John Rapley
DESPITE THE persistent optimism about the future among most American economic analysts, a few have in recent months begun using the dreaded S-word to describe what might lie ahead: stagflation.
Stagflation refers to a damaging combination of low growth and rising prices. It is very difficult for policy-makers to tackle, precisely because they have to decide which evil - stagnation or inflation - they will target. And since each responds to different levers, the wrong choices can compound the situation.
1970S STAGFLATION
The last time stagflation gripped the U.S. was the 1970s. That decade saw almost no growth and soaring prices. It ushered in the painful adjustments of the 1980s, which managed to put the US economy back on a path of low-growth inflation.
But might this phase have run its course? In fact, it probably had by the late 1990s, when soaring asset-prices, in particular, the runaway stock market, were camouflaged by the depressed earnings of labour.
While the stock-market bubble burst, a housing bubble appeared subsequently to inflate. Sooner or later, one would expect the rising cost of housing to feed into wage demands. In the 1990s, globalised labour markets, bolstered by the Clinton administration's liberal trade orientation and strong-dollar policy, kept a lid on wage costs. Because it was cheap to invest in China and other low-wage zones, US employers could confront their employees with a nasty choice: accept wage restraint, or lose their jobs.
Much has changed since then. Given the U.S. current account deficit - itself a legacy of the '90s - the dollar has been weakening. The Bush administration has meanwhile abandoned the strong-dollar stance in the hopes that a weaker dollar might improve the U.S.' trade competitiveness.
The result is that overseas investment has become more expensive for U.S. firms. So, too, have goods imported from abroad. Coupled with the rising trend in global commodity prices, the costs of U.S. imports have been rising significantly over the last few months.
LABOUR MORE EXPENSIVE
Partly because of the weaker dollar, labour markets are less globalised for U.S. firms. It is just not as easy as it was in the '90s for them to look abroad for cheap labour. Meanwhile, there are signs that global labour costs may be headed upwards. China's vast labour reserves seem to be diminishing as rural-urban migration slows to a more sustainable pace. Meanwhile, the turn against neoliberalism in many Third World countries is making labour markets slightly less receptive to foreign investment.
The result is that U.S. employers have had to step 'back into the ring' with their own workers. Not surprisingly, labour costs have been rising in consequence. When this effect is added to the rising cost of inputs, the U.S. "core" rate of inflation looks set to keep rising.
U.S. Federal Reserve Board chairman Alan Greenspan has expressed his concern at rising labour costs. As a result, the Fed is likely to keep raising interest rates on short-term credit for the foreseeable future. Sooner or later, rising interest rates are likely to depress economic growth.
The problem is that investors appear to have already anticipated this eventual slowdown. As a result, they have begun buying government bonds. But, given the way bond markets operate, this has depressed yields on government paper. As interest rates on these securities come down, interest rates on mortgages also drop. The American spending binge thus continues unabated.
For now, that is. While few analysts fear the eventuality, there is a danger that bond yields could turn around sharply later this year if inflation keeps rising. And for as long as the economy remains on track and employers keep hiring workers, inflation need not slow. The risk then would be that as bond yields rise sharply, so too would mortgage rates. This would puncture the housing bubble, slowing the economy or even tipping it into recession.
But by then, owing to wage-inflation, prices will be rising. A contracting economy amid rising prices: that would be a nasty brew to have to deal with.
Fortunately for Mr. Greenspan, he will be retiring next year. So while he may leave his successor a bitter legacy, at least he can observe it from a life of leisure in which he can reminisce about happier times.
John Rapley is a senior lecturer in the Department of Government, UWI, Mona.
