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Are We Headed for Stagflation? Examining the Economic Warning Signs

Are We Headed for Stagflation? Examining the Economic Warning Signs
May 14, 2024

The latest economic data continues to show stubbornly high inflation, with the Producer Price Index (PPI) up again in April according to the latest report. While pundits tout that rising retail sales show “the consumer is resilient”, we need to look beneath the surface.

Those retail sales numbers aren’t adjusted for inflation, so of course they are up – we’re all paying significantly more for the same basket of goods than a year ago. As regular Americans know from firsthand experience at the gas pump and grocery store, our dollars are buying less and less.

The uncomfortable truth is that real inflation, measuring the increased cost of living, has drastically outpaced the meager wage gains most workers have received over the past year. Our purchasing power is being steadily eroded.

This brings up the serious risk of stagflation – persistent high inflation combined with a stagnant economy and rising unemployment. We may already be entering the leading edges of this scenario.

Why Stagflation Is a Risk
On one side, the Federal Reserve is attempting to crush inflation by raising interest rates and tightening monetary policy. But working against the Fed’s efforts is the excessive money printing and deficit spending by the government and Treasury Department.

It’s a tug-of-war, with the Fed trying to let air out of the economic balloon through rate hikes, while the government keeps blowing air into the balloon through more stimulus and debt-funded spending. This fiscal and monetary policy conflict creates the toxic brew of stagflation.

As the Fed raises rates, it will slow economic growth. Businesses will have less appetite to expand and hire amid higher borrowing costs. Consumer spending will get crimped as the cost of mortgages, auto loans, and credit card interest rates all increase.

At the same time, the excessive money supply in the economy, exacerbated by more government deficit spending, will keep inflation elevated. We could end up in a situation of slow or even contracting GDP growth coupled with high inflation – the 1970s stagflation scenario.

Warning Signs to Watch
There are already some early warning signs in leading economic indicators that stagflation risks are rising:

– Housing markets are cooling rapidly amid higher mortgage rates, with home prices starting to decline in some areas
– The spike in delinquencies on auto loans and concerns about “sub-prime” auto debt
– Increased credit card debt delinquencies as consumers get squeezed
– Debt levels and servicing costs rising for businesses and consumers
– Reduced profit margins for companies facing higher input/labor costs
– Slowing manufacturing activity
– Negative real wage growth as inflation outpaces wage gains

The Fed may be cornered into having to decide whether to continue aggressive rate hikes to combat inflation, potentially grinding the economy to a halt and causing recession, or pausing and living with higher inflation.

Protecting Your Wealth
For investors, this potentially toxic economic environment requires carefully managing portfolio risks. Strategies like increasing allocations to inflation-hedging assets like commodities, TIPS, I-bonds, and some cryptocurrencies may make sense. It could also present opportunities in certain sectors like consumer staples and pharma that can maintain pricing power.

Most importantly, investors need to stay vigilant, follow economic data closely, and be prepared to pivot your investment strategy as conditions evolve. Stagflation is a risk that can not be ignored or dismissed lightly given the accumulating warning signs. Prudent preparation today could avoid wealth destruction tomorrow.

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