Stagflation

0:00 Stagflation is a word that, for one reason or another,

0:02 is going to get thrown around a lot more over the coming months.

0:05 But, all it means is simply increasing unemployment and slow economic

0:08 growth at the same time as there is persistently high inflation.

0:12 None of these outcomes are ideal,

0:13 even individually, but when they all happen together,

0:16 they become one of the worst economic scenarios imaginable.

0:19 Something that can, and has in the past,

0:21 genuinely lead to years of economic struggle

0:23 or even the outright collapse of entire economic systems.

0:26 The heart of what makes this so bad is that the treatment

0:29 of these problems only makes the others worse, in theory anyway.

0:32 Low interest rates and lots of money printing can

0:34 pump up market activity and, at least on paper,

0:36 make growth look good for a little while,

0:38 but more money flowing into the economy will,

0:40 as we've seen firsthand, make inflation much worse.

0:43 Likewise, raising interest rates and taking money

0:45 out of circulation is also an option.

0:47 This should fight inflation,

0:48 but it will also lead to intense economic hardships.

0:51 Now, the good news is that there are

0:52 ways to unkind economy from this kind of knot,

0:55 but they require careful, considered, dedicated,

0:58 long-term planning and some short-term sacrifices.

1:02 So anyway, for better or worse, those sacrifices are also probably going to be

1:06 felt by almost everyone around the world.

1:08 Yes, the issue of stagflation is getting a lot

1:10 of attention in the US at the moment, but at least for the immediate future,

1:13 they have the luxury of exporting a share

1:15 of that inflation and stagnation out onto everybody else,

1:18 as the US dollar is still the world's default reserve currency.

1:21 This is also not to mention that a lot of other

1:24 countries are arguably further down this particular rabbit hole already anyway.

1:27 So, why is stagflation such a big problem?

1:30 Why has it become such a big problem right now?

1:33 And finally, what kind of sacrifices are typically needed to unstag and deflate?

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2:22 The central bank in the USA,

2:23 as well as most other central banks around the world to some extent,

2:26 have a dual mandate to maintain full employment and stable prices.

2:30 So, perhaps another reason why stagflation is considered

2:32 so scary by the Fed is that it's

2:34 failing both of the goals that give it reason to exist in the first place.

2:38 But even these simple KPIs need a bit of nuance because honestly,

2:42 economists have a habit of naming things terribly.

2:45 Full employment, as the name would not suggest,

2:47 is not the same thing as zero unemployment.

2:50 It is instead the lowest rate of unemployment that is considered sustainable.

2:53 If absolutely nobody in the economy is looking for a job,

2:55 that can actually cause just as many problems

2:57 as too many people looking for a job.

3:00 This will be really important later on, so try and remember it.

3:02 Likewise, stable prices don't actually mean prices not changing at all.

3:06 They instead mean prices increasing by a target of 2% per year,

3:09 a goal that was somewhat arbitrarily set back in 2012 by the Fed.

3:13 The idea is that a slow increase in prices incentivises people

3:15 to get out there and put their cash to good use,

3:18 either by investing it or just spending it instead of hoarding

3:20 it because money not doing anything will slowly lose value over time.

3:24 Now, those are the goals to remember while looking at the issue right now,

3:27 which is that even the Fed itself is quietly sounding the alarm

3:30 that the economy is on the precipice

3:32 of major problems with both inflation and unemployment.

3:35 So, what is going on to cause this?

3:37 Well, for starters, the numbers themselves right now actually look okay.

3:41 Inflation is above the arbitrary 2% target,

3:43 but it's down considerably from its pandemic peak,

3:46 and likewise, reported unemployment is up from last year,

3:48 but by historic standards, it's actually pretty good.

3:51 So, if inflation and unemployment are

3:52 both down considerably from where they were, say, four years ago,

3:56 is this just another case of economists predicting

3:58 20 out of the last three economic disasters?

4:01 Well, maybe, but those numbers themselves are

4:03 becoming one of the first major problems.

4:06 The USA just had its largest job numbers revision ever,

4:08 revealing that almost a million jobs have been overestimated in the economy.

