This shouldn’t be happening. A year ago the only division between economists was about the shape of the post-coronavirus economic recovery. Would it be like a Nike swoosh, or perhaps V-shaped, U-shaped or even W-shaped; but it wasn’t meant to be L-shaped. The global economy wasn’t meant to move from dead-stop to high-priced stagnation.
But it’s starting to look like stagflation – price rises combined with little or no economic growth – is on its way. That’s a nightmare for governments, central bankers, and the man/woman in the street. Sure, the US economy recovered in the third quarter of 2021, expanding by a record 33.8%, but that was not enough to offset earlier losses. The US went into recession in March 2020, ending 128 months of expansion, the longest in U.S. history. The Federal Reserve expects GDP growth to rise by 7% in 2021, slowing to 3.2% in 2022 and 2.4% in 2023. It also expects the core inflation rate to be 3% this year, dropping to 2.1% in 2022 and 2023 – against a target rate of 2%. The core inflation rate strips out some of the most inflation-prone goods, such as food. The US consumer price index – the government’s preferred measure – was an annualised 5.4% in September. But its annualised producer price index rose 8.3% in August, the biggest increase since records started being kept, in November 2010. That came following a 7.8% move higher in July, which also set a record.
These higher wholesale prices will feed through to higher consumer prices. The US National Federation of Independent Business’s latest monthly survey shows the proportion of small businesses preparing to raise prices in the next three months at its highest in more than four decades. It has only once been higher, during the oil crisis of 1979.
Growth is slowing globally, according to the International Monetary Fund (IMF). It now expects world GDP growth to be 5.9% this year, marginally lower than its July estimate. In Germany, Europe’s biggest economy, annualised inflation in September was 4.1%, the highest since December 1993, with heating oil going up by an astonishing 76.5%. The UK economy actually shrank in July according to official statistics.
It may be time to dig out the “misery index”, the creation of the US economist Arthur Okun. He invented it to give President Lyndon Johnson an easily digestible snapshot of the US economy. Okun added together the unemployment rate and the annual inflation rate and came up with an index. During the 1969-74 Nixon administration (1969-74), the misery index highest point was 13.61. It hit 19.9 during the Gerald Ford presidency of 1974-77. During Jimmy Carter’s presidency (1977-1981), it hit 21.98, and was at least partly responsible for his defeat in the 1980 election.
Since Okun created it, the misery index has been modified several times, the latest formulation by the esteemed economist Steve Hanke. Hanke’s modified index is the sum of unemployment, inflation, and bank‐lending rates, minus the percentage change in real GDP per capita. Higher readings on the first three elements are “bad” and make people more miserable. These “bads” are offset by a “good” (real GDP per capita growth), which is subtracted from the sum of the bads. The higher the score, the more the misery. Hanke’s index also includes many more countries, not just the US.
Hanke’s annual misery index for 2020 has Venezuela at its top, the most miserable country. No surprise there; inflation is about 2,500% and Venezuela cut six zeros from its currency, the Bolivar, at the start of October. Venezuelans have lost all faith in their fiat currency and prefer holding US Dollars, but they are required to use the Bolivar for everyday transactions. While the Bolivar loses 2,500% of its value each year, the US Dollar is losing only some 5%.
The UK ranks number 87 on the 2020 index, with a reading of 22.5, while the US comes in at 109, with a reading of 16.7. But if we stick with Okun’s orthodox index, we see that the misery index for the US has risen to almost 11%. High, but not yet President Carter levels. But it’s definitely travelling in the wrong direction.
Stones in our shoes
Kristalina Georgieva, the Bulgarian who this week narrowly avoided being fired from her job as head of the International Monetary Fund (IMF) after allegations that she tampered with data while chief executive of the World Bank, to flatter China’s economic record, says recovering from the Covid-19 pandemic is “like walking with stones in our shoes”. It feels more like walking in clogs containing boulders.
The IMF, like most economists, is superb at telling us what we already know. It did it again this week. In the words of the Financial Times, the IMF said: “The global economy is entering a phase of inflationary risk… it called on central banks to be ‘very, very vigilant’ and take early action to tighten monetary policy should price pressures prove persistent”. One wonders what planet the IMF’s experts are living on. Maybe their tax-free Washington D.C. lifestyles have caused a collective brain-spasm. In the UK real wage rises are about 4% higher than a year ago – but those lucky to get a wage rise will not be better off, because inflation will outstrip most wage rises. Once that sets in, then we can expect workers to demand more increases – and wage-price spiral will be with us. The only thing preventing this from happening already, the key difference with the 1970s, is that workers today are far less likely to be able to flex union muscles than in the 1970s.
