The disconnect between inflation pressures and slowing global growth has economists debating whether stagflation is afoot
https://asiatimes.com-by William Pesek
People planning to return to their hometowns wait at a checkpoint to leave Ho Chi Minh City in the early hours of October 1, 2021, following the easing of strict Covid-19 coronavirus restrictions that had been in place for the past three months. Photo: AFP / Chi Pi
China’s growth downshift in the July-September period may confirm virtually every economist’s worst fear: that the supposed post-Covid-19 rebound has already peaked.
Gross domestic product (GDP) reports from the globe’s largest trading nation tend to flag zigs in the global economy where analysts had expected zags.
And China’s 4.9% growth from a year earlier in the third quarter suggests trends in the US, Europe and Japan – where data are disappointing, too – are for real.
Meanwhile, even the “post-Covid” recovery may be inaccurate phrasing. The shock uptick of cases in the highly inoculated UK is raising fears that vaccines are losing their efficacy.
All this means the V-shaped recoveries already built into most investment strategies for 2022 need to be reassessed. Perhaps drastically.
Much of the global data of the moment “masks large downgrades for some countries,” says Gita Gopinath, chief economist at the International Monetary Fund. Worsening pandemic dynamics, she adds, are darkening the outlook for low-income developing economies, while wealthy countries are struggling with supply disruptions and inflation spikes.
Claus Jensen at Danske Bank notes that as inflation and overheating risks increase, “a number of indicators” suggest “the global recovery has peaked.”
Analysts at Fitch Solutions agree that odds are the “global recovery has peaked” thanks to “a further weakening of economic momentum across developed markets and emerging markets.”
America’s most recent employment report suggests growth is slowing in the biggest economy. It only added 194,000 jobs in September, down sharply from 366,000 in August. An Hodgson at advisory Euromonitor International notes that the US is “Exhibit A” of countries being hit by the Delta variant and low vaccination rates.
“Moreover,” Hodgson adds of the US, “vaccine skepticism complicates government efforts to reach herd immunity, forcing state and federal governments to impose stricter regulations, which in turn are likely to cause some contraction in consumer spending, particularly on various non-essential services and recreation activities.”
Economist Robin Brooks at the Institute of International Finance also cautions that the pandemic “is slowing the reopening process and has caused us to mark down growth globally.” The IIF sees GDP running at about 5.7% forecast for this year. That is well down from an earlier 6.2% forecast for 2021.
Slower US growth is compounding Asia’s troubles. For China, it means less demand for exports at a moment when trade channels between the US, Europe and Japan are clogging and as inflation rises faster than GDP or productivity.
Are inflation fears over-inflated?
But not all economists are concerned about inflation trends.
“We remain of the view that inflation is not as big a worry for the Asia Pacific as a whole, as in the US and many other major economies,” says Priyanka Kishore at Oxford Economics.
Supply shortages and rising commodity prices are behind the boost in inflation. Yet in “most APAC economies,” Kishore says, “cyclical drivers are less evident, with weak growth prospects slowing the pass-through from input to output prices.”
She expects inflation to peak in the current quarter of 2022.
Though the IMF thinks inflation will revert to pre-pandemic levels in 2022, Gopinath says “central banks should be prepared to act quickly if the risks of rising inflation expectations become more material in this uncharted recovery.”
Yet the disconnect between inflation pressures and slowing growth has economists debating whether stagflation is afoot.
Former Morgan Stanley Asia economist Stephen Roach worries busted supply chains are putting the globe on such a path. Olivier Blanchard at the Peterson Institute for International Economics, though, dismisses the risk.
“I feel the use of ‘stagflation’ is wrong,” Blanchard says. “We are not seeing anything like stagnation. What we are seeing instead is very strong growth, fueled by private and public demand, hitting supply constraints, and leading to some sharp price increases. Nothing to do with stagflation.”
What will happen if the growth which Blanchard refers to loses forward thrust?
As Huw Pill, the Bank of England’s chief economist, puts it, “The balance of risks is currently shifting towards great concerns about the inflation outlook, as the current strength of inflation looks set to prove more long-lasting than originally anticipated.”
The central bankers’ dilemma
All this greatly complicates central banks’ hopes of scaling back their crisis support by slowing asset purchases or raising interest rates. As growth slows, inflation pressures limit options for monetary authorities to add liquidity.
