When in the Great Financial Crisis (GFC) gambling banks turned belly up and pulled the world into a maelstrom of bad debt, we found it irritating that the very same banks had to be rescued for the sake of all of us with taxpayers’ money, benefiting the banks’ creditors rather than the people suffering the consequences of the recession.
Wouldn’t it have been better to let the banks all go bust and hand out the money to households instead? More so as most governments tried to recoup that money with austerity for all, which caused years of hardship to workers and businesses.
When economic activity was arrested by governmental fiat during the pandemic, administrations did not wish to repeat the mistake of prematurely balancing the books. They compensated workers for their loss of income. Some governments sent them cheques when they were furloughed. In other countries, more wisely, salaries were supported instead, keeping employment intact for a future recovery.
This unusual ‘pandemic recession’ combined a loss of economic activity with a preservation of purchasing power for all. The result was galloping inflation, triggered by the US where workers suddenly had income without a job, living the life of online consumers in a country of milk and honey.
After a devastating but short slump, asset prices inflated skywards too. Sitting at home, idlers could earn a fortune betting on anything, from crypto to meme stocks. Both the government support cheques and unusual investment returns turbocharged consumption. Soon everyone had to realise that such fierce, unmatched demand needed people willing to labour. As workers went missing in manifold ways, salaries rose too, fuelling inflation.
Supplies ‒ still disrupted, incomplete, and hamstrung by labour deficits ‒ could not keep up. Shortfalls originated in the US, affected markets globally, ensuing inflation everywhere.
Initially it looked that the fallout would predominantly and justly be felt in the US alone. But limited energy supplies would ensure that no country was left out, eventually. The war in Ukraine and the ensuing energy war made sure that soon the epicentre would be Europe. All of a sudden, businesses and households were confronted with energy bills nobody could possibly afford.
Everyone living at home or making stuff, saw their lights turning off. Once again, after the GFC, after Covid, governments are called in to come to the rescue. Only this time around all and sundry seem to be in need of a bailout: not only households strangled by ever higher fuel bills, but any industry there is, from toilet paper makers to fertiliser producers, from steel makers to the very suppliers of electricity which had become so unaffordable: they will go bust if not supported.
Yet at this juncture, central bankers cannot side with governments and buy up their dues. They have to fight inflation as tasked, regardless of the pain their desperate battle will inflict, as their only tool available is killing jobs and income. So governments and central banks everywhere are in opposing camps.
We are facing yet another recession without the ability to curb inflation- Andreas Weitzer
Fiscal support in face of this new crisis will be necessarily expansive, while monetary authorities have to tighten liquidity in their attempt to fight inflation. They do so by raising interest rates aggressively and reversing their bond buying programmes in painful ways.
This means that governments cannot hope that central bankers will be their bond buyers of last resort. Markets will have to digest all the new borrowing necessary to cover budget deficits which form as crisis-fighting and fiscal support mushrooms at a worrying scale.
This accelerates bond yields beyond what central banks prescribe in their interest setting decisions. Such a tug-of-war between tightening and loosening financial conditions was compared with a car accelerating and braking at once.
Compounding this antagonism is the dependence of all central banks on the decisions of the Fed. The US central bank is justified in its efforts to curb excessive domestic demand by tightening financial conditions, as it was this very exuberant demand which had started the worst spike of inflation in 40 years. But by hiking rates and shrinking its bond holdings, it is strengthening the US dollar against all other currencies (except the Russian rouble) and thereby exporting inflation to the rest of the world.
Food, energy and consumer goods imported from east Asia are priced in US dollars. As all other currencies suffer from a strengthening dollar to varying degrees these dollar-imports get more expensive by the day. In order to cushion this effect and to maintain the purchasing power of local currencies, interest rate differentials have to be kept at a minimum. Rates will have to go up even when a dire economic situation does not warrant a further throttling of demand at all.
A case in point is the ECB. Faced with exorbitant energy prices and shortfalls which already demand rationing (hence curbing industrial activity) and which the ECB cannot control at all, it has to slow the depreciation of the euro by hiking rates regardless.
As all other central banks outside the US are in the same boat they throttle liquidity cumulatively beyond what the world economy in total would need to balance demand. Fourteen years after the Lehman collapse and two years after the COVID slump we are facing yet another recession without the ability to curb inflation.
Policies to alleviate the pain of energy price inflation all come with negative side effects. Collecting windfall taxes to fund at least partly the fiscal support given to those in urgent need lessens the inflationary impact of public spending, but might negatively affect future investment.
General price-caps for household electricity and fuel do not incentivise energy saving and benefit even those who are wealthy enough to sustain the burden. The cost of this price-fixing is open ended. If energy prices stay stubbornly high the final bill for national budgets will balloon, while the floor introduced by price caps will extend inflationary energy bills for longer.
Energy price caps for all, with the state paying the difference, as well as financial support and tax relief for troubled industries, suspend market mechanisms by picking winners and keeping losers on life support. It is hard to justify financial help to aluminium smelters, for instance, and let toilet paper manufacturers or airlines go bust. To do nothing is not an option. Yet all this fiscal support is fuelling inflation even further. And at the end of the day it is hard to tell where to draw a line.
Nationalisations of ailing industries sound like a necessary and just measure. Uniper, Germany’s largest energy provider, has been nationalised, costing €29 billion, for instance. We do not want shareholders to profit from backstops provided by the taxpayer.
When will the communised stand on their own feet again? It took more than a decade to privatise nationalised banks after the GFC. The count of state-owned industries will be much larger now. Yet governments are not known for their profit-maximising prowess. Bureaucracies have a track record of being wasteful.
As we stagger along, governments will have to strike a middle course, improvising and compromising on unavoidable tradeoffs. To just wish away this predicament and pretend it does not exist will be harshly punished by markets, as we have seen in the UK lately. Even for countries as sound as Britain, an ‘Argentina’ might beckon.
Andreas Weitzer is an independent journalist based in Malta.
The purpose of this column is to broaden readers’ general financial knowledge and it should not be interpreted as presenting investment advice, or advice on the buying and selling of financial products.
andreas.weitzer@timesofmalta.com