4:12 These official numbers are getting more and more questionable over time

4:15 as fewer businesses and individuals are

4:17 answering surveys that they rely on, because, well, who answers surveys anymore?

4:21 On top of that, there has of course been some level of political

4:24 pressure for data-producing agencies to make the numbers look good or else.

4:27 We very often on this channel give a disclaimer when looking at national

4:30 economic statistics from countries like China that they may not be accurate.

4:34 Chinese economic objectives are set ahead of time,

4:36 and then provincial centres report their results relative to their goals.

4:40 Bureaucrats have been fired or promoted based on how

4:42 well their particular area of government is performing,

4:45 so it's no wonder that many economists suspect that there

4:47 has been systematic and persistent inaccuracies with their data,

4:50 which could compound over time.

4:52 But as much as we may not like to admit it,

4:54 the same kind of pressure could easily have the same

4:56 kind of results in a country like the USA as well.

4:59 And then, above all of that, even if the data was beyond reproach,

5:02 it still may not be telling the full story.

5:05 Unemployment may look decent as a singular number,

5:07 but that only measures the number of people

5:09 not in a job and actively looking for work.

5:12 It doesn't count labour force participation,

5:13 which has been trending down for more than two decades and includes

5:16 a lot of people that have just given up on ever getting a job.

5:20 It doesn't count under-employment for people who can't find a job in line

5:23 with their skills or experience and so resort to something like gig work,

5:27 and it doesn't count people who aren't getting enough work.

5:30 To qualify as employed,

5:31 people only technically need to do an hour of paid work within a week,

5:35 which may make the statistics look good,

5:37 but clearly isn't going to provide enough for a comfortable

5:40 life or make any meaningful contributions to the economy.

5:43 Inflation also has the same kind of measurement problems,

5:45 which can cause laggy or non-responsive results.

5:48 Things like shrinkflation and shitification and the fact

5:50 that housing costs are routinely underestimated means that even

5:53 though on paper the consumer price index is

5:56 only up by 30% over the past five years,

5:59 actual everyday budgets are routinely being stretched even further.

6:02 And it also ignores the bigger problem that even if

6:04 inflation does go back down to the 2% targeted range now,

6:08 that doesn't reverse the years where it was far higher than it should have been.

6:11 Now, these limitations are very important to understand,

6:13 but none of this by itself is anything new.

6:16 So then, why are economists suddenly so worried about stagflation now?

6:21 Well, for starters, there is a good chance that a lot

6:23 of this information is only just catching up with us.

6:26 As we mentioned earlier, a significant revision in jobs creation is a good sign

6:29 that the real employment number may not be as good as it seems,

6:32 even ignoring all of the problems of under-employment,

6:34 which have clearly gotten more widespread over recent years,

6:37 with the proliferation of the gig economy.

6:39 Economic growth is also becoming far more

6:40 dependent on an increasingly narrow set of industries.

6:43 Again, specifically in the USA, GDP growth has actually looked really good,

6:47 but that's been propped up by a lot of government spending,

6:50 a lot of big and probably not

6:52 very sustainable investments into AI and consumer spending.

6:55 However, all of those carry with them significant risks.

6:59 Obviously, US government spending relies a lot on US government debt,

7:03 which has arguably been a problem for the last two decades,

7:05 but might really be entering the find-out stage now.

7:08 New fiscal policy has lowered taxes significantly,

7:11 while spending has remained roughly the same,

7:12 even if it has been shifted around by cutting social programs,

7:16 but increasing spending on things like defence and border security.

7:19 Now, this isn't a straightforward budget issue because, of course,

7:22 the US government can always print more of its own money,

7:24 but that doesn't mean that people will value it.

7:27 Now, sometimes all of the technicalities of how governments move money

7:29 around distract from the simple supply and demand behind it all.

7:33 Taxes are the ultimate source of demand for a currency.

7:36 If people don't collect enough money to pay their taxes, they go to prison.

7:39 So, it's a pretty good demand driver.

7:41 Lowering taxes naturally lowers that demand,

7:43 and all other things being equal, lower demand equals lower prices.

7:47 Now, the price of a dollar will always be a dollar,

7:50 but if the assumption is that there will be

7:52 a lot more dollars floating around in the future,

7:54 their actual value of what they can be exchanged for will be lower.

