Stagflation flourishes amid war

According to the Jamie Dimon, CEO of JP Morgan, we now face "maybe the most dangerous time...in decades." Gita Gopinath, deputy head of the International Monetary Fund (IMF) is feeling nervous too. She says that debt levels are at a record and that there is a lot "that could go wrong". People in their positions are paid to worry - but that doesn't mean they are wrong. Shocks to the global economy are coming thick and fast, the simmering Middle East war just the latest.

Fifteen years ago the world's financial system was on the verge of meltdown. Are things any better today? No sooner than we felt we had survived Covid-19 than a war sprang up between Russia and Ukraine. Energy prices went haywire. Governments and central banks, reeling from the pandemic, responded by injecting even more unfunded resources into the monetary system, with predictable consequences for inflation - it soared to the highest level in four decades. Relations between the US and China have deteriorated; the globalized economy has fallen apart in mutual distrust. Inflation is in retreat, but more slowly than anyone would like - down to an annualized 3.7% in the US, 4.9% in the European Union, and 6.7% in the UK - where it is unchanged from the previous month. Major central banks target an inflation level of 2%/year, a level some, such as the economist Nouriel Roubini, calls 'mission impossible', although the chairman of the US Federal Reserve, Jerome Powell, thinks 2% could be achieved by 2025. Two years to return to "normal"?

And now a major war might erupt in the Middle East out of the localized conflict between Israel and Hamas. Even if no major power gets more involved, a broadening of the conflict will seriously disrupt global economy; growth is urgently wanted as it's the route to generalized enrichment. But growth will be difficult to achieve if there's no peace.

The stagflation trap

But growth looks like being strong in one economy, that of the US. Retail sales rose more than expected in September, an annualized 3.8%. A strong labor market in September, with 336,000 jobs created, added to the rosy picture. Taking this supportive data Goldman Sachs marginally raised its estimate for US gross domestic product (GDP) in the third quarter of 2023 to an annualized 4.%, which would be the fastest since the end of 2021 and higher than the IMF expects globally. Consumer spending accounts for about 70% of US GDP. American shoppers are continuing to spend, drawing on savings accumulated during the pandemic, even though delinquencies on their credit card payments have reached their highest in more than a decade.

Yet all this strong growth will do for policymakers is encourage them to maintain interest rates at their current 5.25-5.5%, the highest level since 2001, or even raise them slightly at the next meeting of the Federal Reserve on 31 October. Jerome Powell warned as much in August when he said the Fed was "prepared to raise rates further if appropriate...and to hold policy at a restrictive rate until we are confident that inflation is moving sustainably down toward our objective." Given that we are according to Powell two years away from the Fed's 'objective', rates are not coming down any time soon.

With a healthily growing economy the US will probably avoid a recession or the much worse outcome, stagflation. But that remains a threat to the UK and Eurozone economies.

Stagflation is the worst of all economic worlds. A combination of high inflation and economic stagnation, with prices rising, wages losing value, and stagnant economic growth, stagflation is rare but it has occurred in the past. Perhaps the best known instance happened during the 1970s oil crisis, when the Organization of Petroleum Exporting Countries (Opec) embargoed oil exports to Western countries that backed Israel in the Yom Kippur War against Egypt and Syria. Sounds familiar? The embargo ended in March 1974. But there's no easy way out of stagflation. Governments need to balance lower interest rates and higher public spending, yet avoiding adding to inflation. Some analysts think that Europe is already in stagflation; it certainly looks that way for the UK. Economic growth in the Eurozone this year will be less than 1% and around the same in the UK, well within a margin of error; both seem to be stuck in a stagflation trap.

If stagflation does get a hold, what's the best place to park one's assets? According to the chart above, gold is a "clear winner in stagflationary" times. This should not be a surprise - after all, inflation is destructive of the purchasing power of fiat currency. The spot gold price has risen modestly on worries about what is going to happen in the Middle East, reaching more than $1,942/ounce. The potential for the conflict to widen is clearly driving greater interest in gold; but of less immediate concern is the strong possibility that many countries will soon be stuck in a stagflationary trap.

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.