Nascent Signs of Stagflation?

UK may be the first country to manifest symptoms of stagflation or “a condition of slow economic growth and relatively high unemployment - a time of stagnation - accompanied by a rise in prices, or inflation” (investopedia.com).

chart from tradingeconomics.com

This from Businessweek-Bloomberg

Britain’s economy unexpectedly shrank the most in more than a year in the fourth quarter as construction slumped and the coldest weather in a century in December hampered services and retailing.

Gross domestic product fell 0.5 percent in the three months through December after increasing 0.7 percent in the previous quarter, the Office for National Statistics said in London today. Economists forecast a 0.5 percent gain, based on the median of 33 predictions in a Bloomberg news survey. Growth would have been “flattish” in the quarter without the impact of the weather, the statistics office said.

The U.K. recovery is losing momentum even before Prime Minister David Cameron’s government steps up its fiscal squeeze to cut the budget deficit. While the Bank of England left its key interest rate on hold this month to support the recovery, inflation has soared to an eight-month high and policy maker Andrew Sentance said late yesterday the “time has come to act” as price pressures intensify.

So economic contraction, which adds to unemployment amidst high inflation rates are signs of stagflation- a tradeoff which traditional Keynesian models have not incorporated.

Other developed economies are likewise seeing signs of emergent inflation

From the Economist:

Recently, however, rich-country inflation has also started creeping up: in December Britain’s consumer-price index hit 3.7%, while euro-zone inflation also rose above the ECB's target. Much of the blame has been put on the increase in commodity prices. But the impact on consumers differs widely between countries. A larger share of income is spent on food in poorer countries such as China (33%) and India (46%), so the rise in global food prices is the main driver of inflation there. By contrast, pricier energy is a bigger factor in the rich world, although it forms a relatively small component of consumer spending.

Given the near unanimity of policy directions by global central bankers, it is not deflation that we should worry about but stag- or super-inflation.

WSJ Economic Scenarios: Just, Right, Too Cold or Too Hot

Here is a quaint chart from Wall Street Journal depicting on the possible scenarios for the US economy and its financial markets

Here are some excerpts from the article...

Just Right

``Hefty government stimulus -- easy Federal Reserve monetary policy and $787 billion in government spending, tax breaks and other perks -- encourages consumers to spend and businesses to hire. This bolsters economic growth, keeps a lid on unemployment and finally ends the pain in the housing market.

``At the same time, the massive structural problems facing the economy, including burdensome debt on consumer and government balance sheets, keep just enough of a brake on growth to keep inflation in check.

``Under this scenario, corporate profits and economic growth limp their way back to recovery through the second half of the year, setting up a stronger 2010. Stocks rise, though perhaps not by much. The consensus view among many strategists is that the broad Standard & Poor's 500-stock index will stagger its way to somewhere between 1000 and 1100 by the end of the year, a 17% gain from Friday's close.

Too Hot

``Under the too-hot scenario, surging asset prices trigger worries about inflation, hurting the dollar and causing the interest rate on government debt to rise. That might force the Fed to buy more Treasurys to keep interest rates low -- yields move in the opposite direction of prices -- fueling more worries about higher inflation and a devalued dollar.

Too Cold

``This pessimistic scenario is a recipe for retesting the stock market's March lows. In the longer run, it could also lead to deflation, in which prices tumble as consumers keep delaying purchases. Deflation can be long-lasting and have a chilling effect on stock markets."

Here is how I see it

Just Right is a fantasy premised on the efficacy of the Obama administrations' magical powers to successfully subvert the laws of scarcity and heal the economy.

Too Cold (or deflation)-a scenario where the US is insulated from the world and or that money has no impact on real economic activity.

Too Hot (or inflation)- a scenario presupposing the reemergence of inflation.

Our take: hot, too hot and possibly boiling hot!