Disco, Stagflation, and Other ‘70s Horrors

Story Highlights:

• Fears of a weak economy and a recent uptick in inflation have given rise to a new round of stagflation worries.
• The last time so-called stagflation hit the US was the late ‘70s. Comparing the two eras reveals few meaningful similarities.
• The term stagflation is nebulous. Depending on the media's mood, it can be used to describe many historical periods.

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For months (though it seems like eons) the financial press has championed the recession and credit woe storyline. Recently nominal inflation ticked up slightly, giving the press license to veer in another even more frightening direction—stagflation.

The Fed Finds Stagflation One Tricky Foe to Fight
Loren Steffy, The Houston Chronicle
https://www.chron.com/disp/story.mpl/business/steffy/5561143.html

That 70's Look: Stagflation
Graham Bowley, The New York Times
https://www.nytimes.com/2008/02/21/business/21stagflation.html?_r=3&adxnnl=1&oref=slogin&ref=business&adxnnlx=1203606046-tYtLd2kq394lcmDbIdhzEw&oref=slogin&oref=slogin

Stagflation is the twin specter of rapidly rising prices (inflation) and sluggish economic growth (or recession) that haunts the yellowing pages of dusty economics textbooks. How could stagflation happen in the first place, you might ask? After all, monetary policy seems pretty simple. If the economy is slow, you lower interest rates to jumpstart it. If prices are outpacing growth, you ratchet up rates to put the brakes on.

Stagflation is the coexistence of these conditions, making monetary policy decisions far more difficult on central bankers—hence headlines with serious shock value proclaiming a return to the ‘70s.

But we're currently nowhere near the decade of disco that inspired the term stagflation. For instance, recent inflation (as measured by the Consumer Price Index) is comparatively low—year-over-year monthly CPI grew at a rate of about 4% in January and has averaged less than 3% this decade. Compare that to an average year-over-year monthly rate of more than 7% in the ‘70s and over 12% to end the decade.

And CPI is a broken indicator anyway. It's based on a vast number of assumptions and esoteric calculations. In our experience, it is far more valuable to watch a market-determined indicator like the yield on the US government 10-year Treasury. The US 10-year Treasury yield is essentially the market's best estimation of the long-term, risk-free cost of money.

Today, government bond yields are exceedingly low. So far this decade, the 10-year yield has averaged just a little less than 5% and ended last year with a yield of 4%—yields have fallen even lower since then. In the ‘70s, government bond yields averaged well over 7% and finished the decade over 10%. So, clearly bond yields—and hence inflation—are currently benign.

And what about the other side of this twin terror—slow economic growth? As pointed out by yesterday's cover story, "Conspiracy Theories," we've yet to see a single quarter of negative economic growth (typically two quarters of shrinking GDP define a recession). Also, the US grew at a reasonable 2.5% for 2007. The global economy was materially stronger. Both are forecast to expand nicely again in 2008.

Finally, consider the definition of stagflation…or the lack of one. There is no official accepted statistical definition; it's an abstract concept conjured by a headline hungry society craving sensationalism. Without reference to magnitude, this nebulous term could be used to describe myriad situations over various times. So when more headlines emerge about stagflation—and be assured they will—ignore them.

A throwback to the seventies is frightening at first glance (considering stagflation and bellbottoms were en vogue then), but the facts say it's really nothing to fret. Let's put stagflation back between those dusty old textbook pages—where it belongs.