Transition From Financial Crisis to Stagflation

By: Christopher_Laird

Now that we are just about 2 years into the world financial/credit crisis, it’s time to ask what is next in one or two years.  One is to ask will stagflation emerge in 2010 and after, which is highly gold bullish long term.

Crisis to stagflation?
We may be moving from a two year crisis stage to a post stage of stagflation that lasts years.
There are several aspects to clarify first. First, assuming there is NOT another credit meltdown this Fall/Winter, and the USD does NOT have a big devaluation event, but rather tails down gradually, then I expect stagflation to emerge. The US and Western economy could do a Japan esq battle with deflation for a decade. It is caused by a hobbled credit system and huge government deficits.

Depending on how the West handles that battle, inflation in essentials like food and energy could emerge, while the economy stagnates or has slightly negative growth or flat growth. One problem with the inflation side of the equation is that major currencies are so managed (manipulated) now, that to get inflation in any major currency (especially the USD) requires the others not to inflate or hold their own.

But, if the USD devalues, and we still do have fairly large exports that compete out there, then our trade competitors will be very tempted to co devalue, or else face a significant loss of price competitiveness. That currency linkage to exports is what allows the USD to hold up far better than it would with the US Fiscal deficit now running $2trillion a year – another problem that has to be discussed.

Even with the US running a $2 trillion Federal deficit, if the other central banks decide to co devalue with the USD, they effectively will underwrite the USD, which can hang in there years after it ‘should’ before the bond markets rebel. Sort of like the central banks ‘holding hands’.

Some scenarios
So, assuming the USD does not have a bond market rebellion on that $2 trillion deficit, and there is no new credit meltdown like fall 07/08, a stagflation environment emerges. A few years of stagflation is highly gold and commodity bullish – over the long term.

Another food shortage
Right now, the world economy is battling deflationary forces. I do not see a great deal of inflation, except perhaps food and energy and related commodities. Energy is more manageable, but food production is basically peaking and the world is running out of stocks of grains. Necessities need to be considered separate from the general commodity complex. Obviously if there is any food shortage worldwide, we have a totally new ballgame in many areas. A food price escalation would not be good for an economy struggling to recover. Likely oil speculators would jump in more and do a repeat of the oil and grains speculation bubble of 08 that later collapsed. In fact, if you want one area that can easily do well in 2010, its Potash stocks.

Can we survive a credit blowup III
Another scenario is what would happen if a third credit blowup like the 08 and 07 fall crisi happened again. Since we really shot the wad on the last two, can we do a third? The ‘we’ here is the Western central banks. If another credit crisis of the same magnitude of the 07 and 08 fall crashes happen, and ‘we’ cant’ do another $10 trillion or so of bailout on a flash basis, will we lose control this time and actually have a pan Western bank holiday, which results in a total economic shutdown till its sorted out, and likely shortages of food and fuel? I suspect every stop in every central bank in the world would be thrown at any Credit Crisis III because of the economic disaster that would ensue in a few weeks. If you think the economy is bad now, imagine what it could be like if people pulled their money out of banks and we had banks close across the West.

So, stagflation in 2010/11 can emerge if the Western economy starts to at least ‘land’ and gets out of deflation. One problem with that scenario is that we are still at the early stages of the USD bubble deleveraging that began with the housing bubble crash in 06, then led to the credit crisis I in 07 and II in 08. That could prevent deflation from turning into stagflation.

By Christopher Laird
PrudentSquirrel.com

Copyright © 2009 Christopher Laird

Chris Laird has been an Oracle systems engineer, database administrator, and math teacher. He has a BS in mathematics from UCLA and is a certified Oracle database administrator. He has been an avid follower of financial news since childhood. His father is Jere Laird, former business editor of KNX news AM 1070, Los Angeles (ret). He has grown up immersed in financial news. His Grandmother was Alice Widener, publisher of USA magazine in the 60's to 80's, a newsletter that covered many of the topics you find today at the preeminent gold sites. Chris is the publisher of the Prudent Squirrel newsletter, an economic and gold commentary.

© 2005-2022 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.