Why the global inflation surge could signal an economic collapse

The link between inflation and asset price collapse or debt market implosion might have been forgotten, but it is still there
Policymakers cannot afford to ignore the increasingly shaky state of the foundations on which the global economy rests

Anthony Rowley

Published: 3:30am, 22 Nov, 2021

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Those who argue that the current trend of global inflation is a “transitory” phenomenon are failing to see the phenomenon in the wider, more worrying, context of what it presages for markets, financial institutions and the global economy.

To illustrate, anyone walking down a street of high-rise buildings during an earth tremor when the buildings begin to sway need not panic, alarming though the experience can be, provided the buildings have solid foundations. Tremors are often transitory and do not always portend major earthquakes.

But if some of those figurative skyscrapers are houses of cards or are built on sand, everyone had better run for their lives. This will be no transitory tremor but a shock that could lay waste to the entire city.

Thus it is now with the current bout of inflation, running at a 30-year high in the US and at long-time highs elsewhere. This could be just the passing tremor policymakers are hoping and praying for, but they cannot afford to ignore the shaky state of the soaring edifices around them.

One of these is the stock market (Wall Street and others), whose record high valuations are built on a relatively small base of corporate earnings, or “rich” price-to-earnings ratios in market jargon. Any inflation tremor that does not pass quickly could easily turn into a crash there.

Another is the skyscraper symbolising the colossal amount of debt that has accumulated in the global economy at household, corporate and government level since central banks began printing money on a scale that gives new meaning to the term mass production. This tower of debt is vulnerable to collapse now that rumblings of inflation are growing louder by the day.

The link between inflation and asset price collapse or debt market implosion might have been forgotten, but it is not missing and it will hold. Their frequency – seen in the form of rapidly rising inflation episodes – has already led to the tapering of quantitative easing, and central bank moves to raise interest rates will certainly follow as unease grows over the speed and spread of rate increases across economies.

Deutsche Bank CEO Christian Sewing recently called on central banks to tighten monetary policy to counter surging inflation. He argued that it was producing risky side effects and would last longer than policymakers expect. It can no longer be shrugged off as transitory.

This might not sound too surprising coming from a native of a country that experienced the hyperinflation of the Weimar Republic, but fears of runaway inflation are spreading well beyond Germany. The expectation of compensating sharp rises in interest rates is also spreading.

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As analyst Craig Erlam, at foreign exchange specialist Oanda, put it, “Gone are the days when bad news is good news and central bank inaction keeps the party going in equity markets. Investors are concerned about the levels of inflation that we’re seeing and how widespread it is.”

Yet, even Paul Krugman – a commentator and economist for whose writing I usually have much respect – has seemed to overlook the “context” of inflation. He argued recently in The New York Times that policymakers should not overreact to “one-time” spikes.

He brought up examples such as the 1946-48 inflation surge, when consumers came out of hiding again and began sending after World War II, and the great inflations of the 1970s caused by oil price rises and runaway wage inflation in some countries. All proved to be transitory in nature.

But that is not the point. This time is different. As noted, the inflation surge comes at a time when financial and real estate asset values have been boosted to record and clearly unsustainable levels. That was not the case during previous great inflations.

How can inflation be transitory if supply chain disruption is here to stay?

As measured by the consumer price index, the annual rate of inflation in the US to October 2021 was 6.2 per cent. Annual inflation was running at 4.4 per cent in October in the European Union, and the UK’s Consumer Prices Index rose by 4.2 per cent in the 12 months to October.

Dramatically accelerated though these rates have become, they still do not approach the inflation levels seen in some previous episodes and certainly do not suggest hyperinflation. They are, to a large extent, caused by supply chain bottlenecks which continue to worsen as the Covid-19 pandemic reasserts its grip.

But again, it is not the absolute levels of inflation that are most important at this time – it is the very fact of inflation. The phenomenon had, in many people’s view, been banished by supposedly perpetual monetary easing and Modern Monetary Theory.

Inflation has returned from the dead, as the rising gold prices attest, while its persistence is likely to consign cryptocurrencies such as bitcoin to the crypt. Inflation’s resurrection threatens to undermine markets in a way that resembles or even surpasses an earthquake.

Anthony Rowley is a veteran journalist specialising in Asian economic and financial affairs