I wrote a post about the different possible “flationaries” perhaps a couple years back on FB, if I remember correctly that post was mostly ignored. I hope this re-visit on the subject attracts more readers because it now looks as if we’re going to see one of the rarest and worst “flationaries” that exist, known as “stagflation”. (This is written for an 8th grade level, no challenging science here just very straightforward, easy to understand stuff.)

Inflation
There’s a general misnomer about this word. Moderate inflation is expected, in fact it’s even included in the Monetary Policy plans of the Federal Reserve where they target moderate inflation rates between 2-3% per year. It “comes with the territory” in a normal economic expansion. That’s rule #1, you must first understand that economies are either growing or shrinking and a growing economy will face some inflation pressure over time. (What’s not that copasetic is when the Fed leaves out essentials like food and energy costs in their measures of U.S. inflation… this has been a source of controversy. I’m not sure if recent adjustments were made to include these items or not, but they should IMO.)

The stock market will generally “behave” in a modestly rising inflationary environment. This may be due to the abilities of companies to pass on their incremental costs by slowly increasing prices without disrupting demand much? Hence, corporate earnings can still grow. However, the bond market will mostly react negatively to increases in inflation. The bond market is made up of fixed payments into the future, so rising inflation decreases the attractiveness of an investor holding the right to receive nothing but the same fixed payments (non-inflation adjusted) into the future.

Another thing you need to know about inflation is that rising wages are often at the core – the greatest contributing factor to inflation in these United States. So if you’re a minimum wage recipient, watch what you wish for right? 🙂

Disinflation
This just describes a period of declining inflation. Usually a transition period that hopefully will not turn into the “deflation” described below –

Deflation
Here’s where the ugliness starts, right here. If you’re 5 years old or older, you’ve already been alive during periods of deflation. This environment marked most of the two terms of the Obama administration. Deflation, or continually declining inflation rates was so pervasive that then Federal Reserve Chairman, Ben Bernanke had to invent a never used before Monetary Policy move now known as “Quantitative Easing” (QE). Basically, what these programs do is mechanically/artificially decrease interest rates all across the yield curve in hopes of stimulating purchases [of mostly high ticket items]. Purchases large enough to move the needle in the economy. The task? Get the economy moving again by a double whammy – increase the supply of money (availability of money as well as velocity of money). Do QE’s work? Yes they do, they have, the problem is they create distortions in asset prices and other things. (I’m not going to delve into that subject here because it’s beyond the scope of keeping this post simple to understand.)

What’s happening in a deflationary environment is that people are holding off on their purchases. When enough of our population practices deferring purchases, the economy suffers, does not grow and is very likely teetering on recession. Look at some of the Gross Domestic Product numbers between 2009 and 2016, you will find that the U.S. economy never even achieved a 3% annualized growth rate during the Obama years, averaging around 1-1.5% rates of growth. Why is that? (Again, the answer is beyond the scope of this text.)

Hyperinflation
Another ugly scenario. The last time the U.S. economy experienced hyperinflation was a period of time between the late 1970’s and the early to mid-1980’s. Home mortgage rates had risen to 20% for a 30-year mortgage, I think that was the top before the “house built of straw” finally tumbled down. I bought my first starter home in 1983 and our mortgage rate was 12.875% or some crazy borrowing cost like that. However, at the same time, I had retired relatives, Aunts and Uncles that were locking in one-year certificates of deposit (CD’s) @ 10% interest, maybe even more – so many retired folks loved it! Remember that in all economic cycles, there will always be winners and losers. 🙂

Hyperinflation is simply a moderate inflationary environment that got out of hand during a time when demand is still robust enough such that the pace of inflation continues to rise, and unabated, it begins to affect all final costs, even input costs, including loan rates, [the cost of capital]. It’s an unusual situation during these modern times to experience hyperinflation because the Federal Reserve has been able to implement Monetary Policies designed to dampen inflation by hiking rates [enough that is] before events like this can occur. (However, the one caveat to this argument is that each Federal Reserve Board is different as well as the administration housed @ 1600 Pennsylvania Ave. So I’m not going to say that a hyperinflationary environment won’t happen again, it’s just that it’s still considered quite unusual.)

Hyperinflation causes all kinds of trouble because it’s an unsustainable situation. Exceptionally higher and higher prices eventually result in demand destruction for about anything and everything across the board. And believe me, any bond market with any measurable duration [look that up] has sold off by now. U.S. stock markets won’t fair much better under a hyperinflationary cycle. Job losses will mark the beginning of the end to this cycle as the unwinding of overpriced “every-things” eventually ends the over-speculation. Banks will face all kinds of loan defaults from residential real estate to commercial property to you-name-its, defaults will be widespread across the country. The unwinding of a hyperinflationary cycle usually requires the economy to face recession. Just to reset and clear the slate of over-speculation in all kinds of assets.

Stagflation
This is the most unusual “flationary” scenario. It’s also the most perplexing. Periods of stagflation hopefully do not last long. We will almost always find them as a result of “policy errors”. Errors from U.S. lawmakers in Washington to the Federal Reserve to both can lead the U.S. economy into a period of stagflation. This describes an economic environment, a condition marked by a combination of slow growth and rising inflation. You may be asking yourself – wait, how can this happen when it appears (on the surface anyway) to be a dichotomy of forces? Well you’re right, these two forces make strange bedfellows. Indeed!

Unfortunately, I fear that this is where we are in the U.S. economy at this writing. We are most likely in very unusual circumstances – we have slowing growth combined with increasing inflationary pressures, all caused by policy errors. When you increase the regulatory environment, you are artificially reducing the supply [of things] in general. While, at the same time, consumer demand for certain items remains constant [for awhile anyway], while simultaneously the supply of required things has been artificially reduced [again via huge policy errors]. The result? Rising costs, inflationary pressures show up in all areas of the economy, especially in necessary items like food and energy.

I don’t see this situation as sustainable for long, which may be a good thing? As to whether or not this ends well, that all depends. Read below as there are only two ways out of a “Stagflation Hell”:
1) Quickly reversing recent regulatory policy errors out of Washington, D.C. which can facilitate the opening up of sources of availability [for necessary things]. Fuel and energy are among these items.
2) Otherwise rising prices in the U.S. eventually erode demand while (policy error) supply restrictions remained in place long enough to result in the U.S. economy entering into a new recession. In other words, supply constraints are in place long enough to outlast a normal consumer demand cycle.
Just know that these are the only two possibilities out of a Stagflation environment. So would you like to place your bets?… once again – thanks for reading! 😉