stimulus," as it is delicately called. But, when everyone has money, and not much is being made, demand goes up. And so, dear friends, does inflation. Magic time, higher unemployment, higher prices, savings and investments worth nothing -- stagflation! Back to the 70s indeed! It won't be long until we'll all be humming "Candle in the Wind" again.

Would that someone had listened to Lawrence Kudlow in January of this year. It is highly apparent that no one --the banks, the housing industry, the government, or, dear reader, you and me, bothered to try. Cassandra, sadly, is usually regarded as mad.


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