Stagflation is Here

War—after all, what is it that the people get? Why—widows, taxes, wooden legs and debt.

Samuel B. Pettengill

“Armies, and debts, and taxes are the known instruments for bringing the many under the domination of the few.

James Madison, 4th U.S. President (April 20, 1795)

“Let me issue and control a nation’s currency and I care not who makes its laws”.

Nathan Rothschild, 1791

Last summer, I observed that there was a “solvency crisis” underneath the ongoing subprime mortgage liquidity squeeze. Central banks can alleviate a “liquidity crisis”, but they cannot solve a solvency crisis.

Last year also, before the events, I warned that the U.S. was heading toward stagflation.

This was due to three fundamental factors.

First, the structural fiscal imbalances of the federal budget in a period of prosperity, as a result of the Bush-Cheney administration’s continuous deficit spending linked to the Iraq and Afghanistan wars and to its large tax cuts;

Second, the over-indebtedness of the overall U.S. economy coupled with an overall saving rate close to zero (in 1981, it was 12 percent), and, as a consequence, the rapidly increasing foreign debt of the U.S.; and,

Third, the required decline in the U.S. dollar to reverse and correct the deteriorating American balance of payments. The second factor was a harbinger of less consumer spending in the coming months while the third factor would stoke the fire of overall inflation. And with already high budget deficits, there would be less leeway for an aggressive fiscal policy to sustain economic activity. The table was thus set for a bout of stagflation, i.e. slow growth and rising inflation.

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