7:58 Because of this assumption, people who lend money to the government will want

8:00 more interest to make up for that falling value,

8:03 or else they'll just go and buy something else right now.

8:05 This is already happening with major institutions and governments

8:08 opting for alternative currencies and even things like gold,

8:11 the holders reserves, instead of US government bonds,

8:13 which have an uncertain future.

8:15 This means that the US government will end

8:16 up paying higher interest rates for their borrowing,

8:18 which, with so much debt on their books,

8:20 will have a significant impact on the budget.

8:22 Already, the government is seeing that when

8:23 it goes to raise money by selling bonds,

8:25 it's finding it much more difficult to get enough buyers.

8:28 In the medium to long term,

8:29 governments around the world that have been in a similar

8:30 situation have had to resort to austerity measures,

8:33 which means drastically lowering spending and raising

8:35 taxes to start meaningfully paying off debt.

8:38 This would knock out one major component of GDP,

8:40 causing slowed or negative growth,

8:42 and it would also likely come with significant increases

8:44 in unemployment from laid off government employees and contractors.

8:48 The US has been able to get away with this for longer

8:50 than most other economies would have been able to, because

8:52 so many other countries use its currency for international trade

8:56 that it effectively gets free demand from its currency from everybody else,

8:59 not just its own people.

9:01 But, big international institutions and governments are not dumb.

9:05 They are watching a growing budget

9:06 deficit and erratic international policies and they

9:08 are reasonably surmising that this could make

9:10 their reserves less valuable in the future,

9:12 so it's better to get ahead of it now.

9:14 Stagflation is normally seen as a failing of the central bank

9:17 since controlling employment and price stability

9:19 is their sole reason for existing.

9:21 But in reality, it takes careful coordination

9:23 between fiscal policy enacted by the government and monetary policy carried out

9:26 by the Fed to effectively manage these variables,

9:29 especially when they are not going in the right direction.

9:31 Think of it like two synchronised hands being used to play a fine instrument.

9:35 The central bank can make large changes in the tempo of the economy,

9:38 but only the government has finer control

9:40 over specific aspects of how it's managed.

9:43 Now, this is always hard because politicians in particular don't

9:45 want to do anything that could cool down their economy,

9:48 even if it is in the best long-term interest of the nation,

9:50 because they run on short-term election cycles.

9:53 Unfortunately, this could also lead to a situation

9:55 where one hand is fighting the other.

9:57 The Fed is trying to rein in inflation

9:58 while the government is spending record amounts of money.

10:01 As a hypothetical example, look,

10:03 this happens all the time and most central banks are used to dealing with it.

10:07 They are appointed on much longer terms so they can

10:09 enact policies that won't be popular in the short term,

10:12 which is why it's really important that they stay independent.

10:15 Unfortunately, that's not really the situation today.

10:18 Today, the right hand of the Fed is trying

10:20 to play two different instruments at the same time,

10:22 while the left hand of fiscal policy is busy punching itself in the dick.

10:25 On the inflation side, inconsistent and let's be honest,

10:28 reckless trade negotiations have made

10:29 long-term supply chain management incredibly difficult,

10:32 which is hurting prices not only from the demand

10:34 side but also from the supply side too.

10:37 If there are less goods that make it to shelves,

10:39 naturally prices for those goods will rise and that's discounting the eventual

10:42 inevitability that tariff costs will be passed along to consumers as well.

10:46 Cutting taxes, especially for the highest-income owners,

10:49 is also likely to have long-term consequences because at the moment,

10:52 they're the only group driving consumption growth.

10:54 Consumption is the largest component of GDP in the USA and half

10:57 of that consumer spending is now done by just 10% of households.

11:01 If they pay significantly less taxes,

11:03 they can have more money to spend driving up inflation in very narrow markets.

11:07 Now, beyond the immediate social issues of already high-income owners

11:10 getting tax breaks at the expense of 90% of the population,

11:13 there are pragmatic economic problems as well.

11:16 Lots of people spending money requires lots

11:18 of employed people to process those sales

11:20 and if only a small share of the population is spending most of the money,

11:23 then naturally, fuel will need to be employed to serve those consumers.

