What Is Stagflation and Why Should You Worry About It?

what-is-stagflation-and-why-should-you-worry-about-it?

If you’re under the age of 60, you’ve probably only heard about stagflation through tales told by your parents, or through learning about it in economics class. Stagflation defined the 1970s, but once high inflation was overcome in the early 1980s, most people forgot about it. Now we could be on the verge of another stagflationary crisis.

More and more people are warning that the coming recession and economic crisis could be one of stagflation, mirroring events of the 1970s. Those who remember those times aren’t happy at reliving that era. And those who don’t remember those times may not have any idea what they’re in for.

What Is Stagflation?

Stagflation is a portmanteau combining the words stagnation and inflation. It was coined to describe the phenomenon of a combination of economic stagnation and high inflation.

Those two phenomena were thought by economists at the time to be impossible to coexist. Keynesian orthodoxy believed in the existence of the Phillips Curve, that there was a trade-off between inflation and unemployment.

According to the Phillips Curve theory, short-term bouts of higher inflation would boost employment. Once the economy began running hot, the central bank could clamp down on inflation, resulting in slightly higher unemployment.

It was this belief in the relationship between inflation and unemployment that led to the Federal Reserve’s mandate to ensure stable prices and full employment. But the relationship between inflation and unemployment wasn’t as simple as the Phillips Curve made it out to be.

The 1970s threw Keynesians for a loop, as for the first time high inflation coexisted with rising unemployment. That wasn’t supposed to be able to happen, so the Fed had no way to combat it.

No longer tethered by the remnants of the gold standard after President Nixon had closed the gold window in 1971, the Fed began to create even more money than it had before. And as a result, inflation continued to increase while the employment situation continued to stagnate.

Along with oil price shocks resulting from OPEC embargoes, the 1970s weren’t a very pleasant time for the economy. Investors had to deal with stagnation in the economy as well as in markets, as the period from 1966 to 1982 ended up being one of ups and downs with no real positive growth trend.

It took Paul Volcker deciding to get serious about ending inflation to finally put an end to high inflation that had plagued the economy for over a decade, and from 1982 onward the economy finally turned around. Inflation decreased, markets took off, and an economic recovery ensued.

Everyone thought stagflation was a thing of the past, something that would never be repeated again. Even in the aftermath of the 2008 crisis, despite the massive amounts of monetary stimulus the Fed pushed into the financial system through quantitative easing (QE), we didn’t see massive inflation or stagflation. But things are different now.

Why Stagflation Now?

The reason QE didn’t lead to inflation post-2008 was that the Fed sterilized its monetary injections by paying interest on excess reserves. So despite increasing the monetary base significantly, those increases largely didn’t impact total money supply to the extent that you would normally expect them to if the money multiplier had taken effect.

Fast forward to 2020 and all of a sudden the Fed was driving up the monetary base once again. Only this time, it wasn’t taking care to sterilize all of this monetary injection. And the result was that the money supply began to grow faster and faster, with this inflation of the money supply resulting in rising prices.

Why You Should Worry About Stagflation

The danger of stagflation is that it combines economic stagnation with severe inflation. Normally when you have a recession, prices drop so that malinvested resources throughout the economy can be put to better use. Those falling prices help clear out dead wood from the economy and help aid the recovery process. This is the process that everyone is used to, but stagflation is different.

In a stagflationary recession, not only do you have a business slowdown, rising unemployment, and widespread economic dislocations, you also have rising prices. When the economy is contracting, what incentive do firms or individuals have to pay more for goods and services? None whatsoever.

So the stagflationary environment results in a very slow, painful, and protracted recession and recovery that could take years to recover from. Needless to say, if the coming recession ends up seeing a return to 1970s-era stagflation, millions of Americans are going to be in a world of pain.

Protect Yourself Against Stagflation

It has been over 40 years since the United States last experienced this kind of high inflation, and most people alive today have no experience living through it. Whether buying groceries, navigating the job market, or choosing investments, the way we do things is being completely upended by inflation. And if stagflation sets in and we see a repeat of the 1970s, it could significantly harm millions of Americans.

Those who stand the best chance of making it through stagflation are those who both anticipate it and position themselves to protect themselves against its worst effects. And what could help against stagflation? Assets that maintain their value in the face of inflation, like gold.

The last time stagflation reared its head, during the 1970s, gold ended up making annualized gains of 30% over the course of the decade. Could it see similar performance during the next stagflationary episode? Only time will tell. But many people are hoping for it.

Whether you’re looking to protect your retirement savings through a gold IRA, buy a few gold coins to sock away in your dresser, or something in between, there’s a good chance that gold could help protect your hard-earned wealth during the next crisis. So if you’re worried about how inflation and recession could erode your savings, call Goldco today to talk to our experts and learn more about how gold can help you.

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About the Author: Paul-Martin Foss