Friday, July 28, 2006

Stagflation

Many readers out there aren’t old enough to remember the economy of the mid 1970’s. Jimmy Carter was President and we had both run-away inflation and a recession at the same time. This worst-case scenario became known as Stagflation. It takes a lot of government action or inaction to get us into such a mess. I’m sorry to say, it appears we are in almost exactly the same situation today.

But what about the FEDERAL RESERVE you cry? We had a strong respected Fed chairman back in the 1970’s, Paul Volker, if I recall correctly. But the combination of a major economic downturn and a severe lack of foreign investment capital can each overwhelm the minimal ability of the FED to control the situation. The result, we had to let interest rates rise to 18% to get enough capital to stimulate our economy out of near depression.

The Iran Hostage Crisis following a gasoline shortage and price spike added to the general pessimism and lack of consumer spending. Today, the conditions are very similar with another round of energy shortages and price increases plus the continued expansion of the same Islamic Fundamentalist Revolution centered on Iran. We never solved either issue and they are both back.

Economists will argue that the real cause of stagflation was our excessive amount of foreign debt (including years of $1 million/day spending in Viet Nam) that was not offset by exports or productivity inside the US. Eventually, our foreign creditors found better places to invest, more stable currencies (Swiss Franc) and of course gold which topped $350 an ounce for the first time in the late 1970’s. This time I expect it to double that figure.

Today, we have all the same issues but with much larger numbers. We have been spending over $1 Billion/week in Iraq for years, have the largest trade deficit in world history, and as much as $3 Trillion of debt held by foreign banks while our economy is shrinking at the same time much of the developing world is expanding. Investors know they will get a better return in China, Asia, India, Japan, Brasil, or even Russia than here in the US. The result can only be a massive exodus from Dollars to other currencies and a devaluation of our money. This will lead to unstoppable inflation as it takes more and more currency to purchase everything from bread to cars. The Federal Reserve can’t stop it and the Treasury Department printing more paper (as they have been doing for years) will only aggravate the problem.

A $Trillion in capital invested in US corporations will disappear overnight as the stock market drops to record lows causing further flight from the dollar and a steeper economic spiral downward. There you have it. Stagflation. Get ready for a rocky ride over the next three years. It will take at least that long to turn things around as we make drastic political and economic changes to try to recover. Free Trade, open borders, and foreign wars will have to stop so we can rebuild our industry and begin to recover economically. I only hope it isn’t too late. Ronald Reagan pulled us out the first time mostly by massive deficit spending and his special ability to gain our trust and confidence.

We will really need an exceptional leader or personality to turn this one around and more money than even our government can print or borrow. As usual we spent our way out last time relying on the military industrial complex. Most of the military spending was pure waste and did nothing to improve our national security or effectiveness. I was in the military and saw the massive fraud first hand. Somehow our economy survived and recovered but this time we don’t have an industrial base, have far more competition and trade rules that favor everyone else.

I certainly wish I could write about more interesting and positive issues, but since November 2000 America has veered dangerously off course and may already have gone too far to recover. We and our children must pay for that disasterous mistake.

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