Stagflation becoming global

It is important not to succumb to hysteria, tempting as that is right now. It’s equally important not to close one’s eyes to painful reality. The global economy is looking sickly right now, from China to Europe to the US.

China’s gross domestic product (GDP) in the first quarter came in at 4.5% - strong economic growth by most nations’ standards – but hopes that 2023 might see overall growth of 5% are now looking shaky. The unemployment rate for youth (defined as 16 to 24 in China) is almost 20%; college graduates in June this year are expected to total almost 12 million. China will struggle to find jobs for them. China’s Caixin manufacturing purchasing managers index fell to 49.5 in April from 50 in March, suggesting a contraction in factory output. While some companies have expressed disappointment that China’s recovery from its strict Covid-19 lockdowns is patchy, they take comfort from the fact that, officially at least, China’s consumer price index (CPI), i.e. inflation, is very low, just 1% (year-on-year) in February[. Yet this very low inflation rate speaks of a country that is not spending – fuelling economic growth – but saving. Some senior state analysts now think that deflation has started. “The economy has fallen into recession territory,” thinks Liu Yuhui, a professor with a top government think tank, the Chinese Academy of Social Sciences (CASS), during a recent speech.There have been calls for Beijing to hand out Yuan 500 billion ($72.5 billion) in ‘consumption vouchers’ to individuals to encourage spending.As yet there’s no indication that China will resort to this version of ‘helicopter money.’

The global financial adjustment taking place is creating some new partners. Argentina’s government has said that it will start to pay for Chinese imports in Yuan rather than US Dollars. Argentina is a major exporter of soybeans and other agricultural products to China; China exports to Argentina mostly electronic products. Partly this move is prompted by Argentina running out of Dollar reserves but it’s also part of a slowly moving trend; the Yuan has just surpassed the Dollar as the most widely-used currency for cross-border transactions with China. Argentina’s inflation has got out of hand and is now more than 100% (annualized); the black market exchange rate at Pesos 400/$1 is twice the official exchange rate, and the central bank’s main interest rate is now 91%. Argentines no longer believe in their own currency; they withdrew $1 billion from their Dollar accounts over the past month.

Very ‘sticky’ inflation

Fighting inflation has been the main preoccupation of leading central banks for the past year or more. In the US the consumer price inflation (CPI) peaked last June at an annualized 9.1% and has since crept lower, to 5% in March. But core inflation, which excludes energy and food prices, is proving extremely sticky; it was 5.6% in March against February’s 5.5%. In the UK inflation peaked higher, at 11.1% in October, and is falling back even slower, to 10.1% in March, while that month food prices went up by an eye-watering 19.1%. In the Eurozone inflation declined from 8.5% in February to 6.9% in March, though as in the UK this overall figure disguised a rise of 15.5% in food, alcohol and tobacco prices, compared to 15% in February. Eurostat, the statistical office of the European Union (EU), expects inflation in April across the Euro area to be 7%.

Stagflation implies persistently high rates of inflation while the rate of economic growth slows considerably; it’s generally accompanied by higher unemployment rates. It is universally recognised as the worst of all possible worlds – prices increasing, while the economy slows and demand (which if higher would stimulate better growth rates) falls.

Are we close to stagflation? Larry Summers, a former US Treasury Secretary, told Bloomberg recently “I think we’ve got a bit of a stagflationary problem developing.

”It’s a view the economist (and gold investor) Peter Schiff shares: “This is stagflation and it’s going to get worse” he told the US cable channel Fox News. They may be right – time will tell.

Central banks manipulate interest rates to exercise some control over borrowing and spending. They were late to recognise that inflation this time was not “transitory” (as they referred to it in the early stages) and have belatedly put interest rates slightly higher in the hope that it might reduce consumer spending without causing too much consumer pain. The federal funds rate in the US is now 5%-5.25%, in the UK the Bank of England (BoE) base rate is 4.25% (and probably will rise to at least 4.5% this week) and the main rate set by the European Central Bank (ECB) is 3.50%. These rates are obviously all significantly lower than inflation; an odd way of going about stifling inflation, but the central bankers are (understandably) worried that if they put rates up to levels that outstrip inflation they could easily tip economies into recession.

All three central banks have a ‘target’ of maintaining inflation at 2%/year; so why has the BoE, for instance, set interest rates at less than half the inflation rate? It doesn’t make sense – unless we recognise that the UK economy is currently so febrile that putting up interest rates to a level beyond that of inflation would, think the BoE, send the economy into a death spiral, with mortgage defaults, company bankruptcies, unemployment, all zooming to politically unacceptable levels. Presumably the same reasoning is influencing the absurdly low ECB interest rate.

The 2% target for inflation is probably dead in any case – one way or another, central bankers will try to ease their way into pushing onto the public a more easily achievable target, perhaps 4%. Christine Lagarde, the ECB’s boss, is obviously thinking that way. She warned recently that inflation could easily spike up by 5% due to the tensions between China and the US, pointing out that Europe relies on China for 98% of its supplies of rare earths, vital for a wide range of products. The easing of energy prices across Europe is thanks to the unseasonally warm winter we have experienced in the northern hemisphere, not because the energy market has structurally improved.

Crisis after crisis

The job of a central banker is trickier today than it has been for years. Inflation tops the list of worries but astronomical debt, low productivity, collapsing banks and the shrinking of credit are close behind. For political leaders life isn’t any easier. The US under President Biden is spending far more than it is taking in taxes – nothing new there, perhaps, except that the debt ‘ceiling’ deadline is now perilously close without any apparent solution. Fewer banks have folded than in the worst days after the Great Financial Crash, but their assets are much greater. The Dollar has been weaponized against Russia; almost one-third of the global economy is now under sanctions imposed by the US, EU, or the United Nations.

If it’s a question of morality, sanctions may be desirable; if it’s a question of economics, much less so.