Economic growth versus inflation

5 Apr 2022 2 month(s) ago

Inflation is soaring overseas, is it coming here?

The post-COVID world seems to be one of conflicting trends. On the one hand, at least in Australia, economic growth prospects look strong as there is a rebound. Morgan Stanley says:

“The economy rebounded quickly from the disruption of Delta lockdowns to end the year in a strong position. The detail of this release still suggests to us that the set-up for 2022 remains positive - particularly for the household sector. Income growth is likely to remain strong given tight labour markets and rising wages, savings rates are still elevated and are likely to normalise through the year, and robust balance sheets provide an important buffer to any disruptions. We continue to see GDP growth remaining above trend in 2022 (4.5%Y), with the resulting reduction in spare capacity keeping the focus on cost pressures and policy responses.”

That is meeting the script. But the question is, will inflation spoil the party? Internationally, inflation signals are turning bright red. Wholesale inflation in the US is in double digits, German retailers are saying they will increase prices by a staggering 30-50%, and the UK is expecting a 10-15% jump by year’s end. These are staggering numbers, and they are very much caused by the effect on COVID on global supply chains and the effect of government spending to counteract the lockdowns, as commentator Jeffrey A Tucker observes in the US:

“When governments and central banks behave in unbearably stupid ways, it is worth asking whether there might be a point to the madness. That’s how I feel when I look at M2 data from 2020-21. 

This money printing peaked at a 26% rate of increase. Or look at the raw money data (again, we have to use M2. The Fed inspired the addition of some $6 trillion to the supply of money, nearly a dollar-for-dollar match of what the politicians were promising.

All appearances of science aside, it was nothing but the crudest deployment of a classic tale of monetary devaluation: print instead of tax. In raw dollar terms, we’ve seen a 42% increase in the money supply in a mere 24 months.”

In Australia the rise in the money supply was more modest, rising 8.7 per cent in the year to January 2022, but that will still create inflationary pressures.

The pandemic severely damaged the globalised supply chains, which for decades have kept consumer prices low and the war in the Ukraine and the sealing off of the Russian economy is leading analysts to point to a ‘bifurcating global economy,’ a commercial world split into two. We may be witnessing the end of the latest phase of globalisation.

Whichever party wins the next Federal election is likely to be faced with some very difficult economic challenges. Years of falling interest rates have left Australian households mired in debt. The ratio of housing debt to household income in September 2021 reached a record high of 140.5 per cent. The debt binge created massive asset inflation in Australia, especially in housing. Residential housing is worth almost five times the stock market and five times the nation’s annual economy (GDP).

Such extreme asset inflation has been largely ignored by politicians and regulators. Economists have great difficulty measuring it – unlike consumer price inflation which is easy to calculate because consumer products are constantly being transacted. Asset prices, by contrast, can rise with few, or even no, transactions taking place. A house, for instance, can be worth more even if it is not being sold.

Faced with that measurement problem economists have tended to throw up their hands. They resort to circular arguments such as claiming that assets are justifiably worth whatever people are prepared to pay for them so the price therefore must be fair and not inflated. They take the easy way out.

It may soon no longer be politically feasible to ignore asset prices. If the central bank has to raise interest rates in response to rising consumer price inflation – something they cannot ignore because it is part of its charter – then those who have borrowed heavily to afford the high priced housing, who have invested in the inflated assets, will come under pressure.

So here is the burning question. If the era of cheap debt comes to an end and asset prices start to fall will economists, regulators and politicians be able to ignore it?


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