In a Perfect Storm of Economic Stagflation, the Yachting Set Says: "Let Them Eat Pizza"

Stagflation in America? Well, unless you're among the wealthiest, you're soaking in it and have been for quite a while.

But you're not likely to hear much about that story. Officially, the U.S. hasn't experienced stagflation -- a long period of rising prices amid sluggish economic growth -- since the 1970s. The word conjures up images of gas lines snaking around corners, a weary Jimmy Carter looking droopy and forlorn in the Oval Office and the general sense of "malaise" that sunny old Ronald Reagan exploited so adroitly to give rise to the New Conservative movement.

But looking beyond the official numbers -- the data on growth and inflation that most economic reporters bandy about -- reveals a deeper truth about the American economy. The reality is that those who aren't at the very top or the very bottom of America's economic food chain have been mired in a long period of painful stagflation. But it's a reality that's obscured by the ways in which we measure our nation's economic health.

So while anyone who draws a paycheck knows that prices are rising fast and salaries haven't kept up for a long time, the S-word is never mentioned in our economic discourse. There are two reasons for that. First, a number of government benefits like Social Security payments are indexed to inflation, and since the dawn of the Reagan era, a series of changes were made to the way the government measures it, largely as a back-door way of keeping the growth of entitlements in check without pissing off veterans' groups or the AARP.

Second, while our overall growth has outpaced inflation, America's income has also become much more highly concentrated at the top -- the paychecks of 9 out of 10 Americans have actually declined over the past three decades. It's been Bill Gates and his set who have done extremely well during that time.

As a result of both of these shifts, there's now a significant gap between the economy in which most Americans live and work and the one discussed in the business pages and on the cable news blab-fests.

Inflation Nation

Newsweek tells us that "the situation we're in is nowhere near stagflation." After all, "the Consumer Price Index is rising at a 3 percent annual rate, compared with 13 percent in 1979."

What Newsweek doesn't mention is that the measures of inflation commonly discussed today bear little resemblance to the stats used in the 1970s.

In large part, that's because the Consumer Price Index (CPI) -- the most frequently cited measure of inflation in media reports -- is used to determine government benefits like Social Security, federal and state pensions and Medicare payments. Until the late 1970s, the index was based on a relatively simple formula. Officials took a theoretical "basket of goods" that "typical" consumers required and averaged their current prices. But, as economist John Williams, author of the Shadow Government Statistics newsletter, explains, "miscreant politicians, who were and are intent upon stealing income from social security recipients," made dramatic changes to the way CPI is calculated in the 1980s and 1990s, resulting in a drop in the official inflation rate made with a stroke of the pen and with little fuss from the public.

To gauge what most of us are really experiencing on a day-to-day basis, one might imagine economic reporters relying on a monthly "pizza index" instead of the Consumer Price Index. According to a February report by Al Olson of MSNBC, "Pizza makers have seen their cheese costs soar this year from $1.30 a pound to $1.76 a pound. Even worse, the flour used to make the dough has gone from $3 to $7 a bushel to $25 a bushel in less than a year." Between the second quarters of 2007 and 2008, even the paperboard used to make pizza boxes increased by 8 percent. (Several years of inflation in tomato prices -- for the sauce -- have been blunted by the recent salmonella scare.)

The same is true for a host of items that working America buys every day. Olson wrote, "If you're looking for a sure sign the U.S. economy is headed in the wrong direction, all you need to do is look at the skyrocketing price of 'recession-proof' foods: pizza, hot dogs, bagels and beer." But those items, and other costs that impact ordinary people significantly, are under-counted in the consumer price index.

Beginning in the early 1990s, conservative economists were unhappy that high inflation kept increasing entitlement payments to government employees, vets and the elderly -- whiners and greedy gray-hairs -- and, through some impressive intellectual contortionism, began making adjustments to the way the "official" rate of inflation is measured. They began "weighting" items in the basket differently.

Alan Greenspan argued that it was wrong to compare the price of a pound of steak one year to a pound of steak the next because when steak gets too expensive, people start eating hamburger -- they lead more frugal lives when prices rise, and the cost of inflation should reflect their decisions. But as Williams notes:

Replacing hamburger for steak in the calculations would reduce the inflation rate, but it represented the rate of inflation in terms of maintaining a declining standard of living. Cost of living was being replaced by the cost of survival. The old system told you how much you had to increase your income in order to keep buying steak. The new system promised you hamburger, and then dog food, perhaps, after that [emphasis mine].
In the same vein, it was argued that CPI wasn't taking into account the increased enjoyment people got from buying shiny new consumer goods. That new toaster may have cost you 60 percent more than the one you bought just five years ago, but the new one has a computer chip that monitors the internal temperature, and that makes it harder to burn the toast. Therefore, they argued, your happiness at having perfect toast every morning should be factored into the CPI.