Crude oil has topped $80 a barrel, global food prices are a third more expensive than a year ago, container costs on the sought-after route Shanghai-Rotterdam have gone up by 570% from a year ago… the list of huge price jumps goes on and on. Inflation is “transitory”, some leading central bankers tell us, as they resist putting up interest rates – normally the first choice in fending off excessive inflation.
But not all central bankers see inflation as temporary. Poland’s central bank unexpectedly raised its benchmark interest rate by 0.5% on 6 October after inflation hit 5.8% in September, the highest in 20 years. New Zealand’s central bank has raised its main interest rate for the first time in seven years. So too have the central banks of Brazil, Hungary, Romania and Russia, in all of which inflation is moving much faster than officially expected. The 300% rise in the benchmark price of natural gas so far this year in Europe – with winter’s cold just around the corner – has been a nasty shock.
Not looking for work
If the US economy is to get back onto a firm growth foundation then people need to work. So far they are reluctant. In September, the figure for non-farm payrolls – the closely-watched US monthly data that gives a clue about the overall state of the economy – went up by a miserable 194,000, far below expectations of 500,000. This followed an equally disappointing jobs report in August – the estimate had been that more than 700,000 new hires would happen in August, but the actual result was only 235,000. The labour force participation rate – a measure of the share of Americans who are employed or are looking for work – fell in September, to 61.6%. There are jobs; many jobs and sectors are even paying higher wages; average hourly earnings in the US rose by 0.6% in September. But people aren’t flocking back to work. In fact a record 4.3 million Americans quit their jobs in August; employers had 10.4 million unfilled positions at the end of August, down from a record of 11.1 million a month earlier. It was the first decline in job openings since December 2020 but still marked the second-highest figure ever recorded. The British Chambers of Commerce said that 80% of companies struggled to find workers in September. The economy has ‘stagflation is on its way’ stamped across it in florescent red letters.
Why are millions of Americans staying away from jobs? Plenty of explanations are offered – such as people needing to do childcare, or people are still nervous about Covid-19 infections. Maybe there’s a simpler reason – on the whole people may feel they aren’t paid enough.
Source: Center for Economic and Policy Research
We think prices are going up
In September, a survey of 1,300 households by the New York Federal Reserve found that the expectation for where inflation was headed was the highest for the past three years. They collectively think that food prices will rise by 7.9% over the next year; rents are expected to increase by 10% over the next 12 months and the price of medical care is expected to rise by 9.7%.
At some point it will become apparent even to Jerome Powell, chair of the US Federal Reserve, Janet Yellen, the US Treasury Secretary, Andrew Bailey, governor of the Bank of England (BoE), and Christine Lagarde, president of the European Central Bank (ECB), that the inflation they currently see as being a passing puff of hot air is more like a 1915 chlorine gas attack.
But the tools they have to combat stagflation are contradictory. To fight inflation, central bankers resort to putting up interest rates, making credit (mortgages, loans) more expensive and forcing people to cut their spending. It’s worth remarking how they kid themselves that increasing the money supply isn’t inflationary, but when they need to curtail inflation the only tool they have is to cut or stifle the money supply.
And what do they do to avoid economic stagnation? They pump money – either borrowed or freshly made money – into the economy.
Bob Prince, co-chief investment officer at Bridgewater Associates, the world’s biggest hedge fund put the dilemma well: “If there is inflation, the Fed is in a box because the tightening won’t really do much to reduce inflation unless they do a lot of it, because it is supply driven. And if they do a lot of it, it drives financial markets down, which they probably don’t want to do… Deciding between the lesser of two evils, what do you choose? I think most likely you choose inflation because you can’t do much about it anyway”.
That’s why stagflation is the stuff of nightmare. If all you have to fight is inflation, you know what to do – increase interest rates, tighten the money supply. If you face an economic slowdown and deflation, you also know what to do – make money cheaper. But when you face both at the same time, when stagflation is on its way, which one is the bigger enemy?
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