Monday, March 3, 2008

Stagflation, Dead Ahead!

The United States is facing a toxic economic mix it hasn't seen in three decades: Prices are speeding upward at the fastest pace in a quarter century, even as the economy loses steam.

Economists call the blend stagflation, and they're worried it might be coming back.

Paychecks aren't stretching as far and jobs are harder to find, threatening to set off a vicious cycle that could make things worse.

The economy nearly stalled in the final three months of last year and probably is barely growing or even shrinking now. That's the stagnation ingredient. Typically, that slowdown should quiet inflation -- the second key element of the toxin -- but prices are still marching higher.

The latest worrisome news came last week: a government report showing wholesale prices climbed 7.4% in the past year. That was the biggest annual leap since 1981.

Once the twin evils of stagflation take hold, it can be hard to break the grip. People cut back on their spending as they are stung by rising prices and shriveling wages. Businesses, also socked by rising costs and declining demand, clamp down on their hiring and capital investment.

That would be a nightmare scenario for Wall Street investors, businesses, politicians and most everyone else. They're already looking to the Federal Reserve for help, but the Fed's job is complicated by the situation.

The mission of Federal Reserve Chairman Ben Bernanke and his colleagues is to nurture economic growth and keep inflation under control. To brace the teetering economy, the Fed since September has been ratcheting down its key interest rate. Another cut is expected this month. However, to combat inflation, the Fed would be expected to boost rates instead.

"The Fed has its hands full. It is preoccupied with the economic slowdown at the front door, but inflation looks to be sneaking in the back door," said Greg McBride, senior financial analyst at "If that trend continues, the Fed would need to show the economy some tough love, meaning higher interest rates to keep inflation from getting out of hand."

On the other hand, Brian Bethune, economist at Global Insight, said Bernanke can fight only one war at a time, and the more pressing issue right now is to shore up the ailing economy.

"The war on inflation will have to come another day," Bethune said.

Bernanke told Congress Thursday that the nation isn't "anywhere near" the dangerous stagflation situation of the 1970s.

"I do expect inflation to come down," he added. "If it doesn't, we will have to react to it."

High energy prices and rising inflation do complicate the Fed's job of trying to keep the economy growing and inflation contained, Bernanke acknowledged.

Some numbers underscore the concerns:

• Prices paid by consumers are up 4.1% over the past year, the biggest increase in 17 years. Those higher prices -- especially for heating homes and filling up gas tanks -- are taking an ever-bigger bite out of paychecks. Workers' weekly earnings are down 1.4% from a year ago when adjusted for that inflation.

• Oil prices galloped past $100 a barrel last week. Those lofty energy prices are a double-edged sword: They can spread inflation through the economy by boosting the prices of other goods and services, and they can leave people with less money to spend on other things, thus slowing overall economic activity. There are signs that high energy prices are causing some damage on both of those fronts.

People are hunkering down. Earlier this month, nervous shoppers handed the nation's retailers their worst January in almost four decades. High gas and food prices, the toll of the housing bust, the credit crunch and a tougher job market all were to blame.

(In accordance with Title 17 U.S.C. Section 107, this material is distributed without profit to those who have expressed a prior interest in receiving the included information for research and educational purposes. I.U. has no affiliation whatsoever with the originator of this article nor is I.U endorsed or sponsored by the originator.)

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