Fifty years ago, President Richard Nixon had a problem. His first of many. The US economy was still groggy as the US involvement in the Vietnam War was ending. His 1972 re-election prospects were going sour.
To engineer a solution, he fired William McChesney Martin as chairman of the Federal Reserve and installed Arthur Burns, who cut interest rates and increased the money supply.
The consensus view, this time round, is that inflation will be suffocated by an on-going slump. But some analysts are concerned by a possible return of Nixon’s stagflation
Nixon weakened the dollar by cutting its last link to gold and introduced an import tax, to help exports. He introduced wage and price controls which worked, short term. He won his election by a landslide.
The rest of his term was dominated by Watergate, an oil price hike, industrial unrest and double-digit inflation. Wage control was dropped: it is tough to get workers to stick to a pay deal when prices are rising fast.
It took years for subsequent Fed chairman Paul Volcker to squeeze inflation out of the system through monetary discipline and high interest rates.
This is a period of history Americans try to forget. But it shows how things go wrong when policymakers over-stimulate demand while damaging their currency and the means of production.
The consensus view, this time round, is that inflation will be suffocated by an on-going slump. But some analysts are concerned by a possible return of Nixon’s stagflation, as Covid-19 outbreaks continue.
The current price of gold is approaching $1,800 an ounce, close to an eight-year high and the dollar has weakened. The yield on index-linked bonds is the lowest since 2013.
At a recent Bloomberg conference, strategist Nouriel Roubini warned of the stagflationary consequences of monetary stimulus and a fragile recovery. “We’re going to be faced now with a significant amount of negative supply shocks in the global economy. Eventually, the inflation genie will get out of the bottle.”
Global politicians and central banks have been using a rich mix of monetary and fiscal tools to bolster the economy and contain job losses. Maybe you can’t blame them.
In the US, however, stimulus will nearly double the fiscal deficit to 13% of GDP. Spain talks of 20%. Germany has given up six years of fiscal restraint to hit 10%.
Mario Draghi, former head of the European Central Bank, has said debt cancellation may be needed. President Trump, seeking re-election, has supported whatever it takes.
Stimulus is restoring confidence by re-inflating asset values and pension savings. But the measures are enriching wealthier individuals, rather than the relatively poor.
Politicians dare not talk of austerity. Instead, they are expected to print money to support the market, while distributing some to individuals through helicopter money, proposed in Russia and Hong Kong, as well as the US.
They are also blaming other countries for their problems through nationalism, which is leading to military sabre rattling and expensive trade tariffs.
Governments will need to make greater use of bond issuance than taxes to help pay their way. But bond yields close to zero will not be sufficient for investors in an inflationary era.
According to Ardea Investment Management: “Too little stimulus means a painfully severe recession. Too much risks loss of credibility on inflation control and government debt sustainability. It would be imprudent not to question whether government bonds are still the “safe haven” they are assumed to be.”
Ardea reckons we could soon see the return of the bond vigilantes of the 1980s, pushing back on excessive state spending by demanding a bigger yield for their buck. Or we could get ever more extreme money printing.
According to strategist Burton Malkiel, bonds are already starting to lose their appeal: “Safe bonds now do not provide income and in the long run may have some real risk, because if we do get some inflation in the future, yields will rise and their prices will go down.”
The velocity at which money changes hands remains low. But money supply is starting to surge, and moving into the hands of consumers as opposed to ten years ago when it was stuck in the banks.
Economist Tim Congdon expects the increase initially to stimulate the economy, then lead to an inflationary boom. Economist Ken Rogoff warns of disruption of global supply chains: “A supply-side driven downturn can result in sharp declines in production and widespread bottlenecks.”
Inflation in one sector can influence prices elsewhere, if an economy is unstable. In research for Harvard University, Albert Cavallo has found evidence of more rapid price rises for products impacted by Covid-19, led by food. Farm supplies are also being disrupted by Covid-19.
Rogoff adds: “A sustained retreat behind national borders, owing to a Covid-19 pandemic on top of rising trade frictions, is a recipe for the return of upward price pressures.”
Technology could facilitate a glorious rebirth for the global economy. It may even help the discovery of a vaccine against Covid-19, which would change everything. The consensus is that depression is a greater risk than stagflation and stimulus is necessary.
But history shows that when inflationary expectations change, they can change suddenly, as soon as recent experience is forgotten.
Charles Goodhart, former economist with the Bank of England, thinks the process could begin as people leave lockdown.
In the circumstances, hedging against rising prices may make sense. It is also worth keeping an eye on US long-dated treasury bonds, which will surely come under significant pressure if stagflation starts taking hold.