The biggest threat to the economy is not the one you think it is - article by Jeremy Warner
Western governments are drowning in post-pandemic debt, so even modest interest rate rises threaten to tip economies back into recession
Jeremy Warner for the Telegraph
21 October 2021
Inflation is the word; whether transitory in nature, or more enduring, inflation risk is for now the only macro game in town as far as the dismal science is concerned.
As regular readers will know, I've tended to lean towards the latter of these two judgments, but only a fool would say it with any certainty. I'm more than ready to eat my words.
In any case, to the already well trodden arguments of transitioners and endurers might be added a third category, which ever since the financial crisis has been lurking in the shadows, but has not been much aired in the current debate – Japanification.
This is the idea that whatever the present inflationary pressures might be saying, we are all going to end up like Japan, with permanently low inflation, low growth and low interest rates to match.
It's a gloomy prognosis, but one which the pathology of Western economies makes only too plausible.
So here's how it works. Almost everywhere, inflation is on the up, driven primarily by rising commodity prices and the mismatch between supply and demand as economies recover from the ravages of the pandemic.
It's not just the UK: consumer price inflation in the US is already at 5.4pc, a 13-year high.
US inflation rose again in September
Inflation is also rising strongly in both France and Spain, while in Germany it's at 4.1pc, a 29-year high, with more plainly to come judging by wholesale price inflation of 13.2pc, the highest rate since 1973.
For a nation as culturally averse to inflation as Germany, these are eye-popping, almost intolerably high numbers, which if they persist are almost bound to revive questions over the durability of the single currency.
Even as a one-off change in the level of prices, they are very hard to explain to inflation-averse German voters.
The paradox here is that many of the inflationary pressures we see today, particularly sharply higher energy prices, are deflationary in their consequences, in that they take money out of people's pockets, reducing disposable income correspondingly.
Even so, there is only so long central banks can hold back the tide of higher interest rates in the face of such pressures.
In comments last weekend, Andrew Bailey, Governor of the Bank of England, seemed already to have conceded that rates will have to rise sooner rather than later.
For the UK, that probably means the December meeting of the Bank's Monetary Policy Committee and possibly as early as next month.
The rise in Bank Rate anticipated by markets, from 0.1pc to 0.25pc, may sound insignificant. This is just the gentlest of touches on the brake. Just before the pandemic, it will be recalled, Bank Rate was at the positively racy level of 0.75pc.
Yet any change in the interest rate cycle is an important marker; more rate rises will surely follow.
Rates to return to pre-Covid level next year
For those who think inflation is going to be persistent, yours truly included, central banks are behind the curve. They should have acted sooner, and perhaps more aggressively.
Yet the problem is excessive debt. Both governments and their economies are drowning in the stuff following a fiscal response to the pandemic comparable in its magnitude to that of an all embracing war.
As a consequence, it won't take much in the form of higher interest rates to tip economies into recession. In other words, this is very much a Japan-like problem, where the sheer weight of the debt becomes like a permanent anchor on growth, and therefore inflation and interest rates.
Deflation, not inflation, fast becomes the more enduring challenge.
Already we see signs of rapidly slowing growth in the US and China, and that's without any monetary action at all, at least in the US, where for the moment all that's planned is a little gentle tapering in the asset purchase programme.
However, there is one rather glaring gap in the Japanification story.
If we take it as read that one of the biggest factors in the taming of inflation over the past 30 years is globalisation, then if this is about to go into reverse, so too are the disinflationary forces that globalisation has given rise to.
Should President Xi Jinping go through with his increasingly bellicose threats and invade Taiwan, it would put rocket boosters on an already evident decoupling agenda; economic sanctions stretching possibly to a complete trade embargo would likely be the least Western powers would do by way of retaliation.
Money talks, and Beijing would possibly counter by cutting its prices even further, doubling down on its disinflationary effect on Western economies.
Either way, things would quickly get ugly. Even the sort of mild decoupling from China currently envisaged as Western economies attempt to build resilience by making themselves more self-sufficient, would be inflationary.
On the other hand, it would also create a global glut in capacity, which further out would be deflationary. Inflationary and deflationary forces would collide.
Small wonder central banks are running around like headless chickens, not knowing which way to turn.
Once debt on the scale we see today has been created, it's very difficult to get rid of. In the past, governments could simply inflate it away, but in a global economy that's not so easily done.
This article is an extract from The Telegraph’s Economic Intelligence newsletter. Sign up here to get exclusive insight from two of the UK’s leading economic commentators – Ambrose Evans-Pritchard and Jeremy Warner – delivered direct to your inbox every Tuesday.
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