By PATRICK BARTA Staff Reporter of THE WALL STREET JOURNAL August 16, 2004; Page A2
BANGKOK -- One of the dirtiest words in the economic lexicon is making the rounds again: stagflation.
Defined as a noxious blend of stagnant growth and rising prices, stagflation last appeared in force in the 1970s, when it bedeviled U.S. policy makers and gradually degraded the standard of living of average Americans. Economists long thought a repeat to be extremely unlikely.
But now, they are starting to worry again. The fundamental problem: Oil prices are kicking up inflation across the world, at precisely the same time that economic growth appears to be slowing. If oil prices keep climbing, and inflation rates exceed growth rates, some economists say the U.S., Asia and other regions could face a troubling scenario in which policy makers have to fight some of the same demons that plagued the U.S. back in the days of disco.
"Oil at $45 a barrel is a stagflation problem," warned economists at UBS Ltd. in a recent research report. By their reckoning, sustained prices at that level would slow global growth rates by almost half a percentage point in 2005 and by about one percentage point in 2006. Perhaps more important, such prices would push inflation up by about the same amount -- giving the world its first taste in years of what stagflation can be like.
In Europe, the surge in oil prices at a time when the economy is only slowly recovering from a three-year slump has also ignited fears of stagflation. Europe is somewhat shielded from the effects of pricier oil thanks to the euro's strength against the dollar. That makes buying oil, which is quoted in dollars in international markets, relatively cheaper.
Nevertheless, inflation in the 12-nation euro zone at 2.4% is above the European Central Bank's inflation target of "less than but close to 2%." And growth in the second quarter slowed to 0.5% from 0.6% in the first. Some economists fear that the ECB might react by raising rates earlier rather than later to fight the spike in inflation, and in the end dent growth. But the ECB believes that inflation will subside next year, and appears likely to leave its key rate at a postwar low of 2% for some time.
For now, the stagflation concerns seem to be most pressing in Asia, though they could intensify elsewhere if oil prices stay high. That is because Asia's burgeoning manufacturing sector forces it to burn more fuel as a percentage of economic output than the more service-oriented economies of the West.
That lack of energy efficiency is conspiring with a quickening pace of price rises in regional powerhouses such as China and India. In China, inflation hit a seven-year high in July -- with prices up 5.3% from a year earlier -- even though a host of recent indicators have suggested that China's government is succeeding in efforts to slow its overheated economy.
"A large part of Asia is already in stagflation," contends Sung Won Sohn, a Wells Fargo economist in the U.S. who follows Asian economies. By his definition, a country can be in stagflation if inflation is rising and the economy is growing slower than its long-term potential.
Consider South Korea, Asia's fourth-largest economy. While exports are up significantly compared with last year, high levels of consumer debt have curtailed consumer spending. Economists have scaled back their Korea growth estimates for 2004, as a hoped-for recovery in consumer demand has failed to materialize.
Despite the slack demand, inflation is accelerating, due largely to oil. In July, consumer prices were up 4.4% from a year earlier; in March, prices were only 3.1% above those of the year-earlier month.
The combination of rising prices and slowing growth is starting to trouble the nation's biggest companies.
Domestic travel on flag carrier Korean Air is down more than 15% compared with last year. A booming cargo business has more than offset that weakness so far. But now economists are projecting a potentially sharp slowdown in exports in the second half of the year, which could seriously affect the airline's cargo trade.
Meanwhile, costs keep running higher. The airline expects to spend about $400 million to $500 million more on fuel this year than it did last year. It has already raised ticket prices by 5% to 10%, and it isn't counting on oil prices declining soon. The company is planning for prices in the $45-a-barrel range next year.
"The problem is the end of this year and the beginning of next year," after the company's coming peak cargo season ends, says Woo Kee Hong, general manager of the airline's corporate-planning team. "If the economy is slowing, it will impact us."
Similar worries have forced Korean policy makers to confront a conundrum that perplexed U.S. economists during the mid-1970s. Should they cut interest rates to boost growth, even though that might spur more inflation? Or should they raise rates to ward off rising prices, even though that could slow the economy further?
On Aug. 12, South Korea's central bank made its move, cutting its key interest rate by 0.25 percentage point to an all-time low of 3.5%. This time, the U.S. is taking the opposite tack, raising interest rates even amid signs that the economy could be slowing.
To be sure, a lot of economists don't buy the notion that Korea -- or any major country, for that matter -- is close to stagflation. In the case of Seoul's economy, they note that growth could still reach 5% or better this year -- hardly cause for panic -- if exports stay healthy.
Moreover, if global growth slows a lot more, it could bring prices back down, snuffing out inflation before it becomes a major problem. That has occurred in many past periods when inflation rose.
But some economists worry this time could be different. Recent estimates indicate that members of the Organization of Petroleum Exporting Countries now have spare capacity of just 500,000 barrels a day, less than 1% of the world market of more than 83 million barrels a day. With so little room to spare, some economists say oil prices could keep rising even after global growth slows.
For that reason, some economists are advising Asian governments to abandon or reduce recent efforts that some have made to keep their currencies artificially low, a tactic that has boosted manufactured exports but reduced consumers' buying power. If those governments take that advice, it could trigger sizable changes in the world economy, making Asian economies less competitive in the short run -- but improving the prospects of exporters in the U.S.
--Seah Park in Seoul and G. Thomas Sims in Frankfurt contributed to this article