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This article first appeared in the Telegraph
The coronavirus has accelerated trends that were already underway. This is clear to those of us who overnight have been transformed from office commuters to back-bedroom Zoom-workers. A five-year shift in working patterns has been pushed through in three months.
In other ways, too, the Covid-19 outbreak has speeded up changes that were probably on their way but not yet quite on the horizon. Prominent among these is a reversal of the disinflationary environment that has characterised the past 30 or so years. It may seem strange to be talking about inflation as we teeter on the brink of a devastating recession, but just as we underestimated the deflationary trends of the past there is a risk that we fail to grasp the inflationary path we are embarking on today.
Inflation hawks have been the boy who cried wolf for a generation now. The strong growth of the 1990s and 2000s failed to lead to the spiralling prices that some predicted and so too did the emergency monetary policy that followed the financial crisis. In both cases, inflationary impulses were smothered by the massive disinflationary pressures of China’s absorption into the global economic system, technological progress and the suppression of labour by powerful employers.
The coronavirus has knocked the final nail into the coffin of that disinflationary world, but it is really just finishing off a job that the financial crisis had already begun. According to Morgan Stanley, the inflationists’ worrier-in-chief, there are two main drivers of the inflationary shift, both of which were evident before the world locked down.
The first is the way in which governments have belatedly swung behind exhausted central banks in a massive co-ordinated support scheme for economies looking into the abyss of another Depression. The absence of active fiscal policy after the financial crisis - indeed the implementation of its mirror-image in many countries’ austerity programmes - was a key reason we have ended up trapped in a low growth, low inflation doom loop for the last 12 years.
The scale of the fiscal support packages already unveiled - and there will be many more - is staggering. At 14% of GDP in the world’s four biggest economies, up from 3% last year - the stimulus is already 1.6 times that employed in 2009. In the US, the budget deficit is forecast to reach 24% this year, its highest level since 1942. It is the combination of this fiscal largesse with the willingness of central banks to fund it to infinity that is ringing inflationary alarm bells.
The return of fiscal activism is a victory for so-called Modern Monetary Theory, the idea that government spending, not interest rates, should be the principal tool to achieve full employment and stable prices. At its heart is the belief that there are no limits on how much a government can spend as long as it issues and borrows in its own currency. The only effective constraint, as long as you are prepared to accept the end of central bank independence, the politicisation of spending and an erosion of institutional credibility, is inflation.
The second driver, and the reason why all the above are probably inevitable, is the rise in inequality that technology, globalisation and the concentration of corporate power have triggered in recent years. These trends were evident even before the financial crisis but the single-minded focus on monetary policy (which explicitly favours owners over workers) has accelerated them since, culminating in populism, protectionism and growing pressure on what Morgan Stanley calls tech, trade and corporate titans.
Now coronavirus is accelerating all of these inflationary impulses. Globalisation is giving way to ‘slowbalisation’ in a world that’s increasingly looking to close national or regional borders. Global supply chains are cracking in favour of more resilient local networks, especially in areas deemed to be important to national security such as pharmaceuticals, medical equipment and telecommunications. Scrutiny of powerful corporate oligopolies will only intensify.
So, coronavirus is not the cause of inflation but a catalyst. What is less clear than the direction of travel for rising prices is the timing of the shift to a more inflationary environment. Before we get there, we will have to navigate a massive economic shock which the numbers are only just starting to confirm. In the short-term, a collapse in demand for goods and services during lockdown, a rise in precautionary saving, falling confidence due to lower house prices and pension pots, the collapse in the oil price and wage cuts even for those holding onto their jobs, argue for a sharp fall in inflation measures.
In the medium term, one to three years, the inflationary outlook will depend on: the speed with which life gets back to normal; how long social distancing measures remain in place; whether the earthquake of Covid-19 leads to a tsunami of unemployment and then a Fukushima of bankruptcies; the extent to which governments lose their fiscal nerve and try to repair their balance sheets with higher taxation and reduced spending.
But longer-term, the greater likelihood is that governments will keep expansionary fiscal policies in place until they hit up against the one remaining constraint, inflation. They will do this because the impact of Covid-19 and the looming recession will be felt disproportionately by the lowest-paid and most vulnerable, because the disease is seen as an existential threat that must be countered at any cost, and because the scarring from the coming recession will be so deep that it will seem cruel and unreasonable not to maintain supportive policies for longer than hindsight will suggest was necessary.
Important information: Investors should note that the views expressed may no longer be current and may have already been acted upon. Overseas investments will be affected by movements in currency exchange rates. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to an authorised financial adviser.