THE FRITZ REPORT

For those of you who have children, every once and a while you will hear a dirty word slip out. Back in the 70s when I was a kid, if a dirty word slipped out, I was often treated to a little bit of a mouth washing with a bar of soap. It was never pleasant, but it drove the lesson home. The dirty word I want to talk about this week is not a curse or a swear word, but it's probably even more harmful. That word is stagflation. To an economist's ear, it is one of the worst possible words you can hear. To an actual economy, what it describes is devastating. It's starting to be whispered about in the dark corners of economic thought, and it will undoubtedly become part of the national discussion soon if things do not change.

So, what does stagflation mean, exactly? It is defined by three concurrent economic conditions—none of them good:

1. Rising prices aka inflation
2. High unemployment
3. A period of extended slow economic growth

There are very few outcomes that could be worse for our country (and other countries!) than this wicked combination. I'm going to examine all three of these conditions and try to shine some light on where things stand. I will also examine the 1970s when we historically suffered from this condition.

Let's go to the history first so we can put today's developing situation into context. In 1973 the Yom Kippur war ended, and we were faced with an oil embargo as a result. It was described widely in the popular press as "The Oil Shock", because not only did prices skyrocket, but there just wasn't enough gas. I wasn't driving back then, but I am told that a good portion of many days were spent waiting in lines to get gas when, and if, it was available. Gas prices jumped by 350% and it was subject to rationing, such as even-odd days by license plate number.

The cost of heating oil also skyrocketed, and people were faced with tough choices between heating their homes and buying groceries, made even more dramatic because grocery and essentials prices were also constantly creeping higher. Economic condition number one was fulfilled. Prices rose—a lot—and inflation was a daily reality that everyone faced.

What about the second condition of high unemployment? Well, the short answer is yes, it was there. In 1970 the unemployment rate in the U.S. was roughly 3.5% and by May of 1975 it was nearly 9%. Vicious circles were involved, as rampant inflation caused producers who were unable to raise their own prices to simply stop producing—and employing. There was also an incredible amount of labor unrest; strikes, mass layoffs, and supply disruptions. A grim experience if prices are going straight up and you find yourself out of work. Condition number two was certainly in play.

A recession is defined as a period of temporary economic decline during which trade and industrial activity are reduced, generally identified by a fall in GDP in two successive quarters. That is, condition number three. According to this definition, the United States officially entered a recession in the first quarter of 1970, exited in the 4^th quarter of 1970, and then re-entered a recessionary phase in the fourth quarter of 1973. It finally exited that recession at the end of 1975. So, the third condition occurred off and on for nearly 6 years in the 1970's. Output was depressed, and people were suffering.

As I have mentioned in past posts, there is almost never just one cause or effect behind major trends. We could tie the inflation, unemployment, and decreased output all together in one tidy package, and when economists do this, they label it stagflation. Each of these forces can cause the other two to be exacerbated, and that is precisely why stagflation is so abhorred.

Ok, enough history, what about today? Let's examine the three conditions today. As always, history never repeats itself exactly, but as Mark Twain said, "It often rhymes." It is important as we review these conditions that we spot all interconnectedness between them in the evidence.

Condition #1 - Inflation.

I think it is hard to argue that we are not currently experiencing some significant inflationary pressures. Much of this "rhymes" very closely with the 1970's experience described above, but this time, it is mostly self-inflicted. As recently as last year we had achieved a level of energy independence not seen for decades. Wrangling and mismanagement have unfortunately caused this situation to reverse itself, and we are now again reliant upon OPEC+ to increase production and hopefully keep prices down, and so far, they aren't cooperating. Just this week gas prices in California set new records, at just over $5.00 per gallon. Some of this is made up of taxes and environmental charges, but to the average driver that doesn't really matter. Keep in mind these prices were just over $3.00 twelve months back. That's over a 60% increase, in one year. No rationing…yet!

All kinds of other consumer goods prices, including for groceries, are also on the rise. I discussed the inflation problems in my recent post "The Gates Have Been Strained" in late October. Generally, I don't think I will get much pushback if I say condition number one is present today.

Condition #2 - High Unemployment.

This one is a little tricky because we are faced with a very unusual situation. At the end of October, there were roughly 10.44 million job openings in the United States. This is up from just over five million openings in the third quarter of 2020. The talking heads are calling it the Great Resignation because there are about 7.4 million unemployed people. It's a very strange imbalance and is different from the 1970s. In the 70s, producers stopped producing because the prices of inputs were outstripping their ability to raise prices on their finished goods. It was, for the most part, a manufacturing problem. Today, we are faced with supply chain disruptions, high oil prices, and a labor force that is demanding much higher wages (and sometimes bonuses) just to start. In addition, new hires are quitting at the first sign of a better option. Of course, this labor situation does tie into the inflation problem discussed above. So maybe this is one of those stretch, avante garde kind of rhymes with the 70s world: not a "cat and the hat" rhyme but maybe a "large and the cards" sort-of rhyme. I think although not the same, condition number two, version two, is in play.

Condition #3 - Slow Economic Growth.

Once again, we are living in strange times. The pandemic has caused all kinds of dislocations (a tie into #2), and most economists thought we would emerge from the lockdowns at a brisk pace. That hasn't really happened. Many downtown office buildings across the country still sit empty. Many people are enjoying not commuting and have semi-permanently established their workspace inside their homes. The supply chain disruptions I have talked about many times in the past have cleared slowed output (like just try to buy a car). At the same time, people want to travel, dine out, go to shows and sporting events. So, there is an incredible push and pull on the economic front. Normally, we would see recessions arise from a lack of demand, but consumers and companies have plenty of ready cash, so if a recession were to come in 2022 or 2023 it would probably be driven by the supply side of the equation. If that's true, this can be avoided if the supply chain issues can work themselves out in time. So, condition number three? Let's say it's on the watch list.

So, my conclusion is we don't need to wash out the economists' mouths with soap—yet! We are walking a tight rope between stagflation and recovery, and that is a dangerous place to be, but not an inescapable one—as I said, yet.

Final, final thought: Thanksgiving is a week away. Eat less now so you can fully enjoy all of your meal.

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The information, analysis, guidance and opinions expressed herein are for general and educational purposes only and are not intended to constitute legal, tax, securities or investment advice or a recommended course of action in any given situation. Information obtained from third party resources are believed to be reliable but not guaranteed. All opinions and views constitute our judgments as of the date of writing and are subject to change at any time without notice.