I don’t believe our current economic depression will be the Great Depression 2 (my blog’s title is a bit misleading in that regards). Rather, it will be the Great Stagflation. The Carter years of stagflation will look tame by comparison.

Our Fed will simply not let deflation take hold. They would rather print money and create inflation then let deflation do the dirty work….and I don’t blame them. In the grand scheme of things, a horrible stagflation won’t be as bad as a pure deflation. Here’s how it will go down.

We’re going through the worst financial crisis since the Great Depression. To fix the situation, the government has decided to expand its powers greatly. It isn’t just printing money though and loosening credit. Rather, through wasteful stimulus programs, it is spending money like a drunk sailor. Our debt/GDP ratio is climbing by the day.

With the government raising our debt, the ‘crowding out’ effect begins. Why should a bank loan to a business when the bank can loan risk-free to the government? Since the government is creating so much debt,  there’s only so much the Chinese are going to lend to us at cheap rates. Ultimately, rates on government debt go up, resulting in higher interest rates for the rest of us and a continued financial crisis.

Higher interest rates, more unemployment, great depression all over again….or so we would think. The Fed has decided it wants to keep rates low and is even printing money to buy up government debt. A week ago, the Fed said it would buy $300 billion  of US Treasuries, essentially the government is now printing money to service its debt.

This money printing will lead to inflation of course. We have already seen commodity prices start to rise. As inflation kicks in, the most talked-about commodity of all, oil, will go up in price. As I write this article, oil is sitting at $54 a barrel. I forecast oil will once again hit $80-$100 a barrel before we know it.

That’s when the stupidity of Congress kicks in full gear. Congress passes some stupid windfall profits tax plus cap and trade, creating another energy crisis. Gas at the pump goes up to double digits in a year or two. We are more dependent on foreign oil than ever because Congress is doing whatever it can to essentially nationalize domestic companies. A higher trade deficit, a weaker dollar, commodities going higher, more inflation, economic slowdown.

When it’s all said and done, the misery index (which is a crude measure just adding the inflation rate and the unemployment rate) may very well hit 30.  Even during the peak of Carter-era stupidity (when they passed the windfall profits tax in 1980), the misery index reached it’s post WWII high of just above 20. I’m thinking it will go above 30 sometime in late 2010 or 2011. Yes, that’s how bad it will get.