Thursday, September 27, 2007

STOP THE PRESSES--Greenspan sees threat of '70s-style inflation

This graph shows the changes in the annual inflation rate from 1965 to 2005, and how the prices compare between the two years. Former Federal Reserve chairman Alan Greenspan fears a gradual return of the 1970s inflation that crippled the U.S. economy.

I seriously wonder if Americans are either gullible, or ignorant. I found this story on McClatchy:

WASHINGTON —An important point in Alan Greenspan's much-hyped memoir has gone largely unnoticed: He acknowledges that global economic forces, more than Federal Reserve policy, kept inflation low and manageable for two decades.

By global forces he means free trade, the rise of emerging, cheap-labor economies led by China and India and the benefits from information technology and the Internet.

He warns that these forces — "globalization," in shorthand — are weakening as they mature. He fears that could mean a gradual return to persistent 1970s-style inflation over the next 20 years or so. And he worries that could cripple a U.S. economy that's already facing strains from the graying of the population over the same period.

Not everyone agrees.

"I do think he's overly pessimistic. Which is not to say things he's pointing to aren't real or potentially real," said Alan Blinder, a former Fed vice chairman and Princeton University economist who thinks that U.S. and European policymakers are unlikely to let inflation get out of hand because they learned hard lessons in the '70s.

Inflation measures the rise of prices across the economy over time. It's relatively stable at the moment: Consumer prices rose only 2 percent over the 12 months through August. But oil prices are high — more than $80 a barrel — commodities from corn to gold are flirting with records and Americans are increasingly fearful that free trade is hurting wages and workers at home, and may restrain it.

All those factors threaten to boost inflation.

It roared out of control from the late 1960s through 1981. Prices rose so quickly that they eroded the purchasing power of a dollar. In 1979, $100 on Jan. 1 was worth $87 by Dec. 31.

Well, our famous economic seer of the 1980s, Alan Greenspan, is now worried that the U.S. is returning to the 1970s inflation-style U.S. economy. And he writes about it in his memoir. The first question I have to ask is how long did Greenspan either know, or suspected, that the U.S. is heading towards this 1970s economic predicament? I know that, as an economist, Greenspan will talk on both sides of his mouth about economic conditions in the United States--well, we think that the U.S. economy could be heading in this direction, but it is also possible that the U.S. economy is heading in that direction. But does Greenspan even look into past economic history, and look for past economic and historical patterns that are comparable to current events in the United States?

The problem I have with Greenspan here is that he is too intent on looking at the weakening of globalization as the culprit for the rising U.S. inflation. According to McClatchy:

Greenspan, the leading economic seer of the roaring 1990s, fears that the table's being set for it all to happen again.

The biggest reason is that "having largely bestowed its benefits, globalization will slow its pace," he wrote.

For several decades, the benefits of globalization — primarily abundant foreign-made goods produced for low wages and purchased for low prices &mash; helped hold down U.S. inflation. But that's changing.

China, for example, the biggest source of U.S. imported goods, has a growing inflation problem. Its inflation rate hit an 11-year high of 6.5 percent in August.

Wages in China grew 13.5 percent last year. As Chinese workers demand higher pay to cover rising prices, production costs rise. Eventually, the price of Chinese-made goods purchased by Americans will rise as well.

Just as inexpensive imports helped hold down inflation here the past two decades, inflation here will rise with import prices. How much, how fast? While U.S. inflation rates varied greatly over the years, on average from 1939 through 1989 consumer prices rose by 4.5 percent per year.

"That's probably not a bad first approximation of what we will face," Greenspan warns in his book "The Age of Turbulence." An annual inflation rate of 4.5 percent would reduce the purchasing power of $10,000 to $6,439 in one decade, according to the Tax Policy Center, run by the Urban Institute and the Brookings Institution.

Greenspan says the threat of rising inflation is already here. He told CBS's "60 Minutes" that his successor, Ben S. Bernanke, faces a different economic chessboard from the one he had in the '90s.

"We were dealing with an environment back there where inflation was easing. We could have acted without the fear of stoking inflationary pressures. You can't do that anymore," Greenspan said.

Now I can understand the argument that a weakening of globalization could have an effect on the U.S. economy, but is it going to be so bad as to cause a return of the 1970s inflation? I'm not sure. But I do know that Greenspan is ignoring two huge variables here--the U.S. war in Iraq, and the Bush administration's funding this war with both tax cuts to the rich and the printing of more U.S. debt. And here is where history comes in. I wrote two blog posts on this subject. The first post I wrote was on May 11, 2006, titled Inflation worries, oil surge slam stocks:

It is President Bush's Anti-Great Society Program--destroy the social safety net of the federal government by cutting social programs' budgets, and then give out huge tax breaks to big corporations and rich elites, all while fighting two wars overseas. Oh, and pay for it, not by raising taxes, but by turning on the government's printing presses and just print dollars until the sun doesn't shine. George Bush is following the same playbook as Lyndon Johnson was in providing guns and butter during the 1960s with Vietnam and Johnson's Great Society anti-poverty programs. The only difference here is that Johnson was using the government to try to end poverty and create a social safety net for Americans, while also fighting his war in Vietnam. President Bush is using the federal government to not just destroy the Great Society safety net of President Johnson, but also to create a government-paid safety net for big corporations and rich elites. And Bush has got two wars to fight in Iraq and Afghanistan, with a third war on the way in Iran, to Lyndon Johnson's one war in Vietnam.

