All the conditions are in place for surging inflation, instead it has fallen to a two-year low. Should investors be celebrating? Is it time for something radical, like the Green New Deal, unveiled in the US?
Inflation is about as threatening as a puppy; should investors be celebrating? And does this justify the Green New Deal in the US?
“Mark my words,” they used to say, “it will end in tears.” Around the world interest rates had fallen to near zero per cent. Out of desperation, central banks had opted for a new radical measure called quantitative easing or QE — which entailed buying government medium and long-term bonds from the market with money that had been conjured up out of nowhere, or at least nowhere more solid than in the minds of central banks.
Jens Weidmann, President of the Bundesbank, didn’t like it. Speaking from a land that had still not forgotten the horror of the 1920s and the Weimar Republic, when Germany suffered hyperinflation, he likened quantitative easing to a Faustian pact with the devil.
Across the world, those who ply their trade by warning of doom — constantly, and like a watch that has stopped, are occasionally right — had a field day. Asset prices have surged out of control. There are bubbles — bubbles in bonds, bubbles in equities, bubbles in house prices, it is no wonder they didn’t warn of bubbles in bubbles.
Their remedy normally involved buying gold.
And they were wrong.
Another type of doomsayer warned that government borrowing was out of control — that tears would result, that austerity was the only answer, and they were wrong too.
Chronic lack of demand
What these critics failed to grasp is that worldwide, there was a chronic lack of demand. The cause was many-fold, including rising inequality in the West, especially the US, globalisation of labour leading to higher corporate profits at the expense of wages, the ageing of the baby boomers leading to excess savings in some countries and the rise of China with an exceptionally high savings rate.
For a short period before 2008, the problem of poor demand was overcome via low interest rates leading to higher house prices, meaning that in some parts of the world, households could borrow against their home to fund spending. But that all came horribly unstuck in 2007 and 2008.
Ten years on
The 2008 crash happened over ten years ago. And still not much has changed. Incredibly, despite seeing one of the worst economic recoveries ever, the global economy is slowing.
And that nasty inflation that was expected on the back of QE proved to be about as dangerous as a puppy, in a particularly un-dangerous mood.
The Faustian pact turned out to be a contract that the devil had no way of enforcing, he may have thought he had bought our souls, in fact he had been conned, like a greedy but gullible speculator buying swamp land.
UK inflation fell to 1.8 per cent in January — a two-year low. In the US, it dropped to 1.6 per cent. In the euro area it was 1.6 per cent in December.
As a general rule, low interest rates are good for investors, as when the markets calculate the value of a stock, they are supposed to factor in expected dividends in the long term, discounted by an interest rate to create a net current value. If expectations of long-term interest rates are low, then that discount rate will be low.
But there is a deeper problem and it is one I expect to get worse. Globally, the world is producing below full capacity — it has been for years. That is why, despite such low interest rates, and years of QE, inflation is so low.
Consider this thought experiment. Assume the convergence of autonomous cars with the sharing economy does happen, as many expect. Car sharing is already becoming a thing in some places, such as Moscow. Such a convergence will mean that demand for car transport can be met from significantly fewer cars. That is why I expect the global car industry to hit a major, existential crisis in a few years.
What’s the solution. Maybe it is MMT — modern monetary theory. The idea is to turn current thinking on its head. Governments borrow at zero per cent, fund all spending from borrowing, and taxation is used simply as a device to control inflation — the precise opposite of the way we do things at the moment. And for as long as inflation is so tiny, that means the scope for MMT but low taxes is quite extensive.
MMT provides some of the economic justification for the Green New Deal unveiled by Alexandria Ocasio-Cortez in the US. A plan that encompasses slashing carbon emissions, carbon capture by extensive planting of tees, universal basic income and free healthcare for US citizens.
Critics of the Green New Deal are legion, even quite leftish economists think it is pie in the sky.
The reality is, that those who don’t think some radical new policy is required to get the Western economy out of the malaise of low inflation, low investment, poor productivity, and growing social disquiet are themselves practising cooking pies in the sky.
It is undoubtedly time to declare war on climate change. The other policies in the Green New Deal seem expensive, and maybe it is too soon for them. But if inflation continues to veer close to deflation, as it has for all of this century so far, and as seems likely to continue given how the fourth industrial revolution is panning out, something radical may be required.
These views are those of the author alone and do not necessarily reflect the view of The Share Centre, its officers and employees