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What is Stagflation?

Tyler Beachler November 01, 2021

Inflation has been a major headline in 2021. The economy has roared back, money supply has increased dramatically, and we are currently dealing with supply constraints leading to higher prices for goods. There have been a lot of terms thrown out describing the inflationary environment we are in, but one that seems to be attracting the headlines is stagflation. We will walk through what this means, provide some historical context, and evaluate if this is applicable to what we are seeing today.

Stagflation is the term used to describe an economy that has stagnate economic growth while having higher inflation and higher unemployment. Stagflation can be seemingly contradictory as stagnate economic output leads to higher unemployment, which normally should not lead to rising prices as economic demand falls. For the most part stagflation is rare, in fact we have not seen a stagflation type period for almost 50 years. We have to go back to the 1970’s to find a true stagflationary period.

In the mid 1970’s, inflation reached double digit growth due to loose monetary policy, but especially because of the oil embargo that occurred in 1973. Tensions in the Middle East led to the oil embargo which ceased U.S. oil imports and led to oil production cuts. This resulted in the price of oil nearly quadrupling in a very short period of time. Lines at gas stations were extremely long as people waited hours just to fill their gas tank. This crippled economic growth and demand sending the U.S. into a recession shortly after this extreme supply shock. As we have seen the price of oil and other commodities rise in 2021, it raises the question are heading for 1970’s inflation and lower growth?

This year we have witnessed our own supply issues with clogged ports and supply capacity being slow to ramp back up resulting in bottlenecks and price pressures. We think this is where the similarities end. The increasing inflation that we have witnessed this year has largely been driven by the restart of the economy and expansion of the money supply rather than a scenario like 1973 where the price of oil was driven by an extreme supply shock. While Q3 real GDP growth came in at a modest 2.0% annual rate, it comes after growing at 6.5% during the first half of the year. By no means are we in a stagnate or declining economy. We believe this growth has room to run and that supply will eventually increase to meet demand whereas in the 1970’s you had demand decreasing to meet supply.

We don’t see 1970’s style stagflation being the case for today, but this does not mean that inflationary pressures are going away. We do see short term supply issues eventually getting resolved, but, as we have discussed in previous writings, the amount of stimulus and the enormous growth of the M2 money supply (up nearly 36% since Feb. 2020) will lead to some persistent inflationary pressures. We don’t believe these pressures will derail our economic growth prospects, but it will be key to watch how central banks manage these pressures. If inflation runs hot for too long causing central banks to aggressively tighten policy, this could pose a risk to markets. We don’t believe this risk is at the door but it is one that we will be closely monitoring.

For the latest updates on our economic and market commentary, please see our Private Client Letter, and be on the lookout for our 2022 Outlook coming in January 2022.

Tyler Beachler

disclosure

THIS COMMENTARY HAS BEEN PREPARED BY CLEARWATER CAPITAL PARTNERS. THE OPINIONS VOICED IN THIS MATERIAL ARE FOR GENERAL INFORMATION ONLY AND ARE NOT INTENDED TO PROVIDE OR BE CONSTRUED AS PROVIDING LEGAL, ACCOUNTING, OR SPECIFIC INVESTMENT ADVICE OR RECOMMENDATIONS FOR ANY INDIVIDUAL. ALL ECONOMIC DATA IS DERIVED FROM PUBLIC SOURCES BELIEVED TO BE RELIABLE. TO DETERMINE WHICH INVESTMENTS MAY BE APPROPRIATE FOR YOU, PLEASE CONSULT WITH US PRIOR TO INVESTING. INVESTING INVOLVES RISK WHICH MAY INCLUDE LOSS OF PRINCIPAL.

This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities, insurance products, or to adopt any investment strategy. The opinions expressed are as of the date of writing and may change as subsequent conditions vary. The information and opinions contained in this material are derived from proprietary and nonproprietary sources deemed by Clearwater Capital Partners to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. Past performance is no guarantee of future results. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this material is at the sole discretion of the reader. Investment involves risks. International investing involves additional risks, including risks related to foreign currency, limited liquidity, less government regulation and the possibility of substantial volatility due to adverse political, economic or other developments. Index performance is shown for illustrative purposes only. You cannot invest directly in an index. S&P 500 is a registered trademark of Standard & Poor’s Financial Services, a division of S&P Global (“S&P”)  DOW JONES, DJ, DJIA and DOW JONES INDUSTRIAL AVERAGE are registered trademarks of Dow Jones Trademark Holdings (“Dow Jones”). The two main risks related to fixed-income investing are interest rate risk and credit risk. Typically, when interest rates rise, there is a corresponding decline in the market value of bonds. Credit risk refers to the possibility that the issuer of the bond will not be able to make principal and interest payments.

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