Posted on 07/03/2021 12:57:15 PM PDT by blam
Years of ultra-loose fiscal and monetary policies have put the global economy on track for a slow-motion train wreck in the coming years. When the crash comes, the stagflation of the 1970s will be combined with the spiraling debt crises of the post-2008 era, leaving major central banks in an impossible position.
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.
For now, loose monetary and fiscal policies will continue to fuel asset and credit bubbles, propelling a slow-motion train wreck. The warning signs are already apparent in today’s high price-to-earnings ratios, low equity risk premia, inflated housing and tech assets, and the irrational exuberance surrounding special purpose acquisition companies (SPACs), the crypto sector, high-yield corporate debt, collateralized loan obligations, private equity, meme stocks, and runaway retail day trading. At some point, this boom will culminate in a Minsky moment (a sudden loss of confidence), and tighter monetary policies will trigger a bust and crash.
But in the meantime, the same loose policies that are feeding asset bubbles will continue to drive consumer price inflation, creating the conditions for stagflation whenever the next negative supply shocks arrive. Such shocks could follow from renewed protectionism; demographic aging in advanced and emerging economies; immigration restrictions in advanced economies; the reshoring of manufacturing to high-cost regions; or the balkanization of global supply chains.
More broadly, the Sino-American decoupling threatens to fragment the global economy at a time when climate change and the COVID-19 pandemic are pushing national governments toward deeper self-reliance. Add to this the impact on production of increasingly frequent cyber-attacks on critical infrastructure and the social and political backlash against inequality, and the recipe for macroeconomic disruption is complete.
Making matters worse, central banks have effectively lost their independence, because they have been given little choice but to monetize massive fiscal deficits to forestall a debt crisis. With both public and private debts having soared, they are in a debt trap. As inflation rises over the next few years, central banks will face a dilemma. If they start phasing out unconventional policies and raising policy rates to fight inflation, they will risk triggering a massive debt crisis and severe recession; but if they maintain a loose monetary policy, they will risk double-digit inflation – and deep stagflation when the next negative supply shocks emerge.
But even in the second scenario, policymakers would not be able to prevent a debt crisis. While nominal government fixed-rate debt in advanced economies can be partly wiped out by unexpected inflation (as happened in the 1970s), emerging-market debts denominated in foreign currency would not be. Many of these governments would need to default and restructure their debts.
At the same time, private debts in advanced economies would become unsustainable (as they did after the global financial crisis), and their spreads relative to safer government bonds would spike, triggering a chain reaction of defaults. Highly leveraged corporations and their reckless shadow-bank creditors would be the first to fall, soon followed by indebted households and the banks that financed them.
To be sure, real long-term borrowing costs may initially fall if inflation rises unexpectedly and central banks are still behind the curve. But, over time, these costs will be pushed up by three factors. First, higher public and private debts will widen sovereign and private interest-rate spreads. Second, rising inflation and deepening uncertainty will drive up inflation risk premia. And, third, a rising misery index – the sum of the inflation and unemployment rate – eventually will demand a “Volcker Moment.”
When former Fed Chair Paul Volcker hiked rates to tackle inflation in 1980-82, the result was a severe double-dip recession in the United States and a debt crisis and lost decade for Latin America. But now that global debt ratios are almost three times higher than in the early 1970s, any anti-inflationary policy would lead to a depression, rather than a severe recession.
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.
Bkmk
It’s not as complicated as this article makes it seem. Inflation follows the money supply. The Fed has been increasing that at 38% per year. Therefore, sooner or later, we are going to get near 38% inflation
Well. Golly. I feel bad that central banks will be left in an “impossible position.” That breaks my heart.
Only if you have to buy things. In my neck of the woods inflation is well over 100% since the installation of the Chomo in Chief. Oh wait. But will save 16 cents on a hotdog or something....
Just remember, what they feel, we feel first, and more severely.
But the Fed will buy bonds to set interest rates.
Not to worry…they’re ‘to big to fail’ so someone else will pay…like you and me. So simple even a caveman…well you know
The Fed will keep spinning lots of plates in the air at the same time....while they “carefully monitor the situation”...
Remember—”Nobody could have seen this coming...”
;-)
bookmark
If you’re reading this, you are exceptional. A sad fact is that many of us no longer READ!
Fedzilla LOVES THAT!!
That sad fact is what moved me to produce a somewhat primitive AUDIO version of one of the most important books written in my lifetime, “MIRACLE ON MAIN STREET” (MOMS) by our late friend, F. TUPPER SAUSSY.
I broke MOMS down into 11 short videos and posted them to BRIGHTEON.
Now that Biden & his criminal buds are writing a new & more destructive chapter in the saga known as INFLATION, I’m sending this email with links to Chapter 1 (61/2 minutes) and Chapter 3 (8 minutes).
Chapter 3 deals with the Founders’ history with the insanity of inflation and how they TRIED to keep us out of the mess developing in the economy as Fedzilla continues to violate Art.1, Section 10 of the Constitution.
(”NO STATE SHALL... MAKE any THING BUT GOLD AND SILVER COIN A TENDER IN PAYMENT OF DEBTS.”:
If you also believe America is worth saving, please share with others.
MOMS, PART 1:
https://www.brighteon.com/aedb6454-b4f4-4f41-b792-3c7a611c8be1
MOMS, PART 3:
https://www.brighteon.com/c8cc4d35-4d45-4875-b44c-f485ccfdc813
Thanks.
DB
PS: I have also uploaded a comprehensive presentation of this increasingly vital topic by BRUCE McCARTHY, another patriot who went to his grave frustrated that his timeless warning fell on deaf ears.
Part 1 of HIS presentation is here:
https://www.brighteon.com/dd2435a2-f586-438b-86a3-6792cb28e99f
Part 2 is here:
https://www.brighteon.com/c9ceeb06-ed31-45a1-bd42-f217b9d5710f
Roubini must have used every other disaster story in the book , he’s just now getting to this one? He’s predicted so many “dooms” they would overlap for a century if 10% of them had actually happened.
And it is not as simplistic as you put it because you leave out changes in velocity. if you don’t understand that you shouldn’t be pontificating.
All perfectly normal and expected in a debt based monetary system using fractional reserves. Buckle up kids, the road ahead looks bumpy
And it is not as simplistic as you put it because you leave out changes in velocity. If you don’t understand that you shouldn’t be pontificating.
Monetary velocity declined considerably through most of the 2010s even as the money supply expanded at a ridiculous rate.
The delay between the time money is created and when the market reflects it is due to the velocity of money.The velocity of money gets faster the more people realize their money is becoming worthless. They spend it while it still has value. The bigger inflation gets the faster the velocity grows.
Bkmk
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