Central banks warn on stagflation

As the Russian warlord Yevgeny Prigorzhin was (presumably) settling into his new abode in Belarus, the Bank for International Settlements (BIS) published its annual report covering 2022/2023. Perhaps the BIS thought this was a good time to slip out bad news. And bad news is what the BIS anticipates. The BIS is recognized as the ‘central banker’s central bank’, so what it has to say is generally assumed to have been agreed by the 63 central banks that comprise its members. Except for Russia, whose membership was suspended in March 2022 following the country’s invasion of Ukraine. That suspension was a departure from the BIS’s normal neutrality; it stayed neutral in the Second World War, continuing to offer banking services to central banks on both sides of the conflict. It’s difficult to imagine however that none of the world’s central bankers talks to the governor of the Russian central bank, Elvira Nabiullina, who is not thought to be a fan of the current war.

The annual report of the BIS says the global economy is now at a “crucial and perilous” juncture and policymakers face “a unique constellation of challenges.” The most serious danger facing the world economy is something this column has been warning of for months – stagflation. “Stagflation dangers loom large,” says the BIS, “as a combination of lingering disruptions from the pandemic, the war in Ukraine, soaring commodity prices and financial vulnerabilities cloud the outlook…The priority for central banks is to restore low and stable inflation.” The BIS is not alone in warning of stagflation; the World Bank issued a similar warning a year ago. Stagflation – a combination of high inflation and stagnant economic growth – has not been seen since the 1970s and early 1980s. Scholars at the US Brookings Institution point out that the stagflation of that era “ended with a global recession and a series of crises in EMDEs” (emerging markets and developing economies).

Holding the line

Global inflation during 1973-83 averaged 11.3%/year. Global GDP growth in the 1970s averaged about 4%/year, below the 5.5% of the 1960s. The recent bout of global inflation, 2020-2022 has been less, averaging 8%/year, but global growth in advanced economies will be very sluggish. The Organisation for Economic Development (OECD) forecasts that the global economy will grow by 2.7% in 2023 and 2.9% in 2024. The BIS says that governments everywhere should raise taxes or cut public spending to help central banks tame inflation and mitigate the risk of a financial crisis. Agustín Carstens, head of the BIS, says “interest rates may need to stay higher for longer.”

Agustín Carstens, head of the BIS, says “interest rates may need to stay higher for longer.”

This medicine is of course easy to prescribe, difficult to swallow, especially in a run-up to general elections in the US and the UK, when placating voters is a priority. US inflation as measured by the consumer price index (CPI) has slowed from its peak of 9.1% last June to 4% in May; in the UK the May CPI was 8.7%, unchanged from the previous month. But in both countries core inflation rose in May. The dilemma for central banks is that if they target inflation, try to bring it down by higher interest rates, they will increase the costs of borrowing, cut aggregate demand, cause a fall in gross domestic product (GDP) – and create greater unemployment. Yet if they don’t raise interest rates, demand will be unchecked and inflation will steam onward.

The BIS shies away from identifying where responsibility lies for the inflation surge. The trillions given away during the pandemic, to pay people to stay at home or to support businesses to stay open, put vast sums of ‘free’ money into pockets, some of which remains in the hands of consumers. As supply-chains were disrupted thanks to the lockdowns, prices were chased up by people (eventually freed from lockdowns) with an unexpected capacity to buy goods. This ‘demand-pull’ inflation looks like it is currently ebbing in the US at least. During the coronavirus pandemic central banks and governments around the world forgot all about inflation and concentrated on trying to preserve the pre-pandemic economy in aspic, supported by ultra-low short term interest rates and long term interest rates driven ever-lower by relentless quantitative easing.

Cost-push

But with higher prices now baked in, workers understandably want to push for higher wages, to recover some (if not all) of the ground they have lost. Cost-push inflation, the effect of higher input costs from the supply side, may take root. At least, that’s the fear of governments and central bankers. One straw in the wind comes from the UK, where some 2,000 members of the Unite trade union, Heathrow airport security staff, threatened to go on strike for 29 days over the summer. To the relief of millions of airline passengers this strike has now been called off – those threatening to strike have been awarded a pay increase of between 15.5% and 17.5%, twice the rate of inflation. Junior doctors working for the National Health Service in the UK are striking to enforce a 35% pay increase. Walmart, the biggest private-sector employer in the US, raised its minimum hourly wage to $14 in March, effectively setting a new pay floor for many US states that is around double the minimum wage.

Workers everywhere look at inflation rates and understandably agitate for higher wages; inflation cuts the purchasing power of their fiat currency. Andrew Bailey, governor of the Bank of England (BoE), has joined Jerome Powell, chairman of the US Federal Reserve, in calling for workers to stop demanding inflation-matching or beating wages. This is an unpalatable but necessary message; central bankers and governments who are tasked with maintaining price stability cannot tolerate a wage-price spiral.

Stagflation is not yet here. But if it arrives what can one do to defend one’s wealth? Real assets such as property are a defense; people always need accommodation no matter what the economy is doing. Commodities can be hit or miss. But gold did well in both nominal and real terms during the stagflationary 1970s. The past is by no means certain to repeat itself; on the other hand, what other signpost do we have?

At Glint, we make every effort to demonstrate a balanced conversation between gold, crypto and fiat currencies when it comes to purchasing power and, while we strongly believe that gold is the fairest and most reliable currency on the planet, we need to point out that it isn’t 100% risk free. While we have seen a steady increase over time, the value of gold can fall, which means that its purchasing power can also decline.