US Federal Reserve Chairman Jerome Powell is raising warning flags about labor market slack as the pandemic drags on. Other top authorities, like the Reserve Bank of Australia, have been mulling whether – and how – to taper bond purchases as lockdowns slam demand and business confidence.
CrossBorder Capital headlines a recent note “Bad News is Closer Than You Think.”
It explores how slowing liquidity could quickly fuel market instability that heightens global inflation risks. A case in point is China’s slowdown – complicated by China Evergrande Group’s default drama – is exacerbating investors’ worries. US government debt, meanwhile, is surging toward $30 trillion.
“The West now faces two tricky adjustments at once: the end of the QE and the end of the Chinese credit boom,” CrossBorder argues. “Global liquidity looks set to tumble.”
Top economies also face a diminishing returns problem after 12 years of post-Lehman Brothers crisis stimulus. Even before Covid-19 hit, governments from Washington to London to Tokyo threw trillions of dollars of stimulus at flagging growth.
“Policymakers in many major economies now face the difficult conundrum of supporting growth while keeping inflation under control, even as they continue to be hit by domestic and external supply disruptions,” says economist Eswar Prasad at Cornell University.
“Additional stimulus measures, especially monetary easing, are likely to yield an increasingly unfavorable trade-off between short-term benefits and longer-term vulnerabilities,” he added.
Central banks and governments alike “will need to develop a carefully targeted mix of policies in response to the complicated circumstances they now face,” Prasad says.
First, Prasad says, governments must redouble efforts to limit the resurgence of the virus, which remains a “wildcard for short-term growth.” Second, use fiscal policy judiciously to support short-term demand while also improving long-term productivity.
Third, he says, exercise restraint with monetary policy and start reducing – but not yet reversing – the amount of support it provides to the economy.
Fourth, persist with financial, labor and product market reforms to strengthen private sector confidence and ease the difficult trade-offs governments must contend with.
Pros among the cons
Some see all this disruption as a positive.
Economist Christopher Smart at Barings Investment Institute says the “far more important questions are, what comes after the pandemic and what might shake off 40 years of ever-lower growth and interest rates? There is a sea change underway in fiscal and monetary policy that just might deliver higher and more durable growth.”
Smart notes that concerns about “secular stagnation” popularized by former US Treasury Secretary Lawrence Summers are no longer theoretical. It “identifies a constellation of structural factors and policy choices that tilts the global economy into saving too much and investing too little,” Smart explains.
The tools that worked in the 1990s, 2000s and 2010s are losing potency. More debt-financed stimulus might backfire, as yields rise and credit ratings weaken.
The ghost towns imperiling China’s property developers demonstrate the limits of conventional stimulus. The Bank of Japan’s balance sheet topping the size of the nation’s annual GDP demonstrate why monetary inducements are losing potency.
Central bankers have long feared this situation.
‘Pushing on a string’
Isabel Schnabel, a member of the European Central Bank’s executive board, says the effectiveness of monetary policy is “highly state-contingent. The benefits from reducing interest rates further from very low levels may still outweigh the costs in certain circumstances. And since we are not yet at the effective lower bound, such actions remain possible in the future.”
However, she notes, when uncertainty is large and private demand constrained, monetary policy “is like pushing on a string. Pushing harder in such circumstances would likely have limited effects. In addition, a growing body of evidence suggests that the potential benefits of pushing rates lower may diminish even when uncertainty fades.”
The whole idea behind slashing rates is to incentivize increased consumption and investment.
“But,” Schnabel says, “when rates have been low for a long time, fewer and fewer firms and households are left to respond to an additional monetary policy impulse, in particular when investment and durable goods demand are both ‘lumpy’ and infrequent, as a large body of evidence suggests.”
It’s not hard to understand why the risk of “Japanification” is making its way into more and more investment theses. Few fates panic policymakers more than an economy falling and not being able to get up again. And when old-school monetary and fiscal stimulus no longer works.
Part of Barings economist Smart’s optimism stems from governments being forced to target the supply side. In recent decades, politicians in the US, Europe and Japan happily shifted the economic management role to central banks. Why do the heavy lifting on regulations and risk irking vested interests when monetary tweaks can keep growth on track?
The global economy is now reaching the limits of such complacency. And the end result may be something worse than the secular stagnation Summers and his ilk fear: a stagflationary cycle from which there’s no easy remedy.