In 1995, under Bill Clinton, the Boskin Commission -- led by a former economic adviser to the first President Bush -- was formed to "fix" the way we measure CPI. Changes were quietly made, with little Congressional oversight; ostensibly, they were to improve accuracy, but their net result was a dramatic reduction of the "official" rate of inflation.

So while Newsweek touts our 3 percent annual rate of inflation (5 percent since this spring), the reality is that CPI as it was calculated before the Clinton-era changes went into effect was more than 8 percent last month. And that's not including a whole other set of methodological changes made in 1983 (which I'll get to shortly).

Even more misleading is the "core" inflation rate, used by the Federal Reserve. The "core" rate simply excludes certain "volatile" goods from the basket -- little things like energy and food. It's become increasingly popular among pundits to cite the core numbers in recent years, but with energy and food costs making up about a quarter of most household expenses, it's a poor measure of the economic pain most Americans are feeling. In just the last year (ending in June), food prices increased by more than 5 percent, and energy costs skyrocketed by almost 25 percent.

When it comes to food and energy, we're facing a perfect storm. Increased demand for ethanol is pushing grain prices upward, climate change is depressing yields, the costs of transporting goods to market over ever-greater distances is rising and investors are sheltering their loot against a falling dollar and bursting real estate bubble in the commodities markets. It's all coming together and creating a real squeeze that isn't fully reflected in the official economic statistics.

(Obviously high energy costs do factor into the current CPI formula because they increase the prices of everything moved by truck or ship -- from timber to engine parts to consumer goods. The International Herald Tribune noted in February that global inflation -- which other countries usually measure in the same way they did during the 1970s -- has risen to "historic levels.")


Until 1983, CPI included the cost of owning a house -- it factored in home prices, mortgage rates and real estate taxes. But in 1983, the Bureau of Labor Statistics -- the agency that crunches all these numbers -- decided to replace the cost of home ownership with rents (actually, a rental equivalent) as the key housing component in the CPI. As home prices ran up higher and higher over the past 10 years, rents remained relatively stable (this, argued economists like Dean Baker, was evidence that the housing boom was in fact a "bubble," untethered from the basic laws of supply and demand).

Consider this graph from the New York Times, and imagine if those home prices that spiraled during the first years of the new century were still the key housing measure in the CPI, as they were in the 1970s:

Click for larger version
(click for larger version)

While home prices increased dramatically between 1995 and 2005, the "owners' equivalent rent" used to calculate inflation actually declined by a few points.

With all these factors in mind, let's return for one second to Newsweek's calming words. The 13 percent inflation rate they cited (in 1980, not 1979) represented a bit of cherry-picking -- it was a historically high year. The average rate of inflation during the 1970s was just over 7 percent (and 9.75 percent during the Carter years). Williams estimates that CPI understates the actual inflation rate -- the rate as it was calculated before the Reagan era -- by about 7 percent. Here's what the official measure of CPI looks like compared with Williams' inflation rate using the methodologies that existed in 1980:

Click for larger version
(click for larger version)

It's a controversial claim, but if he's right, inflation in the first eight years of the 21st century has averaged around nine and a half percent -- or 2 percentage points higher than it averaged during the 1970s. Contrast that with the official rate, which increased by an average of only 2.4 percent during that time.


OK, so prices are high, but what about the other side of stagflation -- anemic growth? Most people still see the American economy as a powerful engine for economic growth, and overall, it has produced modest but steady economic growth, with the exception of a few periods of recession, since the 1970s.

But that's not the whole story. To get a real sense of where we're at in terms of economic growth in America, one needs to understand three points.

First, when people talk about Gross Domestic Product (GDP) -- the size of the economy -- they mean GDP adjusted for inflation. If the rate of inflation is underestimated, as we've seen, then the rate of inflation-adjusted growth will be consistently overstated (I should note that the growth rates I just mentioned were calculated using the same methodology -- apples and apples).

Second, we only talk about "stagflation" over a relatively long term, and all of this is part of a long-term trend. Yes, the Bush years have been terrible for working people -- the period following the last recession was the first "recovery" in which median incomes didn't bounce back -- but overall growth has been sluggish, and declining, for decades. Economist Robert Brenner described what he calls a "long downturn" in the world's most advanced economies. In the 1960s, the G7 economies grew by a steady 5-plus percent annually; in the 1970s, that fell to 3.6 percent, and it has averaged around 3 percent ever since.

In part, this is a consequence of what the activist and social critic Walden Bello calls a "crisis of overproduction." In the booming years after World War II, the wealthy countries, led by the United States, did very well manufacturing goods for the entire planet. But as Japan rose from the ashes, and, later, as production in countries like Taiwan, South Korea and Singapore increased, the industrial world simply started making more crap than there were consumers to purchase it. Bello notes that during the 1990s, the automobile industry cranked out around 70 million new rides each year but could only sell 53 million of them. In his new book, How to Rule the World, Mark Engler quotes a report in The Economist about "the world [being] awash with excess capacity in computer chips, steel, cars, textiles and chemicals."

