Feb 24, 2008

February 23, 2008: Four Horsemen over Middle America, Malaise Days, Downward Spiral Toward Argentina

Dark clouds gather on the horizon looming like the four horsemen over Middle America. With oil now trading above one hundred dollars a barrel, about four times what it was when ‘Ol Two-Cows took office, the price of gasoline in the last twelve months has soared nearly 30% from a nation-wide average of $2.38 a gallon for unleaded regular one year ago to $3.03 today. With uncontrolled urban sprawl spurred by the dictum that “one drives until one can afford it” (that is one commutes far enough into the countryside to find affordable housing), Americans more than ever rely on the automobile to drive long distances to work. The result is that when the price of crude oil increases by 400%, as it has under the able leadership of the Great Decider, middle class households find themselves thrown into a bind from which they increasingly cannot extricate themselves. Americans find they are choosing, because of the ravages of inflation or the loss of a second or third job in the household, to skip a mortgage payment, miss credit card payments, or to not meet the payments on the auto loan in order to buy food or gasoline.

As the economic indicators begin to drop like the barometric pressure before a deep upper-level trough one senses, as the clouds gather, a certain foreboding. As noted earlier (see previous post: Inflation is a Cruel Mistress) the inflation rate is much higher for working class Americans and is now biting deeply into household budgets. The unemployment rate is also beginning to inch its way upward. This has translated itself into growing credit card delinquencies, but more importantly growing mortgage defaults and automobile repossessions. It was reported today on MSNBC that Goldman Sacs estimates that 15 million mortgages are now at risk with homeowners finding themselves “under water” or “upside-down”. Due to speculation and the boom in construction—market forces beyond the homeower’s control--real estate values have begun to fall and many find that they now owe more on the mortgage than their home is worth. An estimated two million mortgages are at immediate risk of default and today it was reported that automobile repossessions are at a 10 year high, with repo lots filling to capacity. For the first time since the early 80’s the term ‘stagflation’—a condition in which the economy simultaneously suffers from stagnation and inflation-- has returned to the political lexicon.

We, of course, have been here before. In the 1970’s, under the maladministration of Nixon and Ford, the price of crude jumped from roughly $7.00 to around $30.00 a barrel, forcing Americans to endure more than a decade of what we then coined ‘stagflation’. Inflation, as heretofore generally understood, was caused by “demand-pull” that is an overheated economy in which rising wages created too much purchasing power in relation to the amount of goods and services then being generated by the economy. Simply put, too many dollars chasing too few goods and services; demand ‘pulling’ prices upward. The palliative was to raise interest rates and further restrict credit thereby reducing demand bringing supply and demand at a somewhat lower price into classical balance. But under Nixon and Ford we were presented, because of OPEC mandated increases in the cost of oil, with something entirely novel; we did not have high employment and inflation, instead we were for the first time confronted with high unemployment and inflation. It is one thing to have rising income ravaged by inflation; it is quite another to have inflation with stagnant or declining household income. The problem was that the breaks had already been slammed down on the economy before Volker and the Fed jacked the interest rates through the roof. The result was an economic train-wreck so serious as to make an actor look like a President and Ronald Reagan look like a populist.

The problem is that this model for inflationary control does not work when confronted with a different cause of inflationary pressure; in this case the rising cost of raw materials. Oil is an excellent example. Used in everything from road construction, to anti-freeze, to clothing and packaging, gasoline and lubricants, fertilizers and grain-drying operations, oil is a basic commodity with price fluctuation sending reverberations throughout the economy. This is what is known in economics as “cost-push” inflation; that is increases in prices are not the result of a robust economy having an excess of purchasing power, but the increase in the cost of basic commodities—energy, and food for instance—due to the quantum leap in materials cost. It is for this reason that recently the Federal Reserve, unlike the Greenspan era, moved to lower rather than raise interest rates in the face of rising inflation. To raise interest rates would be to misread the root cause and further erode demand. Business would then be caught between wholesale increases in operating costs—energy, transportation, raw materials—and a worsening retail market in which to pass on those costs. This is what happened in the 1970’s. This is what created the malaise days of Jimmy Carter when unemployment stood at 12% the prime rate was at 18%, consumer loans in the twenties, mortgages in the low teens; when America experienced for the first time simultaneous inflation and stagnation.

It remains to be seen how we work through the present crisis. The movement of the Fed to keep interest rates low, and the stimulus package, such as it is, are indicators that we will not move so quickly to repeat the mistakes of the Volker-Greenspan era. But such a course, over a period of time, could also serve to further reduce the value of the dollar in international currency markets leading not only to the flight of foreign investment in the United States but also making foreign goods more expensive. This will force up prices at Wal-Mart, the dollar stores and—lets face it—virtually every retail outlet in America because so much of the goods purchased in this country are now made overseas. Inflation threatens then to further weaken the dollar creating more inflation in a wicked downward spiral toward Argentina. What is certain is that this is a conundrum that, from past experience, is not easily overcome; one that requires fiscal discipline born of political wisdom and will, all of which have been woefully lacking in the last 8 years.

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