Stagflation – is an economic phenomenon characterized by high unemployment (economic stagnation), significant inflation (rising prices), and little or no growth.
Stagflation is a portmanteau word of stagnation and inflation. It is used in economics when the inflation rate is high, the growth rate slows down, and unemployment stays high. It raises a dilemma for economic policy since actions designed to lower inflation may worsen unemployment and vice versa.
Before the 1970s, unemployment, and inflation were thought to be negatively connected, with unemployment rising as the economy slows but inflation falling. As a result, to stimulate economic growth, a country’s central bank might raise the money supply with some inflation to boost demand.
Beliefs about inflation and unemployment were based on the Keynesian school of economic thought, named after twentieth-century British economist John Maynard Keynes. According to this theory, the growth in the money supply can increase employment and promote economic growth.
As developed nations entered a period of stagflation in the 1970s, Keynesian economists had to reexamine their beliefs. Stagflation is characterized as weak economic development accompanied by high inflation rates.
Stagflation is unquestionably on the rise throughout the world. Rising commodity prices, energy reliance, and a worsening economic and financial climate are wreaking havoc on Europe, which the conflict in Ukraine has worsened.
Economic risks appear more acute, particularly in Europe. Because of the region’s significant reliance on manufacturing, the durable goods-driven recovery has transitioned into one fueled by service expenditure, which is less favorable to the region. Money supply expansion has also slowed significantly, which is frequently a solid indicator of lower company confidence and activity. The Ukraine conflict has compounded this, producing a spike in the price of essential commodities such as natural gas (Picture 1).
(Picture 1. Monthly natural gas price – gold.org)
Stagflation is a danger in the United States, although it may not be as severe. According to economic statics, the US economy shows signs of resilience. However, suppose the difference between US long-term and short-term bonds continues to shrink, which has traditionally been a reliable economic indicator. In that case, it might imply that market participants are experiencing a downturn. The possibility of stagflation might occur if energy and food costs persist at or above current levels.
The US Treasury yield curve has been flattening at an alarming rate across many tenors, and consumer sentiment is at a ten-year low (Picture 2). In addition, the Atlanta Fed’s GDPNow estimate puts growth at 0.5% in Q1 2022. Should current conditions drag on, the risk of a stagflationary squeeze will rise materially.
An increase in the unemployment level results in a decrease in consumer spending power. If you tack on high inflation, that means that what money consumers do have is losing value as time goes by—there is less money to spend, and the value of the money is in decline.
During the last major historical event of stagflation, which occurred at the turn of the 1970s and 1980s, Gold showed its power.
The price of Gold soared as the gap between inflation and economic growth expanded in the United States, signaling growing stagflation.
Between 1976 and 1980, the price of Gold grew eightfold, from 100 to around 800 dollars per ounce, while the difference between annual inflation and annual GDP growth reached double digits.
(picture 3. Stagflation & Gold in 1970s and 1980s)
In recent weeks, there has been a huge surge in investor interest in safe-haven assets, such as Gold. The world’s largest gold-backed ETF, SPDR Gold Trust (GLD), had net inflows of $3.2 billion, or 5% of its assets under management (AUM), in the first two months of 2022. Inflows into GLD, in particular, have increased dramatically since the end of January, as geopolitical concerns between Russia and Ukraine have worsened.