Do you remember the "misery index" that was tracked during the stagflation of the Carter Administration? The misery index is calculated by adding the unemployment rate to the inflation rate. In 1980 it hit a high of just under 22%. Last year it was over 11% and this year it's on track to be at least as "miserable".The bar graph below provides the numbers since 2000:
| 2000 | 7.35 | ||
| 2001 | 7.59 | Bush, G.W. | |
| 2002 | 7.37 | ||
| 2003 | 8.26 | ||
| 2004 | 8.21 | ||
| 2005 | 8.48 | ||
| 2006 | 7.87 | ||
| 2007 | 7.46 | ||
| 2008 | 9.61 | ||
| 2009 | 8.92 | Obama | |
| 2010 | 11.29 | ||
Stagflation is defined as rising inflation occurring simultaneously with economic stagnation. Doesn't sound plausible does it? How can prices rise if economic growth is anemic? Well, take a look at what happened in the late '70s-- then you may start to understand this phenomenon. Interestingly enough, two of the major factors that brought about the stagflation of the '70s were a oil price shock followed by accommodative policies by the Central Banks. Does this sound familiar?
Some will argue that it's quite a leap to go from what happened in the '70s to make a forecast for stagflation for the near future. What is that line that people use? Oh yes, "THIS TIME IT'S DIFFERENT".
What's different? The Central Banks [FED,ECB,BOE etc.] are flooding the world with liquidity while inflation is rising and economic growth is underperforming. That sounds pretty familiar. What IS different this time is that food costs are skyrocketing [causing geo-political unrest] and most of the world's developed economies are basically insolvent [when future liabilities are considered].
Yes, the developing world [China,India,Brazil etc.] are taking steps to rein in inflation. But will they --can they-- do enough to really stop it? How much of an economic slowdown can they allow? More than a few Chinese leaders have talked about the threat of unrest in their country if economic growth slows too much. One indicator of how concerned they are is their efforts to block information regarding what is happening in the Middle East from getting into China.
Now we see the eurozone experiencing accelerating inflation [ around 2.5% against a target of 2%] and economic growth is pitiful [.3%]. If you remove Germany from the equation, the picture becomes much more bleak. Ireland, the canary in the mine, has just lowered its 2011 growth forecast from 2.4% down to 1% in the face of rising prices. The UK has just lowered its already dismal 4th Quarter GDP from .6% down to .5% while inflation is running at 4% [above its 2% target].
The US is monetizing its debt in the hope of increasing inflation and it seems to be working. The latest PPI [crude goods up 4.0%!!] results were quite elevated and the CPI is on the rise. Will the FED be able to put the brakes on this accelerating inflation when it gets to their 2% [CPI] target? I wouldn't bet on it.
We are now in a world where inflation is picking up momentum and economic growth is insufficient. The Central Banks of the world are in a very difficult position. They can't allow their economies to slow down [geo-political unrest,fiscal insolvency etc] and they don't have the wherewithal for another "bailout". So the least dangerous option for them is to drag their feet on tightening and hope they can eventually rein in the inevitable inflation. The key word there is HOPE.
Even though the evidence seems to be mounting, I don't know of anyone other than PIMCO's El-Erian [and me] warning of the possibility of stagflation unfolding. Could it be that the specter of such a development is just unthinkable for the average Wall Street analyst? I hope this isn't one of those situations where they "shoot the messenger".
During the stagflation decade of the '70's US stocks has a less than 2% return and bonds lost around 3.5% [both not adjusted for inflation]. Real estate [commercial] and oil did well, while gold produced dramatic returns. Gold started the decade trading at $35 per oz and reached a parabolic high of around $850 in early 1980--an increase of almost 25 fold.
How do you protect yourself financially given what is coming?
This time real estate isn't an attractive investment option given the condition of the market, Some stock sectors might do well but you will have to pick the right "needles" in the overall market haystack.
Now is the time to be accumulating gold . It is a store of value that has proven its ability to perform extraordinarily well in a stagflation environment. GLD is a good option for your core gold holdings. It mirrors the physical price of gold and does not carry the management and political risks that gold stocks are susceptible to. GLD is trading up around $137 near its all time high of just under 140. See chart below.
You should initiate or add to your position here and look to make periodic buys on price dips over the coming months. The $133-$136 level is an attractive level for accumulation and ---if it gets there---the $127-$130 level. The price volatility will be high, so we will see wide price swings over the coming year. Be disciplined and you will be rewarded with an attractive cost average in your position.
The stagflation scenario is just starting to manifest itself. By the time the mainstream analysts start to acknowledge its presence, gold will be trading at much higher prices and you will have been well rewarded for your foresight.
Disclosure: I am long GLD, SLV, TBT.
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