“I don’t see the stag or the flation.” ~ Fed Chair Jerome Powell, May 1, 2024
The initial reading for first quarter 2024 GDP came in at 1.6 percent growth, lower than expected and much lower than the 3.4 percent seen in the fourth quarter of 2023. Inflation readings have come in above expectations, leading a few pundits lately to claim that we are heading for “stagflation.”
Stagflation was a term first used in Britain by Iain Macleod in a 1965 speech before the House of Commons. Most Americans attribute it to Jimmy Carter, whose administration brought us a combination of double-digit unemployment with very high inflation and negative GDP growth. In short, stagflation is an economic term that represents the worst of all combinations.
What caused it? Stagflation is a combination of bad outcomes and likewise doesn’t have one single cause, but instead arises from a confluence of poor economic policies. The list of policy mistakes includes deficit spending, over regulating, and overly progressive taxation, accompanied by high levels of unionization.
Deficit spending stimulates demand in the economy. Regulation and taxes constrain supply. High demand and constrained supply give us inflation. Inflation became embedded in 1960s Britain and 1970s USA because unions pushed for higher wages to offset the sting of inflation. This makes sense on the surface, but the problem is, one cannot get blood out of a turnip. The money for those raises wasn’t there, so companies had to reduce the workforce to pay higher wages to those who remained. This may sound controversial today, but at the time, union leaders openly admitted this was their goal. That drove up unemployment and further constrained supply, which made inflation worse, creating a reinforcing feedback loop.
Before I’m accused of being political, note that much of this bad policy in the U.S. came from the Nixon administration, and the reversal of this destructive path began under Carter. It is also important to note that many of these things were being tried for the first time, so leaders of the day did not know the consequences as we do – or rather, should – today.
If this stew of poor policy sounds familiar, it is because we are heading down the same path currently. This track, along with the GDP and inflation data, are leading some to claim that stagflation is back. Is it?
No, we are not experiencing stagflation today. As Jay Powell brilliantly pointed out in his post-Fed decision press conference, “I don’t see the stag or the flation.” First the “stag”: Our economy is still growing. Yes, the 1.6 percent headline is disappointing, but we need to look under the hood. The slowdown relative to the fourth quarter was driven by a slowdown in consumer spending, exports, and government spending. Imports increased, which are actually a negative for the GDP calculation, but not for the economy in reality. The economy must be strong for consumers to be able to purchase foreign goods.
The slowdown in consumer spending was on goods, while services actually increased. So, services increased, and imports increased; that hardly reflects a weak consumer. We must also remember that this is only the first reading. It will get revised, and I would wager the revision will be higher. GDPNow, the real-time GDP calculation provided by the Atlanta Fed, finished last quarter over 2 percent. It has been very close to the final reading, which it should be as it is purely based on the data with no assumptions. Currently it says we are growing at 3.3 percent. It is early and that will likely drop as more data comes in this quarter, but it is still solid growth. The economy is not stagnating.
How about inflation, or as Powell said, the “flation”? The readings have been higher of late, but as we have noted, this is in line with what should have been realistic expectations. Once inflation got down to 3 percent, that last 1 percent the Fed wants is going to take time, and month-to-month data will be lumpy. Powell stated that their read of inflation is that it is just under 3 percent, which is in line with the year-over-year readings for the Fed’s preferred measure, Personal Consumption Expenditures (PCE). That isn’t the 2 percent target, but it isn’t 2022 levels of inflation, let alone the 1970s.
Meanwhile, corporate earnings are coming in strong for this quarter. In the long run that is what drives stock prices. Unemployment remains low and the labor market remains tight. This doesn’t mean that we should not be concerned about the deficit spending and the current regulatory onslaught, as these things can absolutely cause damage over the long term. However, we should not participate in the culture of hyperbole. We will let our yes be yes and our no be no. There is no stagflation today and to suggest otherwise is simply an attempt to be bold and grab attention. That may work for social media, but it doesn’t work for investment results. We will focus on the latter.
Warm regards,
Chuck Osborne, CFA
Managing Director
