When the world’s most powerful central bankers, surrounded by government officials and economists, gathered last month in Jackson Hole, Wyoming, they wanted to hear the latest sibylline hints about when the relentless rise of interest rates in the US will be over.

All other economies are nothing but a function of the Federal Reserve’s interest rate policies, inescapably linked as they are via exchange rates and terms of trade to the US.

Other countries’ inflation predicament may progress differently and show different characteristics, but at the end of the day their decisions will reflect America’s. Currencies weakened by higher US interest rates and hence a stronger dollar will continue to import inflation as long as the Fed hikes.

Market observers are like tea leaf readers, trying to guess the path of inflation and the risk of recession caused by monetary tightening. I find many of their observations puzzling. By a somewhat arbitrary view, inflation hovering at two per cent a year is good and everything above it, say three per cent, is destroying incomes and savings.

This is, of course, nonsense. Even moderate inflation is corroding our purchasing power. At two per cent, our current income will be worth half in 36 years’ time. As I have argued before, if incomes and corporate profits would rise in line with inflation there’s not much to complain about. When real incomes fall, it will pain consumers; if salaries rise constantly in excess of measured inflation, it will fuel excess demand, which cannot be met in full by supply and will fuel inflation ever more. When people are loaded, they don’t mind paying that bit more.

This is what worries most central bankers now. They eye with suspicion wage improvements (now mostly concentrated in the service sector) in excess of “productivity gains” – an expression for the same hands producing more, thereby matching increased demand with growing supply.

This is a bit of a stretch in the service sector. Doctors or waiters cannot scale their face-to-face profession like producers of microchips or widgets can by applying new technologies and investing in capital stock.

The best outcome everyone hopes for is therefore that the pandemic and war-induced supply shortages will abate, which they do, and that a slowing economy will bring down wage demands. If I can afford more because things get cheaper, I will feel less short-changed when shopping. Salary rises are not that neccessary anymore.

To not fall into the same thought trap of most economists: If inflation stopped, meaning a reversion to annually two per cent as we expect at the end of next year (hopefully not by a crash of the economy, but by a mere cooling off) this does not mean prices will revert to where they were before. The inflation scare might be gone, but our groceries will still be more expensive than they ever were. If an egg’s cost doubles from one year to the next and then costs the same the following year, measured inflation will be zero. But the egg’s still more expensive.

Central bankers, tasked with extinguishing inflation, are operating with a time lag. By making money more expensive they hope to take the heat out of the post-pandemic boom times. It seems to work. Producers reduce their prices and their order books, manufacturing is slowing, job openings are not so plentiful anymore, redundancies are on the rise, house prices are coming down, capital for corporations is harder to come by, graduates struggle to get employed, businesses make less money (with the exception of chip-designer Nvidia, that is).

Germany, Europe’s industrial powerhouse is in the doldrums. It has stopped growing. China, quite incongruously bemoaned as the sick man of Asia (it still grows comparably fast), depresses mining and energy profits. Yet the fight against inflation is not over and the fear to reinvigorate it still lingers.

Vexing also that it is hard to tell how much of the inflation slowdown is due to external, natural factors. Surgical masks and rubber gloves are certainly cheaper now than two years ago. Soon airfares will follow. Or, on a more serious note: energy has digested the Russian onslaught.

Surgical masks and rubber gloves are certainly cheaper now than two years ago. Soon airfares will follow- Andreas Weitzer

What if monetary tightening stops too late?

What muddies the picture is that ever more expensive credit hits industry and consumers unevenly. Many corporations, in wide-eyed panic about the total standstill of the economy during lockdown, have borrowed money at very cheap terms to stem disaster.

Much of this safety cushion proved obsolete. Yet they still sit on vast cushions of cash, shrugging off the rising cost of credit they don’t need for the time being. Often extortionate reopening profits provided even more financial security.

Homeowners servicing fixed rate mortgages secured in cheaper times, or those who have paid down their mortgages, don’t feel the pinch either. Yet growing credit card debt, growing corporate and personal delinquencies are warning signs.

The popular view of a “soft landing” – an economy only cooling back to more sustainable growth – may be wishful thinking. The risk of over-tightening by financial autho­ri­ties is also rooted in the false assumption that inflation can always be tamed by curbing demand. Long-term factors at play are hard to decipher.

For decades, China, as the workshop of the world, has exported deflation. Its cheap labour force and growing man­u­facturing prowess has made consumer goods available at ever lower cost. With growing affluence their workers are not that cheap anymore.

“De-coupling”, “friend-shor­ing”, the shortening of supply chains and strategic warehousing will raise production costs inevitably. Ongoing war expenditure will have inflationary effects. And so will, bar a technological leap, the effects of an ageing, ever-diminishing workforce and the inexorably rising cost of social care and medical treatment.

Climate change and the attempt to forestall or at least mitigate its impact will come with its own inflationary dynamics. Desiccation of arable land will inevitably increase the price of foodstuff, and so will floods, tropical storms, wildfires, pests and the exhaustion of groundwater levels.

To see what happens in every corner of the world we just have to look at our own farmers in Malta.

As we have left it too late to more cheaply fight climate change, the scramble for necessary raw materials and technologies to transit to more sustainable forms of energy generation will impose additional, inflationary costs on all of us. How these external, inflation-accelerating cost factors can be tamed by monetary demand-throttling is not clear to me. We still live in good times when crazy demand is our only headache.

For us retail investors, rising interest rates, or interest rates “higher-for-longer”, have the crippling double effect of lowering bond prices and depressing stock market valuations. We will have to do with years of sub-par investment gains. There’s not much we can do about it. Let’s hope that the spook of ever higher interest rates that we so much wished for in zero-interest-rate times will come to an end soon.

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.


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