XGOP4Hillary

(http://www.msnbc.msn.com/id/24129957/)

We are in for a flood of 1970's rerun stories, all claiming that we are back in the stagflation game. All it proves is that they assign to the business desk people too stupid to be wine critics. The 70's stagflation was from a different universe. Strong unions kept jacking up wages. An economy dominated by big oligopic companies then jacked by prices to compensate. It was a mad hatter's race of higher wages, higher prices, higher wages. All this was agrivated by a monetary policy that simply didn't grok what happened and attempted to provide sufficient money to maintain demand with the result of too much money chasing too few goods.

Today unions outside the public sector are weak. A globalized world is awash in excess productive capacity for near anything except base commodities. [more on that below]. Wages in the First World have been stagnant for two decades and show no sign of the sort of generalized surge that made the 70's a kidney stone of a decade. Similarly the bubble in housing prices that enabled many in the First World to treat their houses as ATM machines and live beyond their means is over. We are living in the wreckage of an asset and borrowing bubble.

So what we are seeing is a commodity boom. Partly this is driven by speculative money, the same flood of excess dollars from the US one way trade with Asia that previously fueled the stock market and housing bubbles. Partly we are seeing the effects of India and China entering the outer stages of a takeoff to being First World economies with First World level of consumption. The bulk of the populations of India and China are still dirt poor but no longer starving peasant poor. Some hundred million and going up are First World middle class if you figure their purchasing power at PPP. In reverse there has been little net investment in most commodity production in the 20th century [except for oil where the last major round of investment was the North Slope and North Sea]. As late as a few years ago the problem was low rates of return and excess capacity. So demand is now outstripping production, the more so as much of the world's productive capacity is in regions [Africa, South America, Russia etc.] where the locals don't invest and political risk / nationalization makes outside investment near insane.

So there is cost push inflation of materials, food and energy. The solution is to do precisely nothing. The higher prices will lead to lower consumption and equilibrium will be reached. People in the First World will eat, drive [somewhat less and over time smaller vehicles - it takes over a decade to turn over national auto fleets] and heat their buildings. They will do this at the expense of buying 'stuff'. Retailing will decline and this will hit Asia which makes most of the 'stuff'. As the Asian 'miracles' are driven by exports this will moderate their demand. Price signals are supposed to move people to change behavior. Given stagnant incomes plus ever growing expenditures for government, medicine and social transfers this is all quite natural and inevitable.

Enter the usual idiots who propose raising interest rates to fight inflation. How do higher interest rates slow down the commodity price rises? Getting people to borrow less is fine except no one is borrowing in a major way anyway. Finance is refusing to lend, having rediscovered that risk means you may not get paid back. Most financial institutions have lost much of their capital in the implosion. The easy way out is to shrink the loans outstanding to what the remaining capital can support. Raising the price of money will accelerate this but is this what we really want? Deleveraging is tricky and has many ways to go wrong. Higher prices for credit at the same time availability is cut is the road to a real risk of a 30's type deflationary Depression. So why are the usual pundits calling for it? Because they react on tropisms. They dimly remember an undergrad lecture where they were told rising interest rates was the answer to inflation. Which it was in 1970 or even 1980 but has nothing to do with 2008. We are governed by fools. So far the Fed is ignoring them but the Fed reads the financial press as well as the election returns. Be afraid. Be VERY afraid.