At Project Syndicate Mouriel Roubini issues a warning:
NEW YORK – In April, I warned that today’s extremely loose monetary and fiscal policies, when combined with a number of negative supply shocks, could result in 1970s-style stagflation (high inflation alongside a recession). In fact, the risk today is even bigger than it was then.
After all, debt ratios in advanced economies and most emerging markets were much lower in the 1970s, which is why stagflation has not been associated with debt crises historically. If anything, unexpected inflation in the 1970s wiped out the real value of nominal debts at fixed rates, thus reducing many advanced economies’ public-debt burdens.
Conversely, during the 2007-08 financial crisis, high debt ratios (private and public) caused a severe debt crisis – as housing bubbles burst – but the ensuing recession led to low inflation, if not outright deflation. Owing to the credit crunch, there was a macro shock to aggregate demand, whereas the risks today are on the supply side.
We are thus left with the worst of both the stagflationary 1970s and the 2007-10 period. Debt ratios are much higher than in the 1970s, and a mix of loose economic policies and negative supply shocks threatens to fuel inflation rather than deflation, setting the stage for the mother of stagflationary debt crises over the next few years.
He concludes:
Under these conditions, central banks will be damned if they do and damned if they don’t, and many governments will be semi-insolvent and thus unable to bail out banks, corporations, and households. The doom loop of sovereigns and banks in the eurozone after the global financial crisis will be repeated worldwide, sucking in households, corporations, and shadow banks as well.
As matters stand, this slow-motion train wreck looks unavoidable. The Fed’s recent pivot from an ultra-dovish to a mostly dovish stance changes nothing. The Fed has been in a debt trap at least since December 2018, when a stock- and credit-market crash forced it to reverse its policy tightening a full year before COVID-19 struck. With inflation rising and stagflationary shocks looming, it is now even more ensnared.
So, too, are the European Central Bank, the Bank of Japan, and the Bank of England. The stagflation of the 1970s will soon meet the debt crises of the post-2008 period. The question is not if but when.
The preponderance of the evidence suggests that a large public debt overhang impedes economic growth. There is no “cliff” at 100% of GDP as was once believed but the evidence still says that debt reduces growth. And politicians will never want to reduce spending. It’s no way to get re-elected. A crisis has been baked in for some time.
Stagflation I can live with. What worries me is the prospect of a catastrophic loss of confidence in the dollar and we’re doing the best we can to induce one.
I could have written that piece. And further, I’m cynical enough about politicians to believe that behind closed doors their advisors have them very worried about what to do about debt, and the chosen path is to inflate their way out. However, I don’t think they understand the potential consequences, and I’m sure many do not care.
YOU may be able to live with stagflation, but others will be harmed. Specifically, mostly fixed income based retirees, those under 35 who have not yet been able to make major purchases (like a house) and those with limited future earnings potential.
I think that’s a powerful argument and one with which I do not disagree. I point again to the graph I showed of personal consumption expenditures which eviscerates the economic argument in favor of large government spending programs. IMO any such programs should be limited to legitimate need and public goods (non-rivalrous and non-excludable).