Will stagflation return to Australia?

Stagflation Australia economy unemployment inflation rising prices
Stagflation is when both the inflation and unemployment rate is high and economic growth slows.

Stagflation.

It’s an ugly word and it is making something of a comeback at the moment as the latest wall of worry investors need to climb over if they are going to brave hitting the buy button.

But why has stagflation come out of the woodwork to scare investors and what does it even mean?

Simply put, stagflation is a nasty combination of a stagnating economy featuring high unemployment and slow economic growth coupled with rising prices (inflation).

We know all about the second bit – inflation – which has certainly been on the rise here in Australia and the rest of the world as prices are hit by a range of influences sparked by the COVID-19 pandemic.

Prices have been rising

Everywhere you look, from skyrocketing shipping costs to oil, consumer goods, cars and houses prices have been on the march and supplies have been interrupted by all sorts of pandemic caused problems from electronic chip and timber shortages to gummed up supply chains.

There are petrol shortages in the UK, blackouts in China and the price of oil has almost tripled, with gas prices also very high and coal prices hitting records as a colder than usual northern hemisphere winter takes hold.

All of those rising energy and oil prices feed directly into the prices of just about everything that is shipped.

Will growth return?

The stagnation part of the equation is simply the fear that economic growth which has been reduced by the pandemic might not spring back into life but rather stay anaemic as the effects of the pandemic slowly begin to wane.

For everyday consumers stagflation would be a total nightmare because jobs are less secure and hard to find, prices keep rising, wages are falling fast in real terms and economic growth has all but evaporated.

It is also a very difficult time to be an investor because it is hard to find the right mix of investments that can keep up with inflation and maintain purchasing power – let alone turn a profit in real (after inflation) terms.

Is a rerun of the 1970’s possible?

The best example of stagflation – which was a term first used by UK Tory minister Iain Macleod in 1965 – was the 1970’s oil shock when OPEC nations restricted supplies to many countries, sending prices of most goods soaring, generating high unemployment and pressure for large wage rises for those who kept their jobs.

While we have gone through some tough times since then – the GFC being one obvious example – stagflation has not really returned because recessions and rises in unemployment have generally been accompanied by low inflation.

The worry is – and here is why markets are talking a lot about stagflation again – that the peculiar circumstances of the pandemic have created the possibility of stagflation returning.

If you listen to the stagflation investment bears, the chronic supply shortages from the pandemic and the lack of consumer demand caused by restrictions will not snap back to “normal” conditions quickly.

Instead, the rising prices that we are already seeing will continue to get worse as central banks that have their eyes fixed on keeping interest rates low fail to react in time and let inflation get away from them.

Once the central banks do finally wake up to what is happening, according to the bears, they will start to jack interest rates up hard in a belated bid to try to beat down inflation.

Those who lived through the 1980’s will remember clearly when interest rates peaked at around 17% – an unthinkably painful level given the amount of household debt around in Australia at the moment.

Stagnation hasn’t happened yet

What is important to remember is that none of this last part is happening yet.

The pandemic has really skewed spending towards goods and away from services such as haircuts and holidays so it is not a terrible shock to see inflation higher.

As we have seen in Melbourne and Sydney, that is already changing as people flock back to get their shaggy locks tamed and scour the internet for the best local or international travel bargains.

This time last year Victorians were in a similar position after emerging from a long lockdown and economic activity bounced back very strongly as the shops re-opened and consumers started to spend their accumulated cash.

It is a very similar situation again and there is really no reason to believe that economic growth in Australia won’t return to a reasonable number.

That may not be a boom but the economy is unlikely to be stagnant – one of the pre-conditions for stagflation.

People are going back to work

The other reason to believe that stagflation won’t be returning anytime soon is that supply lines are starting to improve and people are returning to work.

While the pandemic might have changed many things, it has not destroyed things like the 1970’s oil shock did – the temporary restrictions on the supply of goods are likely to disappear over time and high prices are likely to flatten and then fall as supply catches up with demand.

It is always dangerous to rule any economic possibility out, but the extreme stagflations bears are very much in the minority at the moment.

One important thing that investors can do to keep an eye on the possibility of stagflation is to keep an eagle eye on inflation numbers, particularly in the US but also in Australia as well.

If they start to peak and gently come down over time then stagflation becomes highly unlikely.

If not, then it might be time to dust off some of those traditional stagflation investment favourites such as gold.

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