In recent weeks, the alternation of alerts and reassurances on the economic scenario we are going to encounter has continued without stopping. Every market decline is almost always associated with the widespread fear of the start of a worrying phase of 1970s-style stagflation.
It energy shock is clearly leading us to growing uncertainty and today the IMF revised marginally downward (+ 5.9% compared to the + 6% indicated above) the estimates of global GDP growth signaling the increase in inflationary pressures. The recovery in the first half of 2021 has recently given way to significantly slower growth and a surge ininflation well above the central bank’s 2% target, due to the effects of the Delta variant, supply bottlenecks in both goods and labor markets, and shortages of some raw materials, final goods and labor.
As remarked recently by the economist Nouriel Roubini, Possible scenarios include stagflation with high inflation and much slower growth over the medium term or “overheating” with growth accelerating as supply bottlenecks are eliminated, but inflation would stubbornly remain high, because its causes would not be temporary.
Bridgewater Associates, the world‘s number one hedge fund founded and led by Ray Dalio, believes that the the real risk facing the markets is stagflation.
Is stagflation risk real? The parallel with the 70s
However, there are those who consider the stagflation alert unjustified. “Lack of energy means volatility, not stagflation”, UBS asserts in its CIO Weekly roundup. Gas prices in Europe hit new highs last week due to rapid growth in demand as economies reopened. After years of underinvestment, the deficit will not be easily remedied. “The prospect of shortcomings in the event of a cold winter has intensified worries about stagflation, causing a sell-off of both stocks and government bonds early last week, ”remarks UBS. The Russian president Vladimir Putin he suggested his country could increase supplies to Europe, but with limited unused gas production capacity, electricity blackouts remain a final risk if the harsh winter materializes.
But while investors should brace for further volatility as the shortage unfolds, UBS does not anticipate an upcoming stagflation. First, the central banks they reassured investors that they will look at short-term movements in fuel prices. According to amount of energy used to generate one dollar of world GDP has fallen by nearly 20% over the past decade, and by more than half since the 1970s, reducing the potential damage resulting from supply disruptions. And although consumer spending may be impacted by higher prices, the savings are unusually high following the COVID-19 blockades, providing a cushion against a shock. Finally, UBS explains, economic fundamentals are otherwise in good shape. “The reopening remains on track, as vaccinations advance along with recent positive news about COVID-19 treatments from Merck.”
Inflation yes, stagflation no
The stagflation risk is cited by many as the trigger for the recent fall in equity markets after seven consecutive months of high. Enguerrand Artaz, manager of La Financière de l’Echiquier, thinks differently and briefly recalls the definition of stagflation: it is a self-sustaining phenomenon characterized by high inflation, a prolonged stagnation of economic activity and high unemployment, which shows no sign of decreasing. The concept became popular in the 1970s, after the first oil shock in 1973. At the time, very high inflation, which peaked at 12.3% in the United States in 1974, was due to a shock negative supply, referring in particular to energy raw materials, especially oil. Furthermore, demand was running out in developed countries at the end of the 30-year post-war boom. Today, however, the situation is radically different. Global demand is very strong, especially in developed countries and it is precisely this positive shock in demand, in a context of temporarily limited supply due to the after-effects of the Covid crisis, which is causing inflation. Moreover, it is difficult to speak of “stagnation” in economic activity with global growth expected to reach 4.5% by 2022 and close to 6% this year.
The “stag” part, in the term “stagflation”, is therefore used improperly in the current context even if it does not mean that there are no reasons for concern for economic activity. “We have most likely reached the peak of the recovery. In China first, and then in developed countries, the persistence of bottlenecks in global production chains could eventually affect demand. Finally, there are areas of fragility, such as the Chinese real estate sector, highlighted by the vicissitudes of Evergrande. However, they are for the most part fears of a slowdown in the pace of expansion, not anticipations of a stagnation in growth, ”argues the expert from La Financière de l’Echiquier.
The second part of the word, on the other hand, concerns inflation and deserves more attention. We are certainly a long way from the levels reached in the 1970s and 1980s and the causes are very different, but the issue is still relevant, especially in the United States where the prices of goods and services contributed to the surge in inflation in the spring. Among other things, we see a turnaround for second-hand vehicles which are now taking over from other goods and / or services, such as new furniture and vehicles, directly impacted by shortages affecting global production lines. In addition, the sharp acceleration in production prices continues, a phenomenon accentuated by the recent surge in energy prices, in particular for natural gas and coal. Property prices, which have risen by almost 20% in the last year in the United States, will soon impact the inflation basket.
Finally, the manager asserts, theincrease in wages facing the manpower shortage could trigger a wage-price loop which will keep inflation relatively high. Over the past decade, productivity increases have certainly limited, and by no means a little, the transmission of wage increases to inflation. However, tensions are mounting in the United States. In the latest employment report, many sectors saw wages rise 0.5% or more over the month.
“While stagflation is now a figment of the imagination, inflation is a reality,” concludes Enguerrand Artaz.