Stagflation - Why We Hate It And How To Survive

Stagflation is a term that strikes fear into the hearts of economists worldwide because it can have a devastating impact on an economy and the people living in it. To understand what it is, and why it is so dangerous, you have understand how money controls production in an economy, and you have to understand how stagnation can lead to far more uncomfortable things down the road.

What You Need to Know About Money

We tend to think of money as a kind of "fixed" object. There is only so much of it in the world, and it moves from person to person when people buy things. Both of those obvious truths are dangerously inaccurate.

Money is actually a "place holder". The dollars in your bank account and in your pocket represent goods. A baker cooks a loaf of bread, gets five bucks, and he can buy flour or an hour of baby sitting from the kid next door. Dollars are how we trade things in this nation, and they are how we decide the relative value of things. A Jaguar costs more dollars than a Honda Accord, perhaps because more time and materials went into the Jaguar or perhaps because there are just fewer of them.

Now, if there were only a fixed number of dollars in an economy, we'd have a huge problem. Because we actually make more stuff every year. If we had a fixed number of objects and the same number of dollars, the "price" of every object in dollars would go down. For example: If there are only ten dollars and ten apples in the world, you might pay a dollar per apple. But what if there are suddenly twenty apples? The price of an apple might fall to $0.50 (half a dollar). The guy growing apples would think his apples weren't as valuable as they used to be, and he would probably decide to produce less. The same "falling price" rule applies to almost everything. What if you found out tomorrow that your job suddenly paid half what it currently does? Would you quit and find something else to do?

How Much Things Cost Determines How Many Of Them Get Made

Now that you understand why we need more money circulating every year, you'll be happy to know that the United States has a way to increase the amount of money to keep up with the production of things. Actually it has several. First, the government can just print money. It uses all kind of complicated tools (like buying bonds or making loans to banks) to release more money into the economy. It often does that when it wants to fund things like wars.

The Federal Reserve actively manages money all the time. It sets the rate at which banks can borrow money from the Fed to loan to others. In the months after 9/11, the Federal Reserve set the reserve rate very, very low to stimulate the economy. They had to do that because businesses and consumers were not spending money and many costs (like airline security) had suddenly skyrocketed. Without the infusion of cash, nobody would have bought anything and businesses would have stopped producing the stuff people weren't buying. Businesses would have laid people off, thus further reducing the ability of people to buy things.

That downward spiral is called "deflation" and many folks blame it for the Great Depression. The stock market crash of 1929 sucked a huge amount of money out of the economy, and failure to put it back in made businesses stop production and fire workers, who subsequently wandered the streets looking for something to do. Some guy called Keynes said we'd fallen into a "liquidity trap" and convinced the government to spend money on stuff like building Hoover Dam. The economy got a little better. We had a big World War, the Government printed a bunch of money, and it got better still. That was the economic boom of the 50's.

By this time you understand that money is not a passive thing. Changing the amount of money circulating in an economy, shocks that dramatically impact spending habits, dramatic increases in the real cost of things (like oil) relative to other objects (like food) can have a massive impact on the lives and well being of people who have to live in that economy.

Which Brings Us Back to Stagflation and the Credit Crunch of 2007

Having read all this, its easy to imagine the Government should just print money all the time. Obviously its good for production. The problem is, the more money you have circulating, the less any given dollar can purchase. If you are an investor with a lot of cash, a person living on a pension, or a country that has a lot of its wealth in dollars, you don't like having the dollars you hold become worth less every single day. So you use those dollars to buy something like Euro's that hold their value a little longer. If you are selling things to people with dollars, you charge them more dollars every day. The result is no one wants dollars and prices in dollars go up very fast.

Over the last seven years, the price of oil has gone from $30 a barrel to over $100 a barrel, resulting in $1.29 gallon of gas going up to over $3.50. The cost of health insurance has gone up by more than 400%. The average price of a house in some areas has almost doubled. The cost of food has risen more than 10% this year alone. Five years ago the Dow was at 8000, and earlier this year it was at 14000. That increase far outstripped the growth the nation saw in real production during that time.

Very low interest rates implemented by the Federal Reserve after 9/11, and the increased government deficit spending occasioned by the War on Terror, have created much inflation in the price of things. Wages, have not kept pace with with inflation. An employer who gets twice as much for his bread may not instantly decide to pay his bakers twice as much.

In order to maintain our standard of living, most of us have resorted to the use of credit. Some of us charged up our credit cards. Some of us borrowed against our homes. In effect we've created a new source of revenue based on the increasing value of our homes and the liberality of banks in lending money.

What Went Badly Wrong

People borrowed against their homes, or purchased new homes, with help from Banks. Wages aren't keeping pace with inflation, so folks can't make the payments on all those variable interest rate loans. They are losing their home. Perhaps more important many, many folks are spending far less because they are borrowing less. Partially its because folks have gotten scared. Partially its because banks are less likely to make loans.

People are spending less. That means that producers are getting the signal to produce less. So they are not giving out wage increases. They may be firing people soon. If some way isn't found to make credit available to people and businesses so the amount spent can continue to increase, we will slide into recession.

Now, here is the really ugly thing. It is possible to have massive inflation and massive recession at the same time. If you have a massive number of dollars circulating, and no one trusts they will hold their value for very long, folks will stop producing new goods and selling them for those dollars. Its too risky to invest much in enterprises that might receive a bunch of worthless dollars. That's the kind of ugly thing that happened to Germany in the 1930's where the world saw wheel barrows of cash chasing loaves of bread.

What You Can Do

The truth is, this is a tough situation. The tried and true suggestions in years past are not the ones that will work in times like these. You may actually have to borrow money to avoid being beggared by this national financial crisis. Here are some suggestions

• Continue to get credit at really favorable rates. Banks are making some kinds of loans in great numbers because their balance sheets look so bad. For the most part, Banks only make money when they make loans. Use cheap credit to buy things that do produce money. If you can get government secured fixed loans through the Small Business Administration to start a solid small business, you probably should. Check out SBA Express loans for small businesses and Veterans.
• If you can get a student loan, do it. Get yourself a better, more high paying job now because if we head into recession you may have a hard time finding one later. Prepare yourself for a more competitive labor market.
• Ask for a raise or aggressively search for a higher paying more secure job. You really do need more money to survive.
• If you're situation is dire, contact a credit counselor and get out from under those unsecured credit cards. They are unsecured for a reason. They can't take your house, and you need a place to live. Negotiate with banks to get your interest rates on your mortgage fixed, or to prevent them from going up. A quick tip on home foreclosure. Always demand that a bank prove it holds the note on your home. In many cases they can't because your loan was sold as a package of mortgage backed securities. www.latimes.com/news/opinion/commentary/la-oe-weiner3dec03,0,6880518.story?track=rssThat means you don't owe the bank anything You own whoever bought the package something and they have to be the one who sues you.

There is no best secured loan that any given person will survive and prosper in an economy that is taking a dive, but understanding the forces driving our economy can certainly make it easier to do the right thing. What you cannot do is pretend that its business as usual here in the United States. Like our parents and grand parents before us, we will have to work hard to survive serious financial storms or be devastated by them.

Nancy Fulton is a writer, publisher and filmmaker with a degree in economics and more than twenty years experience running a small business. You can find more about her work by visiting www.complete-support.comhttp://www.complete-support.com and www.nobetterfriendmovie.comhttp://www.nobetterfriendmovie.com