Engler points out that declining returns on traditional investments in manufacturing and related industries had a lot to do with today's highly speculative economy -- pushing capital into developing countries and into bubble after bubble in search of a better profit margin. This, of course, has led to the well-discussed "hollowing out" of the American economy, as investors went abroad in search of better returns and took much of the United States' manufacturing base with them.

Which leads to the third thing one needs to understand about growth: Growth in GDP -- the most popular measure of economic health -- is almost entirely irrelevant to most people's economic lives. It says almost nothing about the ease or difficulty with which people are making ends meet from month to month and year to year.

That's in large part due to changes in how America's income has been distributed over the past 30 to 40 years. While average incomes have continued to grow along with the size of the economy, the distribution of that income has come to look more and more like what one finds in a banana republic -- with a mega-wealthy elite, an ever-slimmer middle class getting squeezed in every direction, and a poor working class struggling to put food on the table and a roof overhead.

Averages can't tell that story. The most telling analysis -- and the most jarring -- of the long-term economic trends that impact most of us was done by economists Emmanuel Saez and Thomas Piketty. They sliced and diced the American economy, and found that when you lop off those in the top 10 percent of the economic ladder, earnings for the overwhelming majority of Americans actually declined during the 33 years between 1973 and 2006. In 1972, all but the top 10 percent earned, on average, $30,174 dollars per year (in 2006 dollars). In 2006, more than three decades of growth later, that number had fallen to $29,952 (Excel file).

(Some conservatives argue that about half of Americans are "investors" and therefore looking only at income from paychecks, without including gains from the stock market and other investments, doesn't give the whole picture. OK, but ownership in securities is also highly concentrated at the top. If we include capital gains -- income from investments -- and again lop off the top 10 percent, incomes for the remaining 9 out of 10 Americans increased annually by about $39 bucks per year between 1972 and 2006 (in 2006 dollars). That works out to about one-tenth of 1 percent annually -- robust growth, no?)

Now, how can it be that the U.S. economy generates inflation-adjusted growth year after year and most of our incomes have shrunk for more than three decades? The answer is that a larger share of income has been captured by those at the top. In 1972, the top 10 percent grabbed about a third of America's income (including investment income). By 2006, that share had risen to 46.3 percent. In 1972, the top 1 percent of the American public grabbed 8.7 percent of its earned income, and that figure skyrocketed to more than 20 percent in 2006. The Wall Street Journal recently reported that "the richest 1 percent of Americans in 2006 garnered the highest share of the nation's adjusted gross income for two decades, and possibly the highest since 1929."

So, just as our pizza index gave us a better sense of the inflated prices most people are dealing with, perhaps a better way to understand economic growth in recent years is by looking at the "super-yacht index" (which really exists). According to the latest release, "just 241 yachts of 80 feet in length or greater were under construction around the world [in 1997], but by the end of 2007, 916 yachts" were being built. This year, orders for yachts over 130 feet in length -- mega-phalluses of wealth -- were up by 18 percent over last year; according to the president of the Luxury Institute, which compiles the index, "Even in an economic downturn, the global wealth boom is still producing new potential customers at a rapid clip."

If you have the means to consider a mega-yacht purchase, then of course none of this is of much concern to you. But the rest of us are mired in a long era of painful stagflation.

OK, Things Suck and Inequality Reigns, but Why Is Stagflation Important?

The economic paradigm that has guided the world over the past 40 years or so is crashing all around us. We face food shortages, an energy crisis, crises of consumption and overproduction, the prospect of catastrophic climate change and a crisis in the legitimacy of government. They're all intertwined.

In his eye-opening book, Collapse: How Societies Choose to Fail or Succeed, anthropologist Jared Diamond argued that societies don't fall apart because they find themselves faced with daunting challenges; they fall apart when their leaders are unable -- too conservative, too inflexible -- to rise to those challenges and overcome them.

The United States, especially, faces deep structural problems, and there are no quick fixes. Forget about "subprime" loans and economic "slowdowns." Forget about the kind of tinkering around the edges that our political establishment offers as solutions. We need some bold new thinking in order to dig out of these messes. We need new energy solutions and new economic models that place human welfare, rather than abstractions like GDP or the Dow Jones Industrial Average, at their center. We need to make consumption a means to an end rather than a goal unto itself.

But none of that can happen until we accept that our current social and economic arrangements are dysfunctional. As long as decision-makers are tied down to the principles of yesterday's tired old "New Economy" -- the globalized, trickle-down economy touted by Democrats and Republicans alike for the past 30 years -- and as long as the economic pain most of us are dealing with is obscured by suspect measures of inflation and growth, none of that will happen.

"Stagflation" is a powerful concept -- a jarring wake-up call. Reagan launched the modern conservative movement (or at least made its principles dominant) during an era very similar to that in which we live today. The time has come for more progressive solutions, and to use the sense that the country is faced with a general feeling of malaise to do what Reagan did.

Understanding that most of us are soaking in a long period of stagnant growth while struggling to keep up with rising costs is crucial to starting that process.

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