Andy Xie: Here Come the 1970s

I recently posted on the idea of stagflation, stagnation coupled with inflation. I cited the examples of Wiemar Germany and Britain in the 1970s as comparisons for the U.S., which I believe is in greater trouble than the U.S. of the 1970s, and wrote:

The point is, we can have inflation and it still doesn't solve the economic problems, which take time to work out. A deflation will wipe out the problems swiftly. People with too much debt will lose some property, businesses fail, and unemployment jumps. It will also allow for a quick recovery because the assets will move from the inefficient to the efficient. Low prices will lead to value buying, and prices will have natural support at the bottom. Instead, the government is desperately trying to inflate the economy. This allows the inefficient structure of the economy to live another day, another year, perhaps another decade. The transition will be long and slow, but high inflation and currency crises means the pain could last longer. For politicians, however, the only worry is the next election.

I finished that post by saying I believe deflation remains my expectation until the evidence says otherwise. In Andy Xie's latest, Stimulate Away Our Imbalances? Dream On, he makes the case for stagflation and echoes my comment above about inflation allowing the inefficient economic structures to survive:

Chrysler's bankruptcy won't solve the industry's problem. The U.S. government intends to use the process to force the company's creditors to accept an 80 percent write-down on their debt holdings. After wiping out shareholders 100 percent and debt holders 80 percent, the company seems able to survive. However, it will survive because of capital subsidies, which puts pressure on other producers that have the same financial burden. It starts a vicious cycle that forces other automakers down the same path.

The bottom line is that the global overcapacity is equal to U.S. sales times two. Supply and demand are roughly balanced if two of the three U.S. automakers shut down for good, neither restructured nor revitalized. However, it doesn't look like that will happen. The political process seems to be wiping out shareholders and bondholders first, and using taxpayer money next to keep an over-bloated industry alive. The industry will destroy capital for years. When governments subsidize electric cars, more money will be wasted. If you invest in the auto industry, you will likely lose.

In a desperate effort to boost auto demand, car owners in Europe and the United States are being offered incentives to buy new and junk the old. This is just advancing future demand. It reduces pressure for the auto industry to restructure and extends the problem over time. The auto industry is an example that current economic difficulties can't be overcome by stimuli, and governments are not yet on the right path.

Finally, he lays out the case for stagflation:

As governments and central banks around the world try to resolve structural problems with stimuli, the global economy is probably heading toward stagflation. Despite exceptionally weak demand, oil prices have been rising. The current price of more than US$ 50 a barrel cannot be justified by supply and demand. Rather, prices are being driven by the withholding of financial supply and demand. Money has been flooding into exchange traded funds that buy oil futures. Oil exporting countries are cutting production; they think it's better to keep oil in the ground than exchange it for paper currencies that could devalue precipitously. Rising prices for oil and other commodities, driven by inflation expectations, could trigger inflation in 2010 despite a sluggish global economy. We could be witnessing a replay of the 1970s.