2023-11-05 11:31:56
More than eighteen months ago, the major central banks and at their head, the American Federal Bank, began a series of increases in key rates in response to galloping inflation and at a sustained and almost continuous pace. They thus marked the end of the previous accommodative monetary cycle, which began with the bursting of the speculative internet bubble at the start of the new millennium and whose war in Ukraine sounded its death knell.
What was initially supposed to be a limited series of tightening measures to counter a sudden, but initially considered transitory, rise in inflation turned out to be a longer, structural and, above all, stubborn movement. Eighteen months later, money markets seem barely reconciled to the idea that interest rates would remain high for longer and that the pivot to an accommodative cycle restoring the old, artificial normality of low rates and abundant liquidity, should wait longer than initially expected. It is interesting, even instructive, to focus on the evolution of the expectations of financiers, economic players and other investors to first understand the path traveled and try to decode the possible scenarios for the global economy.
Transitional sin
In March 2022, the world still seemed to be complacent in an economic paradigm established following the bursting of the dotcom bubble: technological advances and globalization are engines of growth, but also deflationary forces that operate through ‘improvements in productivity on the one hand, and a better match between supply and demand on the other. Central banks can then maintain a low inflation rate at the same time as a strong growth rate to generate enough jobs and above all support ever-rising stock market valuations. The Russian invasion of Ukraine surprised the world and especially the gas and oil markets. The ensuing shock in hydrocarbon prices accelerated an inflationary spiral which, in reality (and with hindsight), had burgeoned in 2021. Economic actors, and at their head the financiers, were more focused on the symptoms than on the real causes. The world was also emerging from a pandemic which caused its share of problems, disrupting global trade, accumulating logistical difficulties and hindering the production and transport of cheap goods from here or elsewhere. The rise in energy prices, logistical and market difficulties post- Covid as well as the torpor of central bankers, too accustomed to monetary accommodation, facilitated the anchoring of the thesis of transitory inflation. What was missing from the initial analysis was obviously the observation of the different indicators over time and above all the observation that the pressure is mainly on wages and services, with unemployment levels which remain low and pressure on increasingly higher salaries. Beyond the transitional shock caused by the war in Ukraine and the Covid disruptions, we are just beginning to digest the helicopter money that was distributed during the pandemic, a movement which accelerated two decades of monetary largesse. We are talking regarding almost desperate measures, which aggressively use monetary leverage to save a particular economy from Covid, or a particular Southern European country from a payment default, “whatever it costs”. Add to this, Western populations deprived of leisure during two years of pandemic. All the ingredients were therefore in place for a vigorous and sustained recovery in demand from households who benefited from fiscal largess and excess savings. Post-Covid disruptions and political changes once morest globalization have at the same time limited the supply of often cheap immigrant labor. Quickly, it was clear that the accumulation of all these very pronounced inflationary factors was going to have a lasting effect.
What landing?
The rate hike cycle that followed is unprecedented and is not over yet. From transitory, we moved to structural and recently, to the established regime of high rates for a long time. The a posteriori analysis reveals the shortcomings of the initial approach and would have rather led to larger increases, but given the structural and established nature of the inflationary factors, the ideal remedy can only be time and the economic slowdown. Time, because monetary transmission mechanisms take time to produce their effect. Furthermore, whatever we do, excess household savings take time to run out. These two processes will converge at best towards an economic slowdown which will weaken demand, and at worst towards a “hard” landing and a recession. In the meantime, if the forces of globalization are in retreat, technological advances in robotics and artificial intelligence will work to adjust the mismatches in supply and demand capacity. This inflationary crisis is a rupture which is accelerating several changes already underway. The pressure on remuneration will not benefit everyone in the same way. New professions are emerging and old ones are replaced by machines. New ecosystems are developing and new priorities such as CSR (social and environmental responsibility) are emerging.
Before the system finds its balance, the transition can be turbulent for the different economic sectors, and especially for developed and emerging countries which will face new challenges, under new constraints: climate risks, rising debt prices, explosion public deficits, purchasing power crisis and social tensions. Adapting, planning and being disciplined will be the keys to emerging from the crisis.
About Omar Mechri
The editorial is available in the Finance Special for the month of October 2023 of the Mag de l’Economiste Maghrébin
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