However you spin this, it is going to spell disaster for the American economy. Lyndon Johnson turned on the printing presses to pay for his guns and butter. Bush has had the printing presses going full blast for the past five years--and another three years to go for his administration. Inflation is going to kick in soon, with higher prices that will hit businesses, consumers, and investors. Look at what has happened today--inflation worries and energy prices have slammed the Dow down by 141 points, the Nasdaq is down 48 points. Interest rates are rising--and the Feds are signaling that rates could still rise even further. Oil and gas prices can still go up, especially if investors are nervous about an upcoming American attack against Iran. If inflation pressures start forcing prices to rise, American consumers are going to cut back on their spending. The Feds are going to continue raising interest rates as a means to combat inflation, forcing businesses to cut back on investment in new factors of production. We're going to see the worst of both worlds--stagflation, where you could have a deep economic recession in the U.S., and rising prices due to inflation. It happened from the mid-1970s to mid-1980s.

But I fear that this will be much worst than what we've seen in the 70s.

The second post that I wrote was on August 28, 2006, titled Real wages failed to match a rise in productivity:

Think about this for a moment. The stagnating wages have been offset by the rising value of benefits, such as health insurance. But the problem with health insurance is that the price of health insurance has also been increasing, thus adding to companies labor costs. Instead of absorbing the costs of health insurance, companies have started passing those costs towards the workers in terms of higher health insurance premiums deducted from workers' paychecks. At the same time, wage increases have certainly gone to the top income brackets--including those of the CEOs. Thus, the inequality gap between the rich and poor has continued to increase. It is interesting how UBS investment bank has called this period as the “the golden era of profitability," and how corporate profits have climbed to their highest share since the 1960s. Lyndon Johnson had started both his Great Society program, and entered into the Vietnam War. And even Johnson's Great Society economic stimulus was added to John Kennedy's New Frontier's stimulus, which included tax cuts, economic reforms, wage, housing and medical regulations. There was a lot of economic stimulus in the 1960s, with Americans happily spending on consumer goods, and companies happily producing those consumer goods for profits. The danger of the 1960s economy was that the U.S. government was funding both this economic expansion and the Vietnam War by printing dollar bills--and not by raising taxes to pay for everything. We see the same thing happening now with Bush's tax cut stimulus and war in Iraq. And the economic benefits of globalization and productivity today have been going towards corporate profits, rather than wage increases.

The biggest pattern that I have been seeing is that in the 1960s, President Lyndon Johnson financed both his Great Society programs and the Vietnam War by turning on the Treasury printing presses. Johnson did not raise taxes to pay for either the war or the Great Society programs. And in the 1970s, we started paying for this debt with inflation. Fast forward to today. We've got President George Bush paying for his tax cuts to the rich and the Iraq war by, again, turning on the Treasury printing presses. I will admit that when I wrote those posts, I was expecting a recession to hit the U.S. in 2007. What I didn't realize was that the housing bubble was expanding in 2006, offsetting the inflation worries, rising oil prices, and stagnating wages. Americans were happy because the value of their homes kept going up due to the housing bubble.

That bubble has crashed. Consumer sentiment has become worried about a combination of the housing crash, increased oil prices, and inflation worries. All of this could cause consumers to cut back spending. Businesses may continue their own investment and produce products for U.S. export, but business exports are not going to keep the U.S. out of a recession if consumers decide to cut back on spending. In the 1970s, we saw the results of Lyndon Johnson's policies of financing his war and Great Society programs through the printing of more money. What we currently have now is President Bush financing his Iraq war with printing even more money. And Bush still refuses to repeal the Bush tax cuts to the rich. Because of President Bush's disastrous economic policies and the war, we may end up heading towards a 1970s-style stagflation of increased inflation and an economic recession.

But there could be another reason here about Greenspan's insistence on blaming a potential 1970s-style inflation on globalization. And this stems not because of economic conditions, but rather political conditions. Greenspan supported both President Bush's tax cuts, and the Social Security privatization plan. But when the Iraq war started, Greenspan shifted his tune, saying that making the Bush tax cuts permanent in 2003, while the U.S. was at war with Iraq, would cause huge budget deficits, and fiscal discipline was needed. In other words, Greenspan performed a political CYA once the Bush administration started pushing their permanent tax cuts at the same time the U.S. was at war with Iraq. Greenspan also kept completely quiet on the link between oil and the Bush administration's war in Iraq, only to finally acknowledge it after he retired and wrote his memoir. He never publicly criticized the the link between oil and the Iraq war while he was the Fed chairman. I seriously wonder if Greenspan's admission in his memoir is another CYA attempt to protect his legacy. Greenspan kept interest rates low, creating the housing bubble that took place between 2001 to 2006. What was Greenspan's reason for allowing the housing bubble to continue growing, even though he knew it would collapse? Was Greenspan motivated to keep the housing bubble growing because in the last two years, it was also contributing to the U.S. economic growth while the country was at war? I can't answer those questions. But what I do suspect is that Greenspan has been performing some major political CYA here to protect his legacy. And this story about Greenspan predicting that the weakening globalization would cause a 1970s inflation in the U.S. may be another political attempt to protect his legacy. I don't recall ever hearing Greenspan presenting harsh criticism against both the Bush economic policies and the Iraq war--again, he spoke between both sides of his mouth on everything. Does Greenspan believe that he will be harshly viewed by history for his support of the Bush war in Iraq, even if that war could cause increased inflation, or even stagflation in the U.S. over the next ten years? Is this another Greenspan CYA attempt at shifting the potential causes for a 1970s-style inflation away from the Bush war and tax cuts and towards this weakening globalization, perhaps even cementing Greenspan's reputation as an economic seer beyond his term as Fed chairman?

It is interesting speculation here.

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