Here Comes Stagflation!

By: Sy_Harding

It’s official. The U.S. economic recovery is stumbling again, as indicated by Thursday’s report that GDP growth plunged to only 1.8% in the 1st quarter (from 3.1% growth in the previous quarter). And spiking oil, food, and other commodity prices have inflation on the rise.

Don’t lose sight of how we got here.

Exactly a year ago the recovery from ‘The Great Recession’ of 2007 – 2009 also stalled significantly as the government’s stimulus efforts, including rebates to homebuyers and cash-for-clunkers programs, expired. Economic reports from the housing industry, auto sales, and consumer spending were the leading indicators that the recovery had stalled, which was then confirmed when the 2nd quarter GDP report was released and showed economic growth had slowed from 3.7% in the 1st quarter to only 1.7% in the 2nd quarter.

At that point, the Federal Reserve seemed to panic, concerned the economy might be dropping back into a double dip recession. It began promising another round of stimulus, and then followed through by flooding the financial system with another dose of easy money via its current QE2 program.

That did the trick. The economy (and stock market) began to recover more strongly again. By the 3rd quarter of last year GDP was growing at a 2.6% rate, and then at a 3.1% rate in the 4th quarter. That was still well below the 5.0% growth of the 4th quarter of 2009, but promising.

However, over the past few months indications have been that the economy is stumbling again, and that it is due to the return of a number of the same issues that dampened growth last spring - along with a few new worries.

The early signs were again the return of dismal reports from the housing industry and consumer spending in January and February, accompanied by another inflationary leg up in oil, gasoline, and food prices.

And, as happened last year, those early signs have now been confirmed by Thursday’s report that GDP growth plunged to just 1.8% in the 1st quarter of this year, from 3.1% in the 4th quarter of last year.

It shouldn’t have been a surprise. Economists have been in a frantic race over recent weeks to revise their forecasts for 1st quarter growth downward. At the beginning of the quarter the forecasts were for 4% GDP growth for the quarter. Over the last two months the consensus forecasts dropped to 3.5%, then 3.0%, 2.5%, and last week to an average of 2.0%.

As noted , the actual number came in even lower, at just 1.8%.

With the negative economic reports, and rapid downward revisions of U.S. GDP forecasts by economists nationwide, and even globally, the first question is why did the Federal Reserve apparently not see the economy slowing?

In its statement after its FOMC meeting in March the Fed said, “The economic recovery is on firmer footing, and overall conditions in the labor market appear to be improving gradually.”

In its statement this week, after its April FOMC meeting, it said, “The economic recovery is proceeding at a moderate pace and overall conditions in the labor market are improving gradually.”

The Fed’s statements this week regarding inflation indicate it is also behind the curve in that regard as well.

Last spring’s economic slowdown was exacerbated by the spike-up in the price of oil from $72 a barrel in February to almost $90 at the end of April (a high not seen again for 7 months), which was taking spending money out of consumers’ pockets. And central banks around the world began raising interest rates to fight back at the food and energy inflation they were seeing coming at them.

But the U.S. Fed said it saw no inflationary problems.

And in its statement after its April FOMC meeting this week, even as oil prices have spiked from $84 a barrel in February to $112 a barrel, food prices have risen further, companies have begun passing their higher costs along to consumers, and central banks around the world have been aggressively raising interest rates even higher to fight back at worsening inflation in their countries, the Fed said, “Inflation has picked up in recent months, but longer-term inflation expectations have remained stable, and measures of underlying inflation are still subdued.”

As it did a year ago, gold, the historic hedge against inflation, spiked up in reaction to the statement, this time jumping a big $24 an ounce, apparently believing the Fed is even further behind the curve on inflation.

Regardless of what the Fed says, the reality is that, as the GDP report clearly reveals, economic growth has stalled again, even while the Fed’s QE2 stimulus program is still in full effect (but will expire in June).

And if gold and global central banks are to be believed, an inflationary spiral has been underway for more than a year.

It does look like the Fed is getting itself into a stickier mess all the time, that if nothing is done the economy seems headed into that 1970’s double-whammy nightmare of stagflation, a stagnant economy with rising inflation.

Sy Harding is president of Asset Management Research Corp, publishers of the financial website www.StreetSmartReport.com, and the free daily market blog, www.SyHardingblog.com.

© 2011 Copyright Sy Harding- All Rights Reserved

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