Saturday, November 16, 2013

Remember Stagflation? What did we Learn from it?

Listen- can you hear it? There is this din- you can hear voices babbling about potential problems with inflation. You can hear voices saying  we cannot invest in America, why you  will cause inflation. And that really bad kind of inflation called stagflation.

Even while we have over 11 million Americans out of work in this country and millions more underemployed, and millions who are paid low, low wages, people are still worrying about potential problems with inflation.

How can there be inflation when demand for goods and services is off by trillions of dollars and millions people are ready able and anxious to go to work to help companies across America produce goods and services. No, there are still worry warts and special interests  that say investing government money would create inflation, and particularly stagflation.

We have experienced stagflation in America. It took place in  the 1970s and it is really important to understand  the right lessons from this period or we are liable to take the wrong lesson  from the experience. It is easy for ideologies to turn history on its head and misshape events to fit their preconceived notions.

Stagflation is a  great example.

I could stick this widely expressed idea around the neck of several authors- but let's quote Bruce Bartlett  ...
Although Keynes’s theory was most appropriate to the Great Depression, his followers did indeed believe in its general applicability and the Keynesian medicine was overapplied and misapplied during much of the postwar era, leading to stagflation in the 1970s. Conservatives like Professor Buchanan were right about that.

You should never discuss the causes of stagflation without acknowledging the biggest factor in the origins of stagflation which was the oil embargo of 1973.

In October of 1973, the Egyptians came up with a plan to attack Israel across the Suez canal into Sinai. Egypt had lost the Sinai in the 1967 war and wanted it back.  They plotted with Syria to attack Israel during the holy days of Yom Kippur thinking the could catch Israel and its citizen army unready.

Egypt bought great water pumps from Germany and used them to wash down access routes into the high sand berms on the Sinai side. This discombobulated Israeli defense strategy- Israeli strategists  figured they had more time to spot and deal with attacks here...  and things were nip and tuck for a few days.

The Syrians had also opened a second front in the Golan heights- but after the 3rd day, the tide of battle turned.  You can look up in the wikipedia on the Yom Kipper war for more info . The October war  the last war between Israel and Egypt to the present day with both sides learning valuable lessons from this experience.

The United States played a key role in coming to the aid of the Israelis- this was a different era of Isreali American relations- this was also deep in the Cold war where the Arabs and Israelis played out in the struggle between the USA and the Soviet bloc,

The Arabs were not happy with US involvement supporting Israel.  Here is how the wikipedia says it.
The 1973 oil crisis started in October 1973, when the members of Organization of Arab Petroleum Exporting Countries or the OAPEC (consisting of the Arab members of OPEC, plus Egypt, Syria and Tunisia) proclaimed an oil embargo. OAPEC decided to retaliate against the United States, announcing an oil embargo.[2] It lasted until March 1974.[3]

Ok, so what is the big deal about an oil boycott?

At that time, we had no strategic oil reserve in this country. That came later. Our entire economy was built around cheap oil. However, by 1970 our reliance on foreign oil- and predominantly Saudi oil was- devastating.

diagram of oil prices before during and after the 1973 oil embargo.
The huge jump in the price of oil impacted the entire economy and created a cost push inflationary cycle with reverberations that became what was called stagflation. The price of oil had a huge impact on the economy running up to the price highs and a great bit to do with the recovery later as the price fell.
- image swiped from the Prairie Research institute in Illinois.

Oil impacted the entire economic supply chain in America. Imagine your next visit to the pump if oil was suddenly over $300 a barrel or $500. This is much scarier than zombies.

There was also a shortage of oil and gasoline not just much higher prices. I was in California in 1973 when gas lines formed. We drove all night to get out of California and back home in Skagit Valley, WA. We picked up some gas at an open station in Oregon along Interstate 5 about 3:45 in the morning.

OK, this was a classic case of cost push inflation. Price of oil resources goes up and every level of the economy has to adjust prices upward. Prices of services go up because it makes products and transportation must more expensive. Workers demand higher wages. Even as prices are going up the economy is tanking because of the disruption. Like ripples on a pond, transient effects of the oil crisis reverberated through the economy and took years to settle out.

This is the biggest cause of stagflation and economic disruption in the 1970's. It was not Keynesian fiscal policy. The oil crisis caused  a stagnant economy with fast rising inflation. There were some political carrying on which had an impact. Richard Nixon- a republican even tried wage and price controls for a while. But the big culprit was the oil crisis.

Stagflation finally came to an end when the price of oil stabilized and actually came down as other producers came to the front with the big jump in prices and OPEC lost most of its power to dictate prices. Saudi Arabia became a great partner in pricing. They understood to sell more oil the advanced economies needed energy stability.

This is such an important lesson to understand because all of our present worry about inflation is misplaced. Government investment is not a big creator of inflation.

Government spending would have to create such demand for goods and services as to reemploy millions of Americans- actually get the economy humming along and then continue to overspend until demand exceeded our economic ability to produce the goods and services to meet demand. We could cut back on government investment, and deal with potential inflation well before this might happen.

A real threat of inflation and stagflation more closely relates to a shortage of energy sources in the world. We have outgrown our supply of fossil fuels. We are discussing inflation issues here, not climate change which is another national security issue- but there is a critical shortage of fossil fuels and energy coming.

World oil and gas production has peaked in the world, even as we are bombarded with happy news about the oil boom in America do to fracking. This new production will help taper off the descent from the World peak production numbers when they occur.  This is a national security issue that looms as a potential disruption which can bring on another even more serious bout of stagflation in the future. This is a national security issue which needs to be funded by government investment. Government investment can help us plan a stable future with plenty of energy or we can continue the path towards crisis energy management.

Fresh clean water is becoming another precious resource even as we have always had all we needed in America. This is a national security issue. We certainly know this is a big deal in Texas. We are hearing more and more about it all the time. Now even the well watered areas of the country are overtaxing their natural water resources.

So why do politicians spend so much time ranting about non crises like potential inflation- when we have so many real issues to deal with- using the tool of Federal funds?

Does anybody else feel nervous about trusting Big Oil to solve our energy problems when they are making higher profits as oil prices raise? As they acquire more power because of the fealty of legislators who pocket the money and buy into the idea that Big Oil is the solution to our energy need? Who thinks that "drill baby drill"  is a long-term solution?

Have you stopped to think of the natural conflict of interest between our American interests and the interests of big Oil?  They are not the same. They are in conflict. So who else feels nervous that so many legislators are in fealty to these big companies.

OK, I have veered totally off subject here. We will discuss understanding the conflicts between our national interests and the special interests of Big Oil separately....

So I  leave you  with one last reminder of our main point here. We have to understand our real challenges and not get bogged down in or distracted by mistaken lessons from history about the fears of inflation and stagflation.

We must understand the real potential for inflation and stagflation. We have issues with natural resource shortages that can create new and even more serious stagflation in the economy. We need to learn the right lessons from history.  We cannot see government investment as a mistaken cause of stagflation but must look beyond the ideology and address real and known issues while we have the time and resources to plan and think with wisdom.

Any questions or any thoughts, speak right up...

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