In a recent interview, former U.S. Federal Reserve Chairman Alan Greenspan
(the "Maestro") warned that the economy was experiencing, "the early signs
of stagflation." This is a very rare occasion where Mr. Greenspan and I are
actually in agreement. I also warned of this in my "Time
to Invest for Stagflation" commentary published several months ago.
In fact, the U.S. economy-and indeed the entire developed world-is in the
beginning stages of an unprecedented breakout of stagflation. The number one
reason for this can be summed up in a single word...debt. Debt not only steers
an economy towards low growth but it also mires the nation with inflation.
Public and private debt as a percentage of the economy had been 150% for decades
prior to going off the gold standard in 1971--a standard of money that Greenspan
himself advocated before becoming Fed chairman. That ratio of total debt to
Gross Domestic Product shot up 350% before the great recession of 2007-9 and
it remains near that level today. And now, the annual level of red ink has
started to rise sharply. The fiscal 2016 deficit is projected to rise to $600
billion, up more than 35% since fiscal 2015.
In fact, global debt as a whole has increased to $230 trillion, up $60 trillion
since 2007, nearly three times the size of the entire global economy. All this
debt engenders the stag part of stagflation because it is difficult to invest
for growth in an economy under such high debt burdens. The baneful part of
this worldwide debt buildup is that it didn't lead to the accumulation of capital
goods for the purpose of expanding productivity. Instead, it was spawned for
the fruitless Keynesian ruse of what amounts to not much more than hole digging
and filling.
While it is true that debt service payments are currently at historic lows,
it is also true that debt levels are at a record high both in nominal terms
and as a percentage of the economy. Therefore, low-interest payments are the
direct result of an unprecedented bubble in the bond market. Individuals are
intuitively aware of this unstable rate environment and must prepare their
balance sheets for rising carry costs.
Most importantly, a debt saturated economy can't function properly because
it is marred by capital imbalances and asset bubbles that must be unwound for
the credit and savings channel to work efficiently. But our economic leaders
seem intent on obduracy.
A perfect example of this condition is Japan. The nation is now set to take
its 26th trip down this deficit spending road to nowhere since its property,
and equity bubble crashed back in 1990. And despite multiple recessions and
lost decades, the government is still clinging to the deluded fantasy that
a debt to GDP ratio greater than 240% is needed to jump start the economy.
But, the effects of this unproductive debt pile aren't just evident in Japan.
U.S. GDP averaged just 2.1 percent since 2010. And that anemic growth rate
is headed even lower; up just 1.2 percent over the past year and only 1 percent
for the first half of 2016.
Indeed, the International Monetary Fund (IMF) recently lowered its 2016 forecast
for the entire global economy to just 3.1 percent.
So where does the inflation part of stagflation come from?
If there is one thing that all central bankers foolishly agree on it's that
a 2 percent inflation goal is now mandatory for growth. According to Haver
Analytics, the balance sheets of the Fed, European Central Bank, Bank of England,
Bank of Japan and People's Bank of China have soared to $17.2 trillion, from
$6.5 trillion over the past eight years.
In pursuit of this fatuous task, ECB and BOJ balance sheets are ascending
at the blistering pace of a combined $180 billion per month of newly created
fiat credit. And now the Bank of England just stepped up its asset purchase
scheme to a total of $570 billion. But unlike what most Keynesians will tell
you, inflation doesn't come from a low unemployment rate but rather from too
much money chasing too few goods.
Therefore, it would be silly to assume that central banks can achieve their
2 percent inflation targets with precision. Reckless deficit spending, surging
debt to GDP ratios and an unmanageable increase in central banks' balance sheets
will eventually erode the confidence of central bankers to maintain the purchasing
power of fiat money. Therefore, inflation won't just magically stop at 2 percent;
it will eclipse that level and continue to rise.
This return of inflation will cause a mass exodus from the bond market, just
as short sellers begin to pile on top. The bond market will respond in violent
fashion-taking yields up 100's of basis points rather quickly-as bond bids
from yield-agnostic central bankers are supplanted by a genuine market that
will justifiably demand higher rates. And of course, the inevitable surging
debt service payments will subsequently render debt-saturated governments completely
insolvent.
An unprecedented accumulation of unproductive government debt that is fueled
by a massive increase in the global base money supply is a perfect recipe for
worldwide stagflation. But the truth is that stagflation isn't something on
the horizon, it has already arrived.
The hallmark of a healthy economy is to have its real growth rate to be double
the pace of inflation. Today, this sign of prosperity has been turned completely
upside down. The core Consumer Price Index is up 2.3 percent year over year
while real GDP has grown just 1.2 percent. Inflation is now running at twice
the rate of real economic growth!
Stagflation is not an economic peril we only need to fear in the future; but
rather it is something consumers are forced to deal with right now. The former "Maestro" is
perhaps getting better with age. Investors should prepare their portfolios
for a protracted period of rising prices and slowing growth.
