The global economy is becoming less efficient — and more expensive
Inflation is a bad thing. It hurts the poor, the elderly, the cautious, those on fixed incomes, and it erodes trust in the state and society. It benefits the “rich”, those with financial assets, the spivs and wheeler-dealers who thrive in times of uncertainty. Of course, it also cuts the real cost of debt — and that makes it particularly attractive at a time when governments and corporates around the world are piling on debt as though there is no tomorrow. In the UK, for instance, the Office for Budget Responsibility projects government borrowing of £370 billion this year, with public debt at 100 per cent of GDP by 2021. It calls that “unsustainable”. Same in the US, and also in the EU, where the Council has just “suspended” the Maastricht rules on debt and deficits (remember them? It was 3 per cent for the deficit and 60 per cent for the debt ratio).
As a result, there is suddenly renewed support for the idea that we might be able to solve our debt problem (if indeed, it is a problem) by inflating our way out. After all, when I was starting out as a financial analyst at the World Bank, our working assumption was an inflation rate of 6-7 per cent and a “real” interest rate of 3-4 per cent; hence the investment cut-off was a financial rate of return of around 10 per cent. Of course, things did get out of hand, not least in the UK, where inflation seemed headed for 20 per cent or higher, before Lamont and Lawson put the squeeze on. But maybe a few years of (say) 10 per cent inflation would help balance the books. Of course, those who were foolish enough to buy gilts at 2 per cent or less (not to mention Austrian investors, who piled into a 100-year bond at a yield of just 0.8 per cent) would be stuffed, though that may still be the least bad alternative.
But is there any chance of a return to our old inflationary ways?
Maybe. Opinion is split. On the one hand are monetarists who see “broad” money rising at an annual rate of 20 per cent or more, and who see no way out except higher prices. After all, it is (almost) axiomatic that inflation is “too much money chasing too few goods” — and there is certainly too much money out there, at a time when the productive capacity of the global economy has been hit hard. Plus, the shortening of global supply chains, the inevitability of “on-shoring” and the need to build resilience (ie redundancy) into the global economic system will all mean that the “new normal” will be less efficient — and, therefore, more expensive.
On top of that, there is the increasingly seductive appeal of what we now call Modern Monetary Theory. It is widely ridiculed by mainstream economists even though its fundamental insight is absolutely true: countries that have their own currency (and that do not raise debt in other currencies) cannot “go broke”, insofar as they can always print enough money to meet their obligations. Hence, MMT-ers think the OBR was absolutely wrong to say the UK’s debt trajectory is “unsustainable”. The only constraint on a government’s spending should (in their eyes) be a resource constraint: is there “unnecessary”, ie, non-frictional, unemployment? For them, inflation is a dragon that has already been slain, and will not return — an assertion that horrifies critics, who point to Zimbabwe and Venezuela as counter-examples (though in both cases they were brought down primarily by foreign obligations). For mainstream economists (and economic journalists), if we succumb to the lure of MMT, inflation will follow as night follows day.
That’s one side of the argument. The other side looks at the numbers.
The latest inflation data makes pretty comforting reading. Here in the UK (where the Bank of England has a clear inflation target of 2 per cent), the CPI is running around 0.6 per cent — though core inflation is 1.2 per cent. Elsewhere in Europe, prices are falling in Spain, flat in Italy, up just 0.2 per cent in France and 0.8 per cent in Germany. As for the US, year-on-year inflation in June was 1 per cent. Nothing to worry about there, surely? Well, maybe not. But that might not last. Prices were actually up 0.6 per cent in both July and June in the US, which means that, if you look at those two months alone, inflation is already running at an annual rate of around 8 per cent. Maybe it won’t last; after all, much of it reflected a one-time jump in gasoline prices. But, just maybe, it is a harbinger of things to come.
There is, however, another argument against a sustained increase in inflation: that we are living in an asset price bubble the like of which the world has not seen for many years. Sooner or later, that bubble is going to burst, and when it does, the money that has helped inflate it will disappear for good, prompting the kind of market collapse that happens once every generation or so (usually, a drop in asset prices of 40 per cent or more). That should be enough to kill any inflationary virus that still lingers in the global economy. Unfortunately, it will also kill any nascent recovery.
Which way should one jump? My personal view is that we don’t really face a problem of generalised inflation yet — and we probably won’t for at least a couple of years. But the arguments about supply chains and resilience are valid; the global economy will be less efficient, and more expensive, going forward, particularly for traded goods. That means an asymmetric boost to inflation, as production and trading patterns adapt. Some goods (and services) are going to be a lot more expensive. As for the asset bubble, well, I put my puny savings into cash a couple of months ago and look very silly now. But I still think this is a bubble waiting to pop; when it does, it will take most inflationary pressures with it — though we might well find that too high a price to pay.
