July 20, 2008

STAGFLATION

Adapted from "Don't Believe the Fearmongers"

There is stagnation when the economy slows down, and inflation when the economy speeds up. It is no wonder therefore, that folks get a bit confused when both conditions occur simultaneously to create stagflation.

Such was the case last week when the U.S. Treasury bailed out two other government operations organized 38 years ago to encourage and protect home loans.

They are the Federal National Mortgage Association (FNMA - “Fannie Mae”) and the Federal Home Loan Mortgage Corporation Act (FHLMC - “Freddie Mac”).

Food and energy prices ticked up sharply this month while employment and home prices sagged.

The Stock Market – forecasting the future six months hence – wobbled here and abroad.

CARTER’S TERM

The term “stagflation" was coined during President James Carter’s administration in the early 1980’s to describe economic stagnation coupled with price inflation.

Paul Volcker
Adapted from Bloomberg.com

To cope with high prices of housing and food, Carter appointed Paul Volker chairman of the Federal Reserve Board.

Volker raised the bank discount rate – the charge to banks loaning money to each other – from 10 percent to 12 percent.

Immediately the “prime rate” to ordinary borrowers hit 21.5 percent -- the highest in government history. This led to a sharp “Carter recession” and long lines at gasoline pumps for which he was blamed.

The economic downturn shook out the bad bank loans, but Carter has been forever blamed for the economic recession that followed.

FEDERAL RESERVE

The Carter years experience with home loans has been well studied by Federal Reserve Chairman Ben S. Bernanke.

Last week he told a House of Representatives Financial Services Committee that Fannie Mae and Freddie Mac are functioning well.

Ben Bernanke
Adapted from Market Oracle

“They are adequately capitalized at this point,” said Bernanke. “We need to restore that confidence so they can have the financial strength to not only be solvent – which they are – but to be proactive in strengthening our mortgage markets.”

He acknowledged that inflation was a ‘mounting concern’ – especially in prices for crude oil, food and other commodities directly affecting consumers.

Prices are up 5.5 percent for the first half of this year – up from 4.1 percent last year.

The Bureau of Labor Statistics expects consumer price increases will double for the year.

OIL AND FOOD COSTS

Except for petroleum and food, costs are relatively mild. Housing costs are declining through the financial shakeouts mentioned above.

The biggest mistakes still spooking us are those linking food and energy. It is stupid to divert corn into ethanol for the few passenger cars equipped to handle it.

Most trucks and family chariots require petroleum for propellant.

The first priority for corn is food for people -- and for cattle and hogs for people to eat.

Energy for vehicles and heating houses must come from the endless supply of oil and coal we have on hand.

Which means we must follow the advice of former House Speaker Newt Gingrich: “Drill here. Drill now. Pay less.”

By Lindsey Wilger Williams, retired newspaper publisher and syndicated columnist