Stagflation could hit the US - Trump's tariffs could worsen the difficult economic situation
The United States economy is showing signs of stagflation, with rising inflation and a slowing labor market. This could create problems for consumers and investors, driving up prices and reducing profits.
Stagflation could return to the US after nearly 50 years, as the latest economic figures point to a slowing job market and continued stagnation in inflation. President Donald Trump's new tariffs will not help improve the situation.
This risks creating a very difficult environment for consumers. Unemployment could rise and wage gains could slow, even as the cost of living rises. Getting a new mortgage or car loan would also cost more.
What is stagflation?
Stagflation occurs when the economy slows or contracts, unemployment rises, but prices continue to rise. It is a problem that first emerged in the 1970s and remains a challenge for government officials, and especially central banks, because the usual policy package does not work well.
Inflation is usually caused when the demand for goods and services increases faster than the supply. The policy response is normally to slow the economy, something that since the 1980s has meant raising interest rates. In stagflation, higher interest costs can reduce price growth, but they can also cause or worsen a recession.
The causes of stagflation are not entirely clear. In the 1970s, OPEC imposed an oil embargo on many Western countries for their support of Israel during the Yom Kippur War. This created a structural price shock that was reflected in the economy, which was not effectively addressed by the government of the time.
What are the warning signs?
Two trends in the current economy point to this problem: jobs data that has been weakening and inflation that has risen more than expected.
January consumer inflation rose. Employers added far fewer jobs in February than in January, jobless claims were worse than expected, and prices rose in the manufacturing sector.
What does stagflation mean for investors?
During the stagflation of the 1970s, both stocks and bonds took a hit. The S&P 500 index fell 48% from January 1973 to December 1974 and did not fully recover until the 1980s, as earnings growth slowed. Bonds also fell because their regular, fixed payments to investors were eroded by inflation.
Investments to weather stagflation include inflation-protected investments such as the US government's TIP bonds and natural resource companies, such as oil, gas, and minerals.
How is deflation fought?
There is no clear consensus on why stagflation ended and which government actions were actually effective in addressing the problem, as many assessments follow the ideological biases of commentators.
While economic growth recovered in the late 1970s, price gains remained faster than average until the so-called “Volcker” shock of 1979-1981, when the Federal Reserve gradually raised the base rate to 19.1% in June 1981. This increased unemployment to a peak of 10.2%, but lowered the Consumer Price Index to 10.8%.
One reason a full-blown repeat of the stagflation of the 1970s is unlikely to happen in the US is that the country no longer has a strong labor movement. Unions were then strong enough to demand wage increases that kept pace with inflation. Companies would raise their prices to cover the rising costs, creating a cycle of rising wages and prices.
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