Stagflation explained………at last
This article was published at henrymakow.com
Since the official start of the Credit Crunch in September 2008 a fierce debate has been raging whether we would be facing deflation or inflation. We can now establish that we will have a very toxic combination of both, known as stagflation.
Stagflation is the phenomenon of rising prices while demand in the economy falls as a result of which production tanks. It was first experienced in the late seventies and although it eventually disappeared, there was never given a satisfying explanation for it.
Proponents of both the deflation and inflation hypotheses in the aforementioned debate had strong arguments. Deflationists would say the banks were insolvent and would not be able to provide credit, leading to a diminishing money supply and declining prices. Inflationists would say Central Banking and Governmental policies of bail outs, QE1,2,x and stimulus would lead to more money in circulation, with rising prices as a result.
Both were right, but were missing a crucial key. This key is, that there are two economies. One is the real economy, where you and I operate. We work and make stuff. Cars, food, all sorts of services. And there is also what I would call the financial economy. This is the shadowy world of finance, FOREX, stock exchanges, commodity exchanges. The graph below shows the vast scale of this financial economy, which is many times bigger than the real economy.
What we see here is the transaction volume for the financial economy in red and the real economy in green. At this point we are talking about 5 trillion worth of transactions per day in the financial economy, many times more than in the real economy. We can also see that where the real economy grows in linear fashion, the financial economy grows exponentially. The unexpected decline we see around 2000 is explained by the introduction of the euro, which diminished FOREX speculation. A small price to pay for that giant leap towards World Currency.
It also shows that the financial sector began to exist in earnest only in the early seventies. This is explained by the rise of the computer. Most people won’t realize that even in the early sixties most wages were paid weekly…..in cash. It is the computer that made it possible for banks to connect everybody to their system. Before then, the administrative load of universally held bank accounts would have been unfeasible. It also explains why stagflation had not been around before the late seventies.
The financial and real economies to some extent interact, primarily via commodity exchanges. But it is very important that the financial economy is largely isolated. A lot of the hot money in the financial economy never reaches the real economy. Thankfully and by design, otherwise the dollar would not even have that meager 1% of the purchasing power it had in 1913. This is so, because for instance FOREX is just an eternal ping pong of transactions within the banking sector, leading to an eternal wealth transfer from the not so savvy to the usual suspects.
The above graph and the fact of two parallel economies also explains why in the last decades price rises were so much lower than the expansion of credit in that time span would suggest: a lot of the newly created money was siphoned off to the financial economy.
With this introduction of the concept of the parallel financial and real economies we can now understand what stagflation is, and why it is the inevitable outcome of the events of the last two years.
What we have is a deflation in the real economy but a massive inflation in the financial economy. What is causing stagflation is that a portion of this hot money is now entering the commodity markets, leading to semi hyperinflation in the primary sector (agriculture and mining). These rising prices there must be passed to producers in the secondary and tertiary sectors (industry and services).
An example of this process were the skyrocketing oil prices in 2009. It has been established that Goldman Sachs was using TAARP funds to drive up prices. Oil prices are not rising because of ‘Peak Oil’. There is no ‘Peak Oil’. There is only the old wine in new bags of ‘artificial scarcity’, which has been the main marketing tool of Big Oil since the days of Standard Oil. Oil prices exploded because of hot money driving it up, not because there is a lack of it.
The deflation in the real economy is caused by the credit crunch, and transparently and by design exacerbated by the new Capital Reserve Requirements that were foisted upon the banking system by the Bank of International Settlements.
Corporations, especially those that are not part of the Transnational Cartels that are Big Business, are choked by lack of credit and going out of production, with rising unemployment as a result.
It is this combination, deflation in the real economy, strong inflation in the financial economy leaking out via speculation on the commodity markets that causes stagflation.
I would like to express my appreciation for Dick Eastman’s courageous and groundbreaking thoughts on the parallel economies and its implications.