11:27 Again, this isn't new by itself.

11:29 We actually made a video on the K-shaped

11:30 recovery where wealthy people will do really well

11:32 and everybody else will do really badly and the problems

11:34 that could cause over five years ago now.

11:37 The problem is that instead of managing those risks,

11:40 current fiscal policy is just turbocharging them.

11:43 This puts the Fed between a rock and a hard

11:44 place even more than they would be when facing stagflation because

11:47 different policies are going to have different impacts on different

11:50 parts of the wealth spectrum and the further they drift apart,

11:53 the harder those differences are going to be to manage.

11:56 For wealthy people and high-income earners,

11:58 the biggest impact that lower interest

11:59 rates will have is increased asset prices.

12:02 There are two general mechanisms that make this happen.

12:05 If interest rates are lower,

12:06 it's easier to borrow money to invest and simultaneously more rewarding.

12:10 Imagine a company that makes a profit of $10

12:12 million per year but is worth $100 million.

12:14 Assuming no capital gains,

12:15 that's a return on investment of 10%, which is pretty decent.

12:19 If interest rates were 5%, an investor could get returns twice as high

12:22 by making a riskier investment into this company

12:24 compared to just keeping their money

12:25 in a savings account paying the nominal interest rate.

12:28 If, however, interest rates dropped to 2.5%,

12:31 but the company was still making $10 million per year,

12:34 it could be worth $200 million while still providing

12:36 twice the rate of return of a secured savings account.

12:40 Now this is of course an incredibly oversimplified example,

12:43 but it's how these investment decisions are made.

12:45 Nobody is going to invest into a risky business when they could get

12:48 better returns in risk-free savings or bonds

12:50 and the lower the interest return is,

12:51 the more people are willing to invest in other forms of income.

12:54 Increasing asset prices primarily help wealthy people who own most

12:57 of the assets and gives them more money to spend, which,

12:59 as we have already seen, is not a problem since they are doing

13:02 half of the spending in the economy already.

13:04 For less wealthy households that don't have a stockpile of investable assets,

13:08 rising prices can make it harder for them to catch up,

13:10 especially in areas like housing.

13:12 The lower interest rates will help them a little bit,

13:14 but consumer debt tends to be overall

13:16 less sensitive to baseline interest rate changes anyway.

13:19 A marginal owner or a mortgage going

13:21 from 5% to 2.5% halves the interest expense.

13:24 A credit card going from 22.5% to 20% might help a little bit,

13:27 but not to the same degree.

13:29 And again, this isn't just a moral problem.

13:32 Crushing the majority for the benefit of asset owners can lower productivity.

13:35 That company from earlier that jumped from $100 million

13:38 to $200 million may have been great for existing investors,

13:41 but it was still producing the same total output.

13:44 So, higher prices and lower employment, that is stagflation.

13:47 And there's a good chance that the US is already there,

13:50 but changes in the nature of the economy

13:52 mean that they just haven't realised it yet.

13:54 So, then the question is, why is this such a cause for panic?

13:57 There are plenty of advanced economies with higher unemployment rates,

14:00 higher inflation and lower growth in the USA.

14:03 In fact, most advanced economies fall into this category.

14:06 So, why is it a headline worthy problem

14:07 for the US and not for a country like the UK?

14:10 Well, for starters, nobody wants to be like the UK right now.

14:14 They are more of an indication of where the US might be headed,

14:16 which is scary enough by itself.

14:18 The other thing is that the world relies on the US,

14:21 so them struggling with stagflation will probably

14:22 hurt a lot of other countries as well, even those that are already hurting.

14:27 If the stability of the US dollar evaporates over a short time frame,

14:31 that alone is a global crisis.

14:33 And then, of course, domestically,

14:34 there is the problem that there are less safety nets in the US

14:37 for people that are impacted by these economic

14:39 variables converging on their household budgets.

14:41 Now, we've made an entire compilation on all of the problems

14:43 these European countries are facing as a point of comparison.

14:46 That same kind of situation in the US

14:48 would have far deeper and wider consequences.

14:51 But you should be able to click that video on your screen now.

14:53 Thanks for watching, mate.

14:54 Bye.