The banks think conditions are fantastic, and it’s nothing but up from here for house prices.
Dr Doom reckons stagflation is coming.
Let’s break down why this is interesting.
So Dr Doom is Nouriel Roubini. He earned his evil villain moniker by being one of the few economists to anticipate the Global Financial Crisis.
He also tends to be a bit bearish by nature, and he’s not known for pulling any punches. Hence, Dr Doom.
And he reckons stagflation is coming.
Stagflation is what you get when the economy is collapsing AND prices are rising. It doesn’t happen that often. Normally prices rise when the economy is doing well.
But every now and then you get a collapse in output, and a rise in prices. The most famous recent examples were the oil shocks in 1974 and 1979.
And this is important. The super-cheap money settings we’ve got right now are based on the premise that inflation is contained and is not going to be a problem.
If the inflation dog gets off the leash, then central banks will be forced to raise rates, choking off the recovery before it’s fully established, and possibly causing asset markets to cool.
So this is something to be watching.
Fortunately, I reckon Dr Doom’s clutching at straws.
I don’t find his shopping list of arguments particularly persuasive. First up, he reckons that the US and the rest of the world are just printing and spending too much money.
Centrals banks have been monetizing large fiscal deficits in what amounts to “helicopter money” or an application of Modern Monetary Theory. At a time when public and private debt is growing from an already high baseline (425% of GDP in advanced economies and 356% globally), only a combination of low short- and long-term interest rates can keep debt burdens sustainable.
Monetary-policy normalization at this point would crash bond and credit markets, and then stock markets, inciting a recession. Central banks have effectively lost their independence.
True, but where’s inflation coming from? It’s not in the data yet. It’s not even in the forward indicators. Old school demand side inflation (where the economy runs so hot that prices get a run on) seems a long way off.
I mean, central banks have been under-shooting their targets for a decade or more. They’re dreaming of inflation. They’re praying for it.
But we live in a world where deflationary pressures are everywhere. Western economies are saturated with supply. We’ve reached peak stuff. At the same time, the developing world continues to add massive production capacity, with a billion or so workers waiting in the wings.
The world has ample capacity to fill any increase in demand that we create.
And it has done for years. That’s what driven disinflation, and made it so hard for central banks to hit their targets.
And none of that is going anywhere.
But stagflation normally happens with a supply-side shock. And it is true that Covid is a big F-off supply side shock.
But will it be long lasting?
Dr Doom believes it could be:
In today’s context, we will need to worry about a number of potential negative supply shocks, both as threats to potential growth and as possible factors driving up production costs. These include trade hurdles such as de-globalization and rising protectionism; post-pandemic supply bottlenecks; the deepening Sino-American cold war; and the ensuing balkanization of global supply chains and reshoring of foreign direct investment from low-cost China to higher-cost locations.
Yeah, that’s fair enough. The poles of global trade are shifting. But that’s not a long term thing. Once supply chains have established themselves with a bit more distance to China, the story’s done. It’s not going to keep driving prices higher. It’s in play now, but I don’t expect it will be in 18 months.
Equally worrying is the demographic structure in both advanced and emerging economies. Just when elderly cohorts are boosting consumption by spending down their savings, new restrictions on migration will be putting upward pressure on labor costs.
Moreover, rising income and wealth inequalities mean that the threat of a populist backlash will remain in play. On one hand, this could take the form of fiscal and regulatory policies to support workers and unions – a further source of pressure on labor costs.
On the other hand, the concentration of oligopolistic power in the corporate sector also could prove inflationary, because it boosts producers’ pricing power. And, of course, the backlash against Big Tech and capital-intensive, labor-saving technology could reduce innovation more broadly.
Ok, this is where Dr Doom is really clutching at straws I reckon.
Demographics in the developed world are highly deflationary. Old people don’t buy stuff. They have lots of stuff. The look to sell down stuff.
And sure, maybe wages get a bit of a run on as workers try to organise and fight inequality. But so what? Wages have been crushed in recent years, as the global labour market becomes more integrated and workers in developed countries find themselves competing with workers in emerging markets.
That’s not going anywhere, and any pick up in wages will be gladly welcomed by politicians and central bankers alike.
And that bit about a backlash against Big Tech discouraging innovation and driving up prices? That’s just nonsense.
The power of big tech has been one of the key features driving down wages costs and driving down the prices of consumer goods. It would be amazing if we could take the foot of that accelerator. But the idea that we could do that, and then get that car in reverse and start putting upward pressure on prices… that’s a bit of a stretch to me.
So yeah, Dr Doom, I’m not buying it.
Yes, there’s some short-term supply shocks in effect. Inflation will spike in the short term.
But this is still a deflationary world.
And our central bankers are chill.