Stagflation

I just finished reading an article in which the writer, and a sound thinker at that, was predicting that if the U.S. Federal Reserve plays along with Donald Trump’s plans to invigorate the economy through massive infrastructure spending, it will mean sharply increasing the debt of the USA with the result that there would be inflation. He wrote that if the Fed doesn’t accommodate the Trump agenda, there will be recession.

But inflation and recession are not opposites. Inflation is the condition of there being an increase in the money supply (usually with an increase in general prices also). Recession is a slowdown in economic activity. Technically it is defined as 2 consecutive quarters of falling GDP. But there can be both recession and inflation. That confluence is described by a word that came into vogue in the late 70s: stagflation. This is when there is inflation and no growth.

Donald Trump seems to admire Ronald Reagan, and appears keen to spend while lowering taxes. President Ray-Gun was able to do that because interest rates were falling hard early in his presidency, so this meant bond prices were rising, creating an easy time to borrow or create money. Maybe I’ll explain on a different day why bond prices move inversely to interest rates, but suffice it to say now that Ronald was able to raise money in an economic climate that Donald doesn’t have (see

http://gordonfeil.blogspot.ca/2016/11/dollars-dollarettes-and-interest-rates.html). When Ronald Reagan came into office, U.S. public debt was 35% of GDP. Donald Trump is taking over at a time when that ratio is 104%. Reagan had room to maneuver; Trump does not. Further, it appears that once the ratio of government debt to GDP exceeds 70%, additional government spending has the effect of lowering GDP because the private sector reduces its spending by a greater amount than the increase in government spending. Trump increasing spending now will likely cause the GDP to fall while the new money created to fund that spending will be inflation. Hence, stagflation. To me, it looks like the USA is heading into more of a Carter era than a Reagan one.