Hi, Stagflation

We’re officially here. Growth is negative and inflation is at 9 percent. It’s 1974 all over again. In that year, all twelve months were spent in recession (one that lasted a year and a third) as prices rose at a double-digit rate. Out of obscure British usage a term became idiomatic in America: stagflation.

It was not supposed to have happened. “As recently as 1970, the major U.S. econometric models implied that expansionary monetary and fiscal policies leading to a sustained inflation of about 4 percent per annum would lead also to sustained unemployment rates of less than 4 percent, or about a full percentage point lower than unemployment has averaged during any long period of U.S. history.” So wrote University of Chicago economist Robert E. Lucas beholding the problem at the time. His associate Thomas Sargent (both of whom now economics Nobelists) added, “as we all know, instead of 4-4, in the mid 1970s we got 9-9, a very improbable occurrence if the econometric models of 1969 had been correct.”

The idea prior to 1974 was that getting off the gold standard and fixed exchange rates, the official accomplishments of 1971-73, would enable ample monetary expansion, if a risk of inflation, and these things would wipe out unemployment. We got the gold-less, unfixed dollar and policy freedom—and on came 9-9. Economic output soured by 3 percent from the 1973 peak to the 1975 trough as inflation totaled 30 percent over those three years. Millions got thrown out of work, while everything cost a nearly a third more. It was a horrid combination.

Today the unemployment statistic goes under a different guise. Instead of unemployment—defined as people looking for work—we have labor force dropouts. These number about 10 million. Labor force participation, the faddish macroeconomic statistic of the post-Great Recession era is down by five points. In the 1980s and 1990s, the number climbed up to 67 percent of the working-age population. Now it is 62. Add those five points to the four points of official unemployment, and we have 9-9 just like in 1974-75.

We have 9 percent inflation, 9 percent out-of-work, and negative economic growth.

Heirs of Lucas and Sargent would note that absurd increases in the Federal Reserve balance sheet, the vast expansion of government benefits (Obamacare, earned income credits, the incessant stimulus checks), and the routinizing of trillion-dollar deficits since 2009, with the big kicks in these directions of 2020 and 2021, came with assurances the whole while, from the likes of Federal Reserve officials and the Council of Economic Advisers that unemployment would go down via such blowouts. Yet “as we all now see, instead of 4-4,” in the early 2020s, “we got 9-9.”

If you talk about sound money—if you talk about gold—in Washington, you lose your reputation, a saying goes. The incredible complacency that official culture has cultivated with respect to monetary integrity has begun to get its comeuppance.

Global markets no longer believe that the dollar will be predominant as an investment and exchange medium even in the United States itself in the coming generation. We are now in the third decade of cryptocurrency. Creative destruction has never failed to transform an industry it has taken an interest in. Creative destruction has, via crypto, taken an interest in the global monetary regime. A process of price discovery has begun whereby the markets would like to learn what this official dollar is worth, against goods and services, now that it is clear that alternatives are stalking from the realm of tech—tech with its record of zero failures in what captures its fancy.

This is our analogue to the departure from gold and fixed rates over 1968-73. The official cashiering of a classical monetary system fifty years ago caused the markets to embark upon a mission to discover what fiat currencies, the dollar among them, were really worth. This price discovery took the form of a dozen years of inflation. Since nobody wants to invest with a depreciating currency—the currency of future profit streams—unemployment and recession necessarily result from official indifference toward maintaining classical money.

God be with the dollar as it tries to compete with the alternatives that creative destruction will bring to money in the coming years.

The like, in the 1970s, to the mass welfare we have today resulting in all the dropouts was the tax structure. Income tax rates began at 20 percent and ran all the way up to 70 percent in the 1970s (todays rates are 10-37 percent). If you got a 30 percent raise to keep whole against inflation in 1973-75, the new income fed into marginal income tax rates far above what you paid on average in taxes. It was impossible to keep whole. Workers demanded super-raises, raises plus a cost-of-living adjustment, or told the boss to take this job and shove it. 2022 and 1974 are quite analogous.

December 1974 was also the long-term (nominal) floor of the stock indexes. The apperception of the markets somehow identified that Americans were not going to continue to take it. Sure enough, an approximation of monetary integrity, and certainly tax-rate cuts and a notable decline in dependence on government programs came in the 1980s and 1990s, along with epochal real economic growth, the collapse of inflation, a massive boom in employment, and untold experiences of success and prosperity. Our own inflation, unemployment, and market nervousness will abate when either officialdom gets wise, pushed by an assertive electorate and public opinion, or creative destruction runs its course. Until then, here’s stagflation.

N.B.: Key new work on stagflation has come in Inflation, the new book by Steve Forbes, Nathan Lewis, and Elizabeth Ames. And this fall sees the history of the income tax Taxes Have Consequences by me, Arthur Laffer, Jeanne Sinquefield.