source: flickr
2022 was supposed to be the year of economic recovery, with companies resuming full operations after the pandemic and consumers spending their accumulated funds on all the vacations and activities they had missed out on due to the virus. Several media outlets claimed it would be the new “roaring twenties,” referring to the decade of consumerism that followed the 1918–21 influenza epidemic.
The present economic prognosis, though, appears to depict a different image. This is not to claim that we will try to predict what will happen, as the only function of economic forecasting is to make astrology look respectable. As the old saying goes, “an economist is an expert who will know tomorrow why the things he predicted yesterday didn’t happen today.”
It's best to consider what may happen and why.
Stagflation
Stagflation is one such scenario. Stagflation refers to an economy that has high unemployment rates along with high inflation rates, essentially a combination of economic stagnation and inflation.
The stock market was in shambles during the 1970s stagflation. It dropped about 50% in the last 20 months, and for the first time in nearly a decade, few people want to invest in equities. Economic development was slow, resulting in growing unemployment that finally reached double digits. The central bank raised interest rates to 20% pricing out many people out of new cars and homes.
It was the horrible narrative of the 1970s' great inflation, which began in late 1973 and lasted until the early 1980s.
What Caused Stagflation?
Number of events in early 1970s facilitated the crisis.
US National Debt
The federal government's debt was rapidly increasing. The United States was spending a lot of money on the Cold War in an armaments race with the Soviet Union, as well as fighting a costly war in Vietnam. These factors coupled with Johnson's Great Society Program's extending domestic and social initiatives, have resulted in massive levels of debt.
As stagflation and the economic recession dawned in 1973 the US national debt-to-GDP ratio stood at 33%.
Major War, Energy Supply Shock & Oil Prices
In 1973, OPEC put an embargo on shipments to Canada, Japan, the Netherlands, the United Kingdom, and the United States in response to their support for Israel during the Arab-Israeli War. OPEC wanted to exploit its dominance over global oil supply to compel policy reforms.
Oil prices have risen by more than 400%, spurring debate about alternative energy and the creation of more fuel-efficient methods in a variety of industries, including automotive.
Given the necessity and dependency on fuel, the steep spike in oil prices translated into higher rates of inflation in both the United States and internationally, resulting in a global recession.
Parallels Between 1973 and 2022
US National Debt
Even before the COVID pandemic, the United States had amassed a massive national debt, which stood at just about $27.50 trillion, the highest since the end of World War II.
Image source: datalab.usaspending.gov
To combat the COVID pandemic, the US Congress passed a stimulus and relief package, resulting in the greatest injection of federal funds into the US economy in recorded history. Approximately $5 trillion was distributed to homes, small companies, restaurants, airlines, hospitals, local governments, schools, and other organisations around the country dealing with the impact of the pandemic. The stimulus package alone provided roughly $700 billion in unemployment benefits to workers.
Image source: nytimes.com
As a result, the US national debt has exceed $30 trillion for the first time in history on February 1, 2022.
Major War, Energy Supply Shock & Oil Prices
Following Russia's invasion of Ukraine, oil and gas prices skyrocketed. Oil reached $139 a barrel at one point, the highest level in nearly 14 years, while wholesale gas prices for next-day delivery more than doubled.
Furthermore, President Biden signed an Executive Order banning the imports of Russian oil, gas, and coal into the United States. Many European nations have sharply cut down Russian oil and gas imports, aggravating the energy supply shock. Gazprom, the Russian energy giant, has blocked gas deliveries to Poland and Bulgaria due to the nations' unwillingness to pay for supplies in rubles.
Given the resilience of the Ukrainian people and the fact that Putin's war in Ukraine can only end in one of two ways: genocide or defeat, it appears that the conflict will continue for some time.
According to FRED, the Federal Reserve Bank of St. Louis, the US national debt-to-GDP ratio stood at 123% by the end of Q4 2021. When the price of crude oil doubled between 1973 and 1975, unemployment jumped from 4.6% to 9%. The current unemployment level in the US is at 3.6%.
With the energy supply shock coupled with the rising national debts, similarly to 1970s, the stagflation is certainly on the cards.
Current Metrics
Economies are facing simultaneous slowdowns and higher prices. Even before war broke out in Ukraine, prices had already risen to multi-decade highs in many countries, including the US, the UK and the eurozone, as the pandemic disrupted supply chains. The war only exacerbated these problems.
