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Stagflation: Stagnant economy, rising inflation

22 Jun 2022

Stagflation | VI

Inflation, hyperinflation, and now “stagflation” – the fear of facing these seemingly related words is here and is real.

What in the world is stagflation though? Why are economists too occupied with defining these terms? Why do they share a common root word: inflation? Should you be scared? How do you protect yourself and your money?

Stagnation + inflation

Perhaps the easiest way to define stagflation is this: it is a portmanteau of two words – ‘stagnation’ and ‘inflation’.

Stagnation is a period where there’s a lack of “activity, growth, or development”. An economic meltdown, if you must. This is often characterised by high unemployment rates coupled with the rate of increase in the output of goods and services.

Inflation, on the other hand, is the rapid increase in prices or the decrease in the value of money. Today, inflation is at more than 7% in the US and Europe, increasing the fears that stagflation is coming.

When stagnation and inflation happen at the same time, that’s what economists refer to as stagflation. And it is worrisome, given the fact that these two phenomena typically move in opposite directions.

Imagine if unemployment is extremely high in your country, and then the prices of goods and services are also sky-high. How would consumers then afford to buy their basic needs?

Now you see why stagflation is also synonymous with an economic malfunction.

What happened, what’s happening

The word stagflation has already been used several decades ago, although there were economists who didn’t think it could actually happen. There are also a couple of assumptions on who first coined the term but let’s not delve into that.

There was one recorded occurrence of the first “stagflation” in the world. During the 1970s to 1980s, inflation rates rose. Oil prices were sky high, even reaching 300% within a year. This was due to OPEC (Organisation of the Petroleum Exporting Countries) cutting off oil exports to the US, UK, and other countries in support of Israel.

When oil prices go up, the tendency is for consumer goods to also be affected. With all these going on, companies had to take action. Specifically, they had to lay people off.

It’s not a secret how the global economy strived to survive in the past couple of years due to the pandemic.

Last year, we saw the economies doing a rebound. Yet, given the still tumultuous supply chains, the high consumer demand wasn’t exactly met as anticipated.

As a result, prices went up. This was even intensified when the Russia-Ukraine conflict started and energy prices surged. We haven’t even touched on the unsolved unemployment rates yet.

And as inflation becomes more painful, the US Federal Reserve and the Bank of England increased the interest rates, all the more adding to the blow as this would further slow economic growth by discouraging borrowing.

Why stagflation happens

As mentioned above, the main causes of stagflation are poor macroeconomics. But surely there are triggers, you might be thinking.

There are, but they remain assumptions. As stagflation is a rare event, with only one evident huge occurrence in the past (as mentioned above), its exact cause couldn’t be pinpointed.

Some say it’s due to oil shocks, like what happened in 1973. Some, however, blame it on poor economic policies, i.e., when former US President Richard Nixon put tariffs on imports and froze wages and prices in an attempt to prevent inflation, which at first glance is a sensical thing to do, but actually when these regulations were lifted, the economy fell into a state of shock.

Its impact

Stagflation's Impact | VI

Stagflation will affect not just impact emerging economies but also developed ones.

Of course, the risk is higher for developing countries as they rely on other countries to sustain economic growth. When stagflation happens, these countries will have very select options to export their products to, thereby, affecting their local economic outlook.

Moreover, countries considered ‘emerging economies’ like India and China won’t get a lot of foreign investment, which then could lead to a debt crisis.

Developed nations such as the US and Japan will also be affected. A lot of people will lose employment. Consumers will find it difficult to live the life they’re used to, as prices will go up but their salaries will remain the same, if not reduced.

The solution

To address stagnation is simple (of course not), but the most obvious way for it to be resolved is to eliminate inflation and to deal with unemployment “naturally”. It is believed that the market recovers faster from high unemployment rates as compared to rising prices due to inflation.

But these two don’t come easy. Individual taxpayers and retail investors like ourselves cannot do anything. We need to rely on central bankers to help get us out of this mess.

But this, too, is difficult as well since the only feasible thing these bankers, i.e., the Federal Reserve, can do is increase interest rates to keep inflation manageable, say about 2%. When it does this, however, the economic growth will be negatively affected.

One word: we’re stuck.

So, guess what? The most viable solution to stagflation is to avoid it. Yes, ‘prevention is better than cure’ applies to economic problems, too. Still, we are in no way saying that avoiding this can be done with closed eyes as the factors that contribute to it are related to each other.

Individually though, we can arrange ways to prepare for what’s to come. If you don’t know yet, a situation like this is anticipated by some of the world’s wealthiest as it provides them the most ideal time to invest their money.

The rationale here is the fact that stocks, as an investment tool, are often sold undervalued in the market, therefore, investors can easily go in and purchase fundamentally strong and stable companies, have a high margin of safety, and then sleep soundly while waiting for their investment to make profits.

If you want to know more about stock market opportunities to outrun inflation, feel free to join our free two-hour masterclass.