Why I Expect Serious Stagflation

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When doing interviews for my new book on the Great Depression, a natural question comes up: will the present crisis turn out as bad as the 1930s?

My standard answer is typical for an economist: "yes and no." On the one hand, there were very specific reasons that unemployment broke 25 percent in 1933, and we don’t have those factors in place today. So I don’t think the official unemployment rate will get anywhere near that catastrophic level, though it could very well come in at the #2 spot in US economic history.

However, even though unemployment rates will not be as severe, I still predict that we are in store for a miserable decade of economic stagnation. Given all of the huge assaults of the federal government into the private sector in just the past six months, I frankly don’t understand how anyone except true believers in Karl Marx can be seeing "green shoots."

What is perhaps worse, laid on top of the stalled output in goods and services, I predict Americans are in store for the worst price inflation in US history. Just as stagflation referred to the combination of high unemployment and price inflation rates in the 1970s — something Keynesians thought was impossible — we can use the term hyperdepression to refer to the mix of hyperinflation and a serious recession in real output. In the remainder of this article I’ll explain my pessimistic outlook.
Why Did Unemployment Hit 25% in the 1930s?

The single biggest blunder Herbert Hoover made was insisting that businesses maintain wage rates after the stock-market crash in October 1929. Hoover adhered to an "underconsumptionist" theory of the business cycle, in which a small shock to business could end up cascading into a full-blown depression if market forces were left to their own devices. In Hoover’s view, the worst thing businesses could do in 1930 would be to slash wage rates, because then workers would have even less money to buy products; there would be a downward spiral into oblivion.

The problem was that the United States was still on a gold standard, and so the Fed couldn’t inflate the economy with new paper money with reckless abandon (the way it has done in subsequent recessions). When Americans began panicking and pulling their money out of the banks, the overall quantity of money (measured by aggregates such as M1 or M2) fell sharply, declining by about a third from 1929 to 1933.

Because of the shrinking money stock as well as people’s desire to hold larger cash balances, prices in general fell substantially as well, falling at an annualized rate of more than 10 percent for portions of the Hoover years.

This is why Hoover’s high-wage policy proved so disastrous. With everything except labor getting cheaper by the month, unemployed workers found it difficult to re-enter the work force. With sales and revenues plummeting, no employer wanted to hire workers at the same wage rate prevailing at the height of the boom in 1929. Because Hoover insisted that wage rates stay the same, even though the market-clearing wage rate was falling with productivity and general prices, the result was larger and larger unemployment. This is Econ 101.

In our present crisis, we don’t need to worry about unemployment rates hitting 25 percent. Even though federal policies will reduce labor productivity, and even though Obama’s pro-union policies will exacerbate "wage stickiness," over the next few years I predict large price inflation that will tend to mitigate these factors. In short, most workers will still be able to find jobs, because Bernanke’s running of the printing press will ensure that their paychecks don’t buy very much at the stores. Consequently, it won’t be as difficult for employers to justify taking on people laid off from other firms, compared to the situation in the Hoover years.

Why Real GDP Will Stagnate

I am not going to be foolish and give annual rates of projected real GDP growth; let me simply summarize my view by saying that the economy will be in the toilet for a decade. (Consult another economics PhD for a precise translation of those terms.)

I really don’t understand how even some free-market analysts on CNBC and the like can talk about the recession ending this year, or who speculate that we’ve finally "hit rock bottom." If they really believe that, then I wonder why they spend so much of their careers praising free markets and blasting socialism? If all of Bush’s and now Obama’s enormous interventions only yield a few quarters of a moderately bad recession, then what’s all the fuss about?

We have all been desensitized to the federal power grabs, because they have been so sudden and so sweeping. The human mind is able to adapt to any new environment fairly quickly.

Read the rest of the article

Bob Murphy [send him mail], adjunct scholar of the Mises Institute, is the author of The Politically Incorrect Guide to Capitalism, The Human Action Study Guide, and The Man, Economy, and State Study Guide. His latest book is The Politically Incorrect Guide to the Great Depression and the New Deal.

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