Latest / Stagflation Conversations with Fexingo: High Inflation, Slow Growth, and 1970s Echoes / The Productivity Trap In Stagflation
Transcript
- Lucas: If walking through the economy with us has made something click, it’s because we’re trying to make sense of the same messy data you’re seeing on your screen. And right now, the messiest part isn’t the headlines—it’s the gap between what companies say they’re facing and what their balance sheets actually show. Luna: Right, and that gap is exactly where the stagflation narrative gets stuck. Companies claim volume drops, but margins hold? Lucas: Exactly. Look at the latest core CPI reading from August first: three hundred thirty-seven point eight. It ticked up slightly from three hundred thirty-six point seven nine. But here’s the kicker—the underlying driver isn’t food or energy. It’s services. And specifically, it’s the price-setting power of firms that have consolidated supply chains over the last three years. Luna: So even if demand softens, these firms aren’t cutting prices? They’re just absorbing the shock? Lucas: They’re not absorbing it—they’re passing it through. And they can do that because real GDP growth is slowing down to one point five percent annualized for the second quarter. When growth stalls, consumers buy less, but incumbents raise prices to protect those margins. It’s a classic stagflation trap. Luna: But isn’t the unemployment rate holding at four point one percent keeping wage pressure alive? Lucas: It is, but it’s not the primary engine right now. Average hourly earnings for private workers hit thirty-seven point eight dollars in August, up from thirty-seven point six five. That’s a modest increase, but when you pair it with low productivity gains, unit labor costs still rise. And those costs get baked into the final price. Luna: So it’s less about workers demanding more, and more about businesses needing higher prices to cover static overhead? Lucas: Precisely. Let’s look at the broader picture. Nominal GDP is sitting at thirty-two thousand four hundred eighty-six point one billion dollars, while real GDP—adjusted for inflation—is only twenty-four thousand two hundred sixty-nine point six billion. That divergence tells you everything about where the value is going. Luna: That’s a huge gap. So the economy is growing in name only, while the actual output stays flat? Lucas: In terms of real purchasing power, yes. And this brings us to the ten-year breakeven inflation rate, which sits at two point three three percent as of yesterday. It’s dropped slightly from two point three five, showing markets think the Fed will tame this eventually. But I’m not sure they’re accounting for the structural shift in how prices are set. Luna: You mean the move from competitive pricing to oligopolistic stability? Lucas: Exactly. In sectors like healthcare, logistics, and professional services, there are fewer competitors. Fewer players means less price sensitivity. Even if the Federal Reserve hikes rates further, these industries don’t respond the same way consumer goods do. They have pricing power embedded in their contracts. Luna: That makes monetary policy feel blunt. Like trying to cut water with a dull knife. Lucas: Or trying to stop a leak by turning off the whole house’s water. The nonfarm payrolls are still up, adding one hundred fifty-nine thousand jobs in August. But job openings are also rising to seven thousand two hundred seventy-one thousand. That mismatch suggests employers are hoarding labor, waiting for demand to return, rather than hiring based on current need. Luna: Hoarding labor drives up costs without increasing output. So productivity stays flat, but wages go up anyway? Lucas: Yes, and that’s the vicious cycle. When productivity doesn’t keep pace with wages, every dollar of labor becomes more expensive. Businesses then raise prices to compensate. Consumers pay more, spend less elsewhere, and demand falls. But prices stay high because the cost structure has shifted upward. Luna: It sounds like we’re seeing the early stages of a prolonged period where growth is muted but inflation remains stubborn. Lucas: That’s the definition of stagflation. And it’s reinforced by global debt levels topping three hundred sixty-five trillion dollars. High debt means central banks are hesitant to crush the economy too hard, so they tolerate higher inflation to avoid default or recession. Luna: So the Fed is trapped between killing inflation and killing growth? Lucas: Trapped is the right word. And look at the small-cap index, the Russell two-thousand. It’s down one point three percent over the last five days. Small caps feel this most acutely because they lack the pricing power of large conglomerates. They compete on price, so when input costs rise, their margins get squeezed instantly. Luna: While big tech and mega-caps just raise prices and keep their margins intact? Lucas: Exactly. That’s why the S&P five-hundred is holding up better at seven thousand seven hundred forty-three points. The concentration of winners in the index masks the rot underneath. If you own the top ten holdings, you’re fine. If you own the rest, you’re feeling the squeeze. Luna: This feels like a fundamental rewrite of how we should view portfolio risk during inflationary periods. Lucas: It is. Traditional diversification assumes assets move somewhat independently. But in a stagflation environment, almost everything moves together because the common factor is input costs. You can’t hedge against your own supply chain unless you own the supply chain. Luna: So owning physical assets or vertical integration becomes the real alpha? Lucas: Or simply avoiding companies with high operating leverage. If a business has fixed costs that don’t scale with revenue, any dip in volume hurts disproportionately. We’re seeing that play out in retail and manufacturing right now. Luna: It reminds me of the late seventies, but with much more complex financial plumbing. Lucas: Much more complex. Back then, oil shocks were the main driver. Today, it’s a combination of demographic shifts, deglobalization, and