Stagflation was prophesied by Nouriel Roubini, a former adviser to President Obama. Roubini is legendary for regular apocalyptic visions of economic disaster. He is rightly nicknamed Dr. Doom.
It is September 2021 and predictions of stagflation are multiplying. On the face of it, it doesn’t look like that at all. Compared to last year, the economies of the major countries are growing at very respectable rates. However, the devil is in the word ‘compared to last year’. In the spring of 2020, the global economy has hit rock bottom. And now it is scraping out. Admittedly briskly, but it still hasn’t reached the edge of the pit. In other words, after factoring in inflation, few major economies have at least reached 2019 levels.
The current recovery has some unexpected features. Around 20 million people lost their jobs in the US after the pandemic broke out. Unemployment has soared. While the recovery has brought a significant drop in the unemployment rate, the increase in employment has not been as significant. How is this possible? There are about four percent fewer people working in the U.S. today than there were before the corona. Many of the unemployed have disappeared from the statistics because they have stopped looking for work. In particular, workers in sectors such as food service and agriculture found that unemployment benefits were more generous than a beggar’s wage. To get them back to work, employers will have to offer them higher wages. This may translate into higher inflation.
Another atypical feature of the current recovery is the continuing breakdown in supply networks. Only now are we seeing that these networks have been disrupted more than we expected. When supplies are absent or delayed, the master is the one who pays too much. It is always better to pay a little more than to stop a production line or send home construction workers. Gradually, everything becomes more expensive. From timber to aluminium to gas. All increases in production prices will naturally be passed on to consumers. They will demand higher wages, which will translate into higher production costs. Just a few years ago, economists feared a deflationary spiral. Today, they are wondering if an inflationary one is coming. What has changed? After all, just a few years ago we were afraid of deflation. And the money printers were going full blast back in 2009. Why wasn’t there inflation then and why is there inflation now?
Inflation in assets
Inflation is a condition where “too much money chases too few goods“. Even though central banks have printed literally mountains of money, the production of goods and services has functioned smoothly. Thus, inflation has mainly been reflected in capital asset prices and not in consumer prices. The last stagflationary episode in the 1970s and 1980s was caused, among other things, by the disruption of oil supplies due to the wars in the Middle East. The shortage of oil sharply increased oil prices. High oil prices literally spilled over into consumer prices. Today, we are experiencing a similar supply shock, albeit not as sharp.
For now, it still seems that these inflationary pressures are temporary and will ease as the global economy, rocked by pandemics, disrupted networks and a sharp recovery, gets back to normal. But when “normal” will return is harder to say today than it was six months ago. A growing number of economists think inflationary pressures may continue not only this year, but next year as well.
Increased inflation is presenting investors with tough choices. In particular, it is eating into savings held in bank accounts. In the US, inflation-indexed government bonds (so-called TIPs) are a popular asset. Their interest rate is set according to the rate of inflation. It looks great, but there are a few catches. The maturity of the bonds is between 5 and 30 years, which is quite a lot. However, we don’t have inflation-indexed bonds in Slovakia anyway, and we won’t have them anyway. Issuing them is difficult for the state. There are few rich countries in the world that can afford such issues. Those who want to can buy US TIPs, but they have to reckon with the cost of purchase and the exchange rate risks of the euro against the dollar.
The obvious choice, on the face of it, is to invest in equities. But there are even more hooks than with TIPs. Central banks have printed huge amounts of money in recent years. Most of it has found no use in the real economy and has ended up in the stock markets. Inflation in assets is huge due to money printing. Before the 2008 crisis, the US stock index was worth 1 500 points. Today, it is worth three times that. The real US economy (measured by the volume of gross domestic product) has grown by only half in the same time. The difference between half and three times is de facto asset inflation.
Besides, historical experience tells us that stocks have not worked very well as a hedge against inflation. – Vladimir Balaz
Many investors have become accustomed to the idea that stock markets can only go up and that this is some kind of law of nature. It isn’t. If increased inflation forces the US central bank to raise interest rates (perhaps as soon as 2023), stock markets will be the first casualty of higher interest rates. If, for example, interest rates reach four per cent, that would be enough for many investors to pull out of the stock market altogether. There is no need to even raise interest rates for a major stock market correction. It is enough if the central bank slows (but does not stop) money printing.
There are no completely safe harbours
What about “absolute safe havens” like gold and real estate? Money printing and asset inflation have also had an impact on the price of gold. A kilo of gold today costs about 50 thousand euros. Three years ago it was only 33 thousand. Contrary to popular belief, the price of gold is constantly moving up and down. Whoever buys a kilo bar today may get more for it in five years’ time, but also less than he paid for it.
Perhaps the biggest price shock has been in real estate. We can’t say how much of the price increase is due to a real housing shortage (especially in Bratislava) and how much to speculative investing to drive up prices. It is also true for real estate that prices do not have to go up. Just look at the long and deep slump in property prices after 2007. Those who buy property as an investment asset must also count on the long-term costs of maintaining it. Rental income may or may not help. Anyone who has rented out a property knows that, in addition to current expenses, one must also count on renovation costs after only five years of renting.
Stagflation can be a big problem for all investors. Inflation will eventually force them to put their money into shares, gold, cryptocurrencies or real estate. However, all these investments will involve even higher risks than before. Unfortunately, there is no optimal solution.
Original Source: DennikN.sk/Vladimir Balaz