Why 1970s Stagflation Is Impossible
We hear a lot of correlations drawn between the 1970s and today. Many feel that we are going to have a similar stagflation period where the economy tanks and inflation remains high. This is rhetoric tossed out regularly by many who obviously do not have much of an idea of what is taking place.
To start, we are in a supply chain crunch that was brought on due to the global lockdown of the economy. Many want to point to the "money printing" by the Fed in particular, completely overlooking the fact that entity does not create USD.
Also there was a fundamental difference that existed during the 1970s that is not only not present today: we have the exact opposite problem.
For this reason, stagflation is off the table.
Economic Headwinds
I do agree with the assertion that we are going to see tough economic conditions ahead. This is going to be unavoidable in my opinion. In fact, we can pretty much presume that another recession is on the table.
Why is this?
To start, every recession since the 1960s followed the same pattern. When a recession hits, the powers that are step in to try and "stimulate" however they can. In this instance, we saw the Congress creating a lot of debt that enabled it to amass dollars to circulate to people (helicopter money). At the same time, the Fed engaged in quantitative easing, and act that actually tightens financial conditions. This results in a pullback in the economy.
We also get the added pleasure of politics and ideologies entering the picture. Because the data comes in strong since most of it compares year-over-year, we are left with the impression that things are going well. This causes programs like extended unemployment benefits to be eliminated.
As stated, this is the typical routine. So far, the playbook is being utilized so we just have to wait for things to pan out. What happens is that people burn through their savings while also turning to debt (credit cards mostly). Of course, at some point, individuals run out of money. Hence, they reduce their discretionary spending to zero. This affects certain segments of the economy, causing tightening of profit margins and, ultimately, layoffs.
This, naturally, only compounds the problem.
What happens when an economy is pumped up, especially in asset classes, that far exceed what the money supply can support? The answer is the same as the Great Financial Crisis. As defaults started to expand, the money supply was contracting. Lending basically stopped, causing a major contraction. At that point, the economy has no choice but to collapse.
While we might not see the same in terms of magnitude, we are going to have the similar pattern.
Difference From The 1970s
If this is the path we are following, how can we be certain it will not reflect the 1970s?
The answer is found on many layers. To start, the velocity of money is much different than it was at that time. We see money stalled in the US economy (mostly due to being locked in the banking system and not in the general economy). This is going to make sustaining high price levels impossible.
That said, the major difference today compared to that era is the Baby Boomers. Starting in the late 1960s and continuing to the middle of the 1980s, we saw the largest expansion of the United States labor force ever. There were tens of millions of people entering every few years. All told, more than 50 million people join the workforce.
What resulted was a lot people getting paid every two weeks. These people rented apartments, bought furniture, clothing, and had lunches with their friends. Eventually, they got married and had kids. All of this resulted in more spending.
Today, we have the exact opposite situation. The Baby Boomers started to retire around 2011. Each year, leading up to COVID, between 2M-2.5M Boomers called it quits. In 2020, the number jumped to 3.25M.
This means we are seeing a large portion of the economy earning less. It is only natural that they compensate for this buy tightening the reigns on their spending. Couple this with the fact that more than 28% of these people already passed away, and we can see how this is not leading to sustained spending.
Of course, the Millennials, albeit slightly smaller as a group, are still around. The major difference is they are already burdened with student loans, hence their spending is curtailed. Also, they do not have the incomes the Boomers have (nor the wealth). This is a generation that certainly is living more paycheck-to-paycheck.
Demographics
Demographics are often overlooked in this discussions. Over a short period of time, they mean little. However, when we are looking at a macro view of things, like on a 10 year timeframe, they do come into play.
In fact, demographics is one of the first criteria to consider in any macro analysis. The reason for this because that is a pillar of certainly in the model. Demographics do not change very quickly, thus we can reliably insert them into the equation.
Here we know the Boomers are not going to slow in their existing of the workforce. That means we can reliably forecast their spending will decline.
Another demographic factor that we know is in play is the drop in fertility rate. Millennials are not having children at the same pace as generations before them. Here again we see the results in the economic numbers. Without a high rate of child births, spending tends to be reduced.
The link between demographics and economic trends is well established. There is nothing about the present demographic situation globally that says we are going to endure a prolonged period of higher inflation. In fact, the bond market is screaming its view of lower inflation AND economic conditions in the future.
Globally, the developed world is all facing the same problem. It is not a matter of if their population starts to decline, but when. The challenge is that, before the decline, the population gets old. Leading the pack in this area, at least in terms of pace, is China. So what happens when the leading exporter and second biggest economy is has a significant segment over 65?
The answer is pretty obvious. We already saw much of this leading up to the start of this decade. Slowing global growth rates put us in a disinflationary position. We will not start to see certain areas exerting deflationary pressures. Of course, this is all taking place in an exponential technological era.
We are in a much different world from the 1970s. The results we get are also going to be much different.
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