Image source: ft.com
Forecasts are looking chilly. IMF cut down its prediction for 143 economies this year, accounting for 86% of world's GDP. Inflation is expected to be 6.2% globally, up 2.25 percentage points from January's prediction.
Former Federal Reserve Chairman Ben Bernanke, who ran the US central bank from 2006 to 2014, warned that the US might suffer simultaneous unemployment and inflation levels not seen since the 1970s.
Recently, Goldman Sachs chairman Lloyd Blankfein warned that the US is on its way to a recession, stating that "If I were running a big company, I would be very prepared for it," Blankfein said on CBS's Face the Nation, "If I was a consumer, I'd be prepared for it."
Deutsche Bank stated that their official view calls for a US recession in late-2023, stating "If anything, we think the risks are skewed towards a much more significant recession, as inflation proves more persistent than is generally expected."
China's retail sales slumped to its lowest in two years while factory output plunged, official data showed, capturing the dismal economic fallout from Beijing's zero-Covid policy with urban unemployment rate hitting 6.1%, highest level since the 6.2% peak seen in the early part of the Covid-19 pandemic in February 2020.
US consumer prices rose at an annual pace of 8.3% last month, more than economists’ expectations and staying at a four-decade high, underscoring the urgency of the Federal Reserve’s push to stamp out inflation.
Image source: nytimes.com
However, US is not the only one affected. In the UK inflation hit 9% in April, its highest level in more than 40 years, after soaring gas and electricity bills intensified the cost of living crisis facing households.
Image source: bbc.co.uk
With economic activity slowing sharply during the first quarter of the year, the UK economy is suffering its worst bout of stagflation, weak growth alongside high inflation since the second oil shock of the 1970s. Bank of England stated that it expects inflation to rise further in the autumn to more than 10% with unemployment rising from 3.8% to 5.5% by 2025.
The central banks are now slowly raising interest rates in order to make borrowing more expensive, discourage spending and allow supply to catch up with demand, but the belt-tightening could trigger a global recession in of itself.
How Was Stagflation Addressed in 1970s?
Paul Volcker
Image source: commons.wikimedia.org - WEF
Paul Volcker was named Fed chairman in August 1979, in large part due to his anti-inflation views. Volcker first adjusted Fed policy to aggressively target the money supply rather than interest rates, but his efforts to reduce inflation and inflationary expectations were insufficient.
Following that, Paul Volcker's Fed rolled out policies that pushed a key short-term interest rate to nearly 20% and sent unemployment soaring to nearly 11% in 1981. The economy officially entered a recession in the third quarter of 1981, as high interest rates put pressure on sectors of the economy reliant on borrowing, like manufacturing and construction.
As the recession worsened, Volcker faced repeated calls from Congress to loosen monetary policy, but he insisted that failing to reduce long-run inflation expectations now would result in a more catastrophic economic situations over a longer time period. Eventually his perseverance paid off and by October 1982 inflation had dropped to 5%, and interest rates had begun to fall.
Jerome Powell
Image source: commons.wikimedia.org - FED
To Jerome Powell, the current chair of the Federal Reserve, Paul Volcker is more than a predecessor. He is one of his professional heroes, and due to spiralling inflation, Jerome Powell may be forced to act like Volcker did.
Double digit interest rates are a real possibility.
Summary
Despite the impending stagflation, there are a number of reasons why 2022 may not be as bad as the 1973.
For starters, the European economy now stands on far firmer ground than it did in the 1970s. The euro eliminates the need for EU Member States to participate in competitive devaluation, which shook exchange rates and national economies in the 1970s.
Second, the oil intensity of the global economy in the 1970s was about 3.5 times greater than it is today. According to Columbia University researchers, in comparison to the early 1970s, the same number of products and services may now be produced with less than half the quantity of oil. Cars, for example, are significantly more energy efficient and use at least 40% less oil than their 1970s counterparts.
As 2022 unfolds, two major growing risks loom large against a backdrop of alarmingly high inflation: the possibility of a Fed policy blunder and a significant disruption in the Eurozone's energy supplies. Policymakers are concerned about how they will negotiate these risks, as well as the implications for economy and the market.
One thing appears to be certain: we won't come out of this unscathed.
DISCLAIMER: The information contained in this article is for educational purposes only and does not constitute any form of advice or recommendation by Wheatstones, and is not intended to be relied upon by users in making (or refraining from making) any investment decisions.