Inflation, Deflation, Stagflation: Weather the Coming Storm

Examining the debate over which economic force is most threatening America’s economy and how you can prepare

Fishermen and sailors have to be constantly on the lookout and prepared for changing weather. Smooth sailing can quickly turn into a fight to keep one’s head above water. Likewise, today’s breadwinners must be prepared for abrupt changes in the economy. Good times can quickly turn into recession; high-flying stock markets can crash; and as history clearly indicates, all bubbles eventually pop. Often, fat years are followed by lean years.

As economist James J. Puplava says, “Economic and financial conditions never remain constant. They are as seasonal as the weather. Forecasts change depending on the patterns that emerge.”

Financial meteorologists and prognosticators identify two looming, yet self-induced storm fronts threatening America’s economy—deflation and inflation. However, like climatologists trying to predict the weather, many disagree as to which poses the most immediate danger. Further, some identify a third and even more powerful economic storm brewing.

Although the fallout from these coming storms is predicted to be very different, their origins are similar.

Exploding Debt Levels

Like a downdraft of dense freezing air, virtually all levels of American society have become weighted down and pressured with debt. Personal, corporate, state and federal debt levels are all at or near record highs.

U.S. consumer credit debt hit an all-time high of $2.35 trillion this past August, soaring 80 percent since 2000. Home mortgage debt jumped 98 percent over that time. Similarly, the amount of household and mortgage debt as a percentage of disposable income is at its worst levels in over a quarter of a century. For the past two years, Americans on average spent everything they made and then some. During 2006, people spent 1 percent more than they earned. The only other time in history America’s savings rate was in negative territory for a full year was during the Great Depression.

In corporate America, debt has become so endemic that there are now more companies with “junk” credit ratings than there are with investment grade ratings, says credit rating agency Standard and Poor’s.

State and federal governments are also bursting with debt obligations. For example, New Jersey’s total debt has almost doubled over the past six years, from $15.2 billion to $29.7 billion. California is heavily indebted; New York, Massachusetts and Hawaii are all in the “danger zone” of debt, according to a Citizens Budget Commission report. Kansas’s state debt exploded from $420 million in 1992 to $4 billion in 2005.

Then there is America’s national debt, which is now a record high over $8.7 trillion. All told, according to the Federal Reserve Bank, Americans owe over $28 trillion in the domestic non-financial sectors—and that doesn’t include future government promises such as Medicare and Social Security—when those numbers are included the total debt soars past $60 trillion.

In contrast, the total value of all the goods and services made in America last year was only $13.2 trillion. The profit made on those goods and services was much, much smaller.

Deflationary Forces

This massive ocean of debt threatens to swamp America. Americans are so indebted that a slowing economy could create a nasty deflationary spiral, or so predicts one school of economic analysts. These analysts say that when the debt bubble explodes, deflation (a reduction in the money supply) will ripple through the economy. For workers, this means less money to spend, whether due to job losses, asset depreciation or other trouble. That is why debt is so dangerous. It doesn’t matter that you lost your job or that your house has no equity left in it—debtors require payment.

A declining housing market is a looming deflationary force. Market psychology has changed, and people are beginning to anticipate lower future prices. The incentive to make a quick purchase has disappeared. “Bids are drying up. Many potential buyers are simply waiting for lower prices. The word is that ‘it pays to wait,’” says economic analyst Richard Russell. Why buy a house today when you can buy it for less next month or maybe much less next year? A 5 percent housing decline would result in at least $1 trillion in lost home equity. That’s definitely a deflationary force—never mind all the lost construction, home supply and financing jobs that would be associated with a housing bust.

Wage pressures are also aggravating deflation. Foreign competition is putting pressure on consumers. Thanks largely to outsourcing, American workers have lost bargaining power at the wage table. In the increasingly globalized economy, corporations have the option to simply move operations to foreign low-cost countries. Consequently, many workers are having problems maintaining their current salaries, let alone bargaining for wage increases. The recent legislated minimum wage increase is proof that at least low-wage earners have little bargaining power. As wages lag and cost of living increases, it gets harder for consumers to make debt payments.

There is coming a time when the consumer will be tapped out, and the debt-fueled consumption binge will end. When it does, consumer confidence will be replaced with fear and eventually panic. This panic will result in increased asset sales and reduced spending as workers attempt to pay off their debts (or save their homes). Evaporating confidence will cause consumers to rethink current and future spending plans. The economy, hit with a lack of demand, will slow, corporate earnings will fall, stock markets will plummet, and layoffs will become prevalent. As more people enter the unemployment line, the deflationary spiral will intensify.

Information on the other economic storms brewing and on how to prepare for them will appear in future articles.