If you listen closely enough, you can hear the stagflation storm brewing across the economy. It’s the sound of rising prices and weak economic growth conspiring to create the Federal Reserve’s worst enemy.
Friday’s lame GDP print exemplified where we’re heading, with the economy gaining just 2.8 percent in the fourth quarter of 2010 no matter how much government economists tried to talk up the robust corporate balance sheet and supposed gains in employment.
The report unveiled the next ingredient in the stagflation cocktail—namely, austerity at the state and local government level.
Combined with rising energy and food costs and unemployment that will suffer all the more as local governments will be forced to cut labor, belt-tightening will ensure weak growth for many quarters ahead.
Real state and local government consumption expenditures and gross investment fell 2.4 percent in the quarter, reflecting the need for austerity amid a huge debt and deficit mess.
At the same time, the economy will have to deal with a new normal in oil prices, with the former range of $80 to $90 now likely to be replaced by something north of $95 and perhaps well into the hundreds.
T. Boone Pickens told CNBC on Friday that he expects oil to hit $120, a daunting prospect for an economy hoping to keep inflation out of the way long enough for employment and housing to catch up to the rest of the economic data points.
Analysts say $100 a barrel oil takes 1 percentage point off GDP, while $120 would subtract 2 percentage points (this was reported on TV earlier by my colleague Bob Pisani who cited Gluskin Sheff economist David Rosenberg). With consensus running only to a bit above 3 percent growth for this year, the damage that Middle Eastern turmoil could do to the US economy is profound.
Of course, economists would be quick to point out that higher gas prices don’t equate necessarily to a surge in inflation. But even those time-honored arguments will get tested.
In a separate broadcast appearance, Richmond Fed President Jeffrey Lacker addressed the importance of inflation perception and how a belief that $4 gasoline and $4 lettuce can convince consumers that inflation is here, economic models be damned.
“The real danger is inflation psychology,” he said, later importantly adding, “We have got to get the timing just right on this thing.”
The emergence of stagflation trends is critical for the Fed in that it means the central bank is failing on both ends of its dual mandate—ensuring stable pricing and employment.
Chairman Ben Bernanke has been a focal point of criticism during the Middle Eastern violence, with detractors saying it is the Fed’s easy-money policies that have driven up the price of dollar-denominated commodities and consequently global food costs. The Wall Street Journal in an editorial Thursday cited the “Bernanke premium” on food and energy, and that was one of the kinder catcalls.
“The fact that the Fed’s massive money printing effort is the progenitor of global food riots completely escapes (Bernanke),” Michael Pento, senior economist at Euro Pacific Capital, said in a blog post. “As more damage is done, the Fed will use the resulting contraction in GDP to justify a third round of quantitative easing—further harming the GDP.
“Unfortunately, the viscous cycle of stagflation will grow more acute with each iteration of the Fed’s love affair with counterfeiting. Countries that make the mistake of continuing to peg their currencies to the US dollar will suffer more inflation and more destabilization. Since it will be hardest for the US to ditch the dollar, our hopes are dimmer.”
With the clock ticking on the second leg of quantitative easing purchases, figuring out the right way to step away will be pivotal to avoid the full stagflation fury.
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