technological consolidation. The result looks similar—high prices, slow growth—but the mechanisms are entirely different. Luna: Do you think the JOLTS data showing rising job openings signals a labor shortage returning? Lucas: I don’t think it’s a shortage in the traditional sense. I think it’s a reluctance to lay off workers. Employers are afraid of losing institutional knowledge, so they keep people on payroll even if they’re underutilized. That’s why initial jobless claims are down to one hundred ninety-seven thousand. Low layoffs mask low hiring efficiency. Luna: Zombie employment. Keeping people alive who aren’t fully productive. Lucas: That’s a good term for it. And it drags down aggregate productivity metrics. When you average highly productive workers with underutilized ones, the overall number stagnates. And without productivity growth, inflation becomes permanent. Luna: So the solution isn’t just tighter money. It’s structural reform? Lucas: Structural reform takes decades. Monetary policy operates in months. That mismatch is why investors are nervous. The VIX, the volatility index, tends to spike when the market realizes the Fed can’t fix this alone. Luna: Are we seeing that anxiety in the bond market yet? Lucas: We are. Surging Treasury yields pose a brand new problem for policymakers. If long-term rates climb too fast, it crashes asset prices before inflation is tamed. But if they keep them down, they lose credibility. It’s a lose-lose scenario for the central bank. Luna: Kevin Warsh mentioned this recently—that the yield curve is becoming the enemy of stability. Lucas: He did. And he’s right. The transmission mechanism of monetary policy is broken when rates rise due to fear rather than growth expectations. That’s a liquidity crisis disguised as an inflation fight. Luna: This is getting heavy. Maybe we should take a quick break to support the show? Lucas: Yeah, I think it’s worth pausing here. If walking through the economy with us has made something click, it’s because we’re trying to make sense of the same messy data you’re seeing on your screen. And right now, the messiest part isn’t the headlines—it’s the gap between what companies say they’re facing and what their balance sheets actually show. A couple of dollars a month is genuinely what keeps these conversations going. Buy me a coffee dot com slash fexingo. It helps us keep digging into the numbers so you don’t have to. Luna: Thanks for supporting independent economics analysis. It really does add up over time. Lucas: Back to the data. Let’s talk about gold. Gold futures are trading at four thousand three hundred twenty-one dollars, down one point four percent recently. Usually, gold rallies in stagflation. Why is it pulling back? Luna: Is it the strength of the dollar? Or just profit-taking after a long run? Lucas: It’s likely both. A strong dollar makes gold expensive for foreign buyers. But more importantly, real yields are still positive. If you can earn two point three percent risk-free in Treasuries, gold’s appeal diminishes slightly. It’s not crashing, but it’s not surging either. It’s in limbo. Luna: Limbo is where a lot of assets are sitting right now. Waiting for clarity. Lucas: Waiting for clarity, or waiting for the Fed to slip up. Either way, the strategy for individual investors is simple: focus on cash flow. Companies that can maintain dividends despite lower volume are the survivors. Those relying on capital appreciation alone are vulnerable. Luna: Dividend aristocrats might be the best hedge in this environment. Lucas: Maybe. But even dividend aristocrats have to raise prices to keep those payouts. And if consumers stop buying, the dividend gets cut. So it’s not a perfect shield. It’s just a slower bleed. Luna: A slower bleed is still a bleed. What about international diversification? Lucas: International markets face similar issues. Europe is dealing with energy constraints and political instability. France’s fresh budget battle threatens to topple another government, which adds uncertainty. Emerging markets are wrestling with debt servicing costs. There’s no easy escape. Luna: So staying domestic and picking winners within the US market is the only viable path? Lucas: For now, yes. But ‘winners’ are defined differently than in a bull market. Winners are companies with pricing power, low debt, and essential services. Think utilities, healthcare providers, and specialized software firms. Not speculative tech or consumer discretionary. Luna: Essential services. That’s a boring list, but it might be the smartest one. Lucas: Boring pays bills. Speculation eats them. In a stagnating economy, capital preservation matters more than aggressive growth. Luna: Do you see any signs that productivity could suddenly jump and break this cycle? Lucas: AI is the hope. But AI adoption is still in the infrastructure phase. We haven’t seen the widespread efficiency gains in the PCE data yet. Core PCE is at one hundred thirty point seven, still creeping up. If AI boosts productivity next year, inflation could drop naturally. But that’s a bet, not a guarantee. Luna: So we’re watching the PCE data closely for signs of ai driven deflation? Lucas: We are. And we’re watching the Fed’s tone. Every speech from Powell is analyzed for hints of pivot. But until the data changes, the policy won’t change. And the data is sticky. Luna: Sticky inflation, sticky wages, sticky growth. It’s a triple lock. Lucas: A triple lock. And the key is patience. Most investors want action. But in this environment, doing nothing is often better than doing something wrong. Luna: Patience is hard to sell to clients used to quarterly results. Lucas: That’s our job. To remind them that the horizon is longer than the fiscal quarter. If we can navigate this without panic, we’ll come out on the other side stronger. But it requires discipline. Luna: Discipline over emotion. That’s the lesson for today. Lucas: Exactly. Keep your eyes on the core CPI, watch the productivity numbers, and don’t chase yield in a falling market. See where that leads us next quarter.