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U.S. Headed for Stagflation

Robert N. Barone

NEW YORK (TheStreet) -- In April, the IMF lowered growth estimates for every industrial economy except Japan, where Abenomics (essentially, monetary and fiscal policies even more stimulative than those of the U.S.) was being praised as a godsend after more than 20 years of deflation.

Since then, markets in Japan have been having second thoughts as to the effectiveness of Abenomics, and, as of June 21, the Nikkei had fallen by more than 15% from its peak on May 22. Europe remains in severe recession, and the BRICS (Brazil, Russia, India, China and South Africa) are experiencing significantly slower growth.

Slow Growth in the BRICS

The IMF assigned an 8% growth rate to China. But all of the ancillary indicators (falling Australian commodity exports, excess shipping capacity in the region, and low and falling commodity prices including copper) portray an economy with much slower growth.

On Friday, in a Bloomberg TV interview, Marc Faber (of GloomBoomDoom.com) remarked that China's growth rate was, at maximum, 4%. Remember, China has been the world's economic growth engine for the past five years.

In Brazil, there are protests over falling living standards. According to BCA research, protestors are "demanding everything from lower bus fares and less corruption to a new political system." BCA indicates that the government misdiagnosed the economy's growth capacity (i.e., supply side economics). They followed stimulative U.S. type fiscal and monetary policies that failed to stimulate economic growth, but did manage to stimulate a significant level of inflation.

Nearing the End Game

As a result, it isn't any wonder that top-line revenue growth in the multinational corporations has stalled. That, and the market-induced backup in interest rates since the end of May, can't be good for near-term economic growth. It is really hard to come to any other conclusion except that we are bearing witness to the failure of Keynesian demand side fiscal and monetary stimulus? As of the end of last week (June 21), the uncertainty as to how this will all end was quite evident in all of the trading markets. So, how will it end?

Is Brazil the Model?

Let me suggest that Brazil could be the model. In the U.S., there is growing evidence that, despite a 7.6% U3 unemployment rate, labor markets are tight.

There are growing job openings and a mismatch of needed skills, falling new weekly claims for unemployment insurance and rising voluntary quits. Besides the tight labor market, for the past five years, firms have been unwilling to reinvest in themselves, choosing instead to hoard large volumes of cash.

As a result, capacity issues could constrain the rate of expansion of real physical output. David Rosenberg, of Gluskin-Sheff, indicates that he believes that noninflationary potential economic growth in the U.S. is between 1% and 2%, as opposed to the 4% view held by those who control economic policies. If correct, the U.S. is currently at or even above its noninflationary growth rate.

The Inflation Recognition Problem

Furthermore, due to the adoption of twisted logic that now welcomes inflation, early warning signs are likely to either be ignored or praised. Inflation is a lagging indicator, which compounds the recognition problem. Over the past year, while the core inflation rate in goods (CPI) has been -0.2%, the inflation in the dominant service sector has been 2.3%. We should recognize that there are measurement issues that bias these inflation measures to the downside.


One logical conclusion for the U.S. is that current monetary and fiscal policies, which are aimed at demand stimulation rather than supply-side capacity issues, could result in today's Brazilian style stagflation.

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