So here is the deal. Right now high energy costs are hurting everyone’s pocket book. Fuel costs for winter heating has doubled since last year, and with gas prices expected to stay around $3 for awhile it’s starting to really hurt. However, most consumer goods have not yet gone up in price to reflect the increased costs, or at least not enough to return the margins to the former levels. Now the problem is that as people’s wages rise to help cover the increased cost of living, then the cost of consumer goods will have to rise too since the increased labor costs can’t be absorbed by the already reduced margins. (I agree that a minimum wage of $5.15 which has been $5.15 for a very long time isn’t enough, but that is not relevant to the discussion.) This problem is called inflation, since people’s purchasing power is reduced however inflation normally occurs when the economy is growing since more money is put into the economy which drives up prices. We’ve got what was called stagflation, since high fuel costs alone are driving the increases in cost of living, so without economic growth we stagnant. The last time we had stagflation was the Carter years, and (I don’t care what you think of him) it took Reagan’s aggressive military spending (sort of like an evil New Deal) to get us out.
This time I think it will be a special stagflation. For many people the wage adjustment will not actually be enough, since it will not keep pace with the rising cost of living, so it will only slow the bleeding. For years people were living on stretched budgets with high housing costs, and credit debit. This means the average American’s savings isn’t enough to cushion increases in expenses. Now is the bad part the Federal Reserve can either go after the inflation by rating interest rates or the stagnation by lowering interest rates. Now increased interest rates are the worse choice in the short term since many people and business currently depend on low debt costs to get by, so increased interest rates will drive a lot of bankruptcies and foreclosures, resulting a collapse of housing prices and increased unemployment. But the root problems are dealt with in the long term. The other way is less painful but might only delay the problem. If interest rates go down, borrowing money is cheaper and so hopefully more people and businesses can continue to make the payments and operate or even grow. Now this makes the inflation worse, but stimulates the economy. However, if the economy doesn’t grow and simply sinks deeper into debit, (like it has for the last 4.5 years), then when they eventually raise the interest rates the ensuing collapse is that much worse.
I don’t envy the choices made by those who set our monetary policy, since they are damned either way and so are we. There are two ways out first get fuel prices down to ~2002 levels, very very soon. This might restore the margins for the companies so they can increase wages, without substantial increases in prices. (The killer in stagflation is the people have less money and things cost more.) Or the government needs to spent big, like FDR or Reagan big. It is possible that all the rebuilding in New Orleans will help some, but the money isn’t spread out enough to really boost the economy. We need roads, and dams, and bombers, things people build but don’t buy. (The government is going to have to buy people’s debts from them to stabilize the economy this way.)
Now you might be thinking why not just raise wages? Well that starts a vicious cycle of price increases that quickly exceed the wage increases, and go around and around until equilibrium is reached, but the cost of living will be higher than wages for quite awhile. (I worked it out for the average Californian cost of living is such they need to make $19 an hour, which is outrageous, and I did the model on cheap energy costs.) Also, the rest of the worlds economy is tied to our economy, oil is sold worldwide on the dollar, and a lot of countries back their currency not on gold but on the dollar. So, our inflation in magnified in the rest of the world and hurts them far more. Besides China most of the world’s largest economies (and therefore more self sufficient economies) have high energy prices already and minimum wages around $10 an hour. Now then that serves as an excellent model for us since we can see how $4 gas in the UK translated into a $7 minimum wage, but that means the rest of the world has to move to compensate. The shockwaves will be terrible, since savings will be cut by a forth, and prices will rise quickly to meet the new price points. Most world economies depend on a stable high value dollar and a strong American desire to buy. If this stops, (sure we are not enjoying ourselves) they suffer far more, especially the poorer economies that depend on exports for most of the income. Now it is possible that the combined economic strength of the EU and euro can serve as a second economic super power and buffer the effects, but since they are stagflating too, I doubt it (gas is 11 pounds a gallon in the UK that is $19.27!!!, so quit whining about $3 a gallon gas.)
Stay tuned for part 2 what to do!
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