Welcome to ‘Bear Market Stagflation’ and a Crummy Economy

Stagnation, inflation, and a declining stock market will align to cut growth

People go Black Friday shopping in Macy's in New York City, on Nov. 26, 2021. Brittainy Newman/AP Photo

Commentary

Netflix’s announcement this week that it had lost 200,000 subscribers should sound a warning on the real costs to the economy of continuing high inflation. I suspect Netflix is just a canary in a coal mine: a warning of bad times for us all, not just binge-watching couch potatoes.

With consumer price inflation at 8.5 percent, consumers whose wages haven’t caught up are planning to make appropriate cutbacks. A CNBC/Momentive poll of Financial Literacy conducted March 23–24 found that 35 percent of respondents have canceled a monthly subscription and 36 percent said they would consider doing so if higher prices persist. Subscriptions, obviously, include one to Netflix.

But the cutbacks among the spectrum of other consumer discretionaries are even worse. More than half of respondents said they have, or would, cut back on dining out. Around 40 percent said they had, or would, reduce driving, which aligns almost perfectly with the 40 percent who say they will cut vacation plans if inflation continues.

Consumer spending is almost always the largest single component of GDP. In 2021, the category of “Food service and accommodations” within consumer spending—the restaurant meals and vacations that Americans say they will cut back—accounted for more than 1 percentage point of the average 5.5 percent of average quarterly 2021 GDP.

What’s more, “Food service and accommodations”—restaurants and hotels—traditionally make up the largest number of new monthly jobs, albeit at the lowest wages, as seen in our monthly jobs reports. If Americans cut back on spending in those categories, the jobs numbers will decline which, in turn, will likely reduce the consumer confidence that propels consumer spending on discretionaries.

While spending in the food service and accommodation area of GDP is the most likely to be cut, based on the survey, it’s important to note that inflation will affect spending in all categories of spending, including consumer staples such as housing, clothing, and transportation.

At the same time, the rising inflation has caused Federal Reserve observers to predict the Fed will raise the federal funds rate, the rate at which banks lend to each other overnight, to as much as 2.25 percent, to further impinge spending. Debt service as a percent of disposable income is already increasing and, with higher interest rates, will increase even more, choking off even more of the spending on goods, services, and investments that comprise GDP.

The Fed rate hikes will also, of course, adversely affect home buying and reduce the amount of mortgages Americans can “buy.” In March, I explained how the interest rate hikes from the Second Quarter of 2020 to those that were in effect last month would dramatically alter how much a buyer could afford now; from $322,600 then to just $283,238 last month—12 percent less.

With Fed rate hikes in the offing, prospective home purchasers will be able to purchase even less and, with that, they will need less carpeting, less furniture, and less “stuff” to furnish their new home. If they try to upsize and pay more mortgage carrying charges than they can comfortably afford, they’ll have less disposable income after paying their mortgage to spend on other things.

Economists in the 1970s coined a term for this phenomenon, where inflation leads to a slowing or stalled economy: They called it “stagflation,” a portmanteau of the words “stagnation” and “inflation.”

But I fear now that “stagflation” may not be the right moniker for what lies ahead. Just as the bell bottoms, platform shoes, and polyester leisure suits of the 1970s wouldn’t be fashionable clothes for today, neither is stagflation suitable for our coming economic woes.

That’s because, after nearly 14 years of the Fed’s near-zero interest rate policies, there will be another knock-on effect to further reduce consumer spending: the Wealth Effect.

Simply put, the Wealth Effect assumes that people who have more wealth tend to spend more. But the opposite is also true: As people see their wealth erode, they tend to watch their spending more carefully and cut back on discretionary spending.

As interest rates rise, equity prices tend to decline as money moves into more risk-averse bonds that pay greater returns. (We saw an example of it with the April 22 “flash crash” of the Dow, which took the index down 2.82 percent and more than 981 points, its worst decline since October 2020.)

When consumers look at their 401(k) plan statements or their stock portfolios in the coming months, they will likely see an erosion of their wealth that will tend to discourage discretionary spending. Vacation plans may be cut back or canceled altogether. That new Lexus will look less appealing. Dinner out is more likely to be a Denny’s than that fashionable bistro everyone is raving about.

And all those reductions in spending will tend to further slow GDP and drive stock prices further lower.

So, I propose we update the 1970s “stagflation” vernacular to a more descriptive new phrase; one that adds an adjective that takes account of the decline in spending in GDP that will occur as the Fed raises rates and stifles the values of stocks. I say add an adjective to the portmanteau and call this new era, “Bear market stagflation.”

Whaddya think?