Economy

On The Threshold Of A New Era Of Global Inflation

Rising prices in the developing world will eventually usher in a whole new paradigm on global currency markets.

A market in Bangalore
Frank Stocker

BERLIN - You have been hoarding money. You purchased real estate. You’ve invested in Swiss francs. All of this you've done to stave off the spectre of inflation, because we've watched how national banks have been printing money for years, as never before.

And then last week the European Central Bank announced that record-low interest rates would be staying low for years to come. In the opinion of the many currency depreciation prophets out there, that means that sooner or later we’re looking at a second 1923 -- an era of hyperinflation, and we’ll soon be using billion or trillion Euro notes. The problem, however, is this: the presses have been churning out money for five years now, and there’s been no explosion in prices, not even a little. Inflation, experts tell us, simply is not coming.

Or is it? Signs have been multiplying that prices could in the not-too-distant future start going up; that the days of extremely low inflation rates are over; that the value of money could start going south very quickly. So the people who’ve been warning about all this for the past several years would turn out to be right: even if they continue to be totally wrong about the causes.

National bank policies don’t have anything to do with it. The reason lies elsewhere.

For about 30 years, rates of price change in the western industrial nations have been on a downward spiral. Initially they were held down by the national banks that set themselves clear anti-inflationary goals and maintained a tight grip on money supplies, keeping them deliberately low.

They were thus able to slow depreciation down drastically. The average inflation rate in the industrial nations in the first half of the 1980s was nine percent. Twenty years later it had gone down to two percent.

And 20 years later – at the latest – another crucial factor started playing a role: the integration of 1.5 billion people into the global labor market. Most of these workers were in China, which became a member of the World Trade Organization (WTO) in 2001, but workers in other developing countries were also a part of it. The opening up of borders and the liberalization of world trade made it possible for companies to move production to wherever it was cheapest.

End of an era

In 2010, Swiss economists tried to calculate in concrete terms just how big the resulting price pressure was. The result: when China gets a one percent share in any given European market, production prices fall by five percent. This figure is particularly high because China exports many labor-intensive goods. For all the developing countries together the figure is on average lower – around three percent. But the impact of this has been that the inflation rate in Germany between 1995 and 2006 fell by about 0.7 percentage points per year, the authors of the Swiss study estimate.

"That phase is now ending," says Alfred Roelli, chief investment strategist at Pictet, a Swiss asset and wealth management bank. He explains that the deflationary effect of China's boom is over because salaries in China have climbed dramatically in the past few years. And that will prove a lasting trend, not least because the number of Chinese in the labor market is going down.

The one-child policy introduced nearly 35 years ago is now exacting tribute. When the number of workers dwindles they are in a position to demand higher salaries. That means that salary-intensive sectors like the textile industry have long been moving production to other countries like Bangladesh, Vietnam and Cambodia. China has a population of 1.3 billion people, whereas all three of the other countries together only have some 250 million.

But just how would the 30-year phase of sinking inflation rates actually come to an end? If globalization impacts prices by even as little as 0.7 percentage points, that would put future price rises at 2.7% instead of 2%. Where’s the problem with that?

But inflation is not linear: prices don’t go up parallel just to developments in supply and demand. Inflation happens much more inside heads. "As soon as expectations change, inflation just explodes, prices are raised in anticipation of it," says Roelli.

Bond time-bomb

It is a kind of domino effect that in turn sets off a spiral of ever-rising prices: I’m raising prices because everybody else is doing it.

This process is not about to start today or tomorrow. It could happen in three, five, even ten years. And whether inflation rates would be four, six or eight percent -- nobody knows. But one thing is certain: it would have major consequences for the financial markets. Just as inflation dropped over a 30-year period so too did yields in the bond markets, which means that for three decades investors have been earning handsomely on bonds.

If inflation rates rise sooner or later yields will rise. That would mean the end of an era on the financial market. And it would be all the more dramatic as nearly all professional investors in life insurance, pension funds or investment companies only know this dynamic of the financial system.

Very few financial pros active today were working in the 1970s. So they would all have to learn how to deal with a new investment world. The same holds for small savers and private investors. Longer-term bonds, both government and corporate, would turn out to be money losers. Companies would find it generally harder to get hold of capital, they would have to pay higher interest and higher salaries, profits would shrink along with the prices of their shares.

At the end of the day, gold and real estate might become winners again, even if the reasons will be very different than what most inflation prophets assume now.

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Economy

European Debt? The First Question For Merkel's Successor

Across southern Europe, all eyes are on the German elections, as they hope a change of government might bring about reforms to the EU Stability Pact.

Angela Merkel at a campaign event of CDU party, Stralsund, Sep 2021

Tobias Kaiser, Virginia Kirst, Martina Meister


-Analysis-

BERLIN — Finance Minister Olaf Scholz (SPD) is the front-runner, according to recent polls, to become Germany's next chancellor. Little wonder then that he's attracting attention not just within the country, but from neighbors across Europe who are watching and listening to his every word.

That was certainly the case this past weekend in Brdo, Slovenia, where the minister met with his European counterparts. And of particular interest for those in attendance is where Scholz stands on the issue of debt-rule reform for the eurozone, a subject that is expected to be hotly debated among EU members in the coming months.

France, which holds its own elections early next year, has already made its position clear. "When it comes to the Stability and Growth Pact, we need new rules," said Bruno Le Maire, France's minister of the economy and finance, at the meeting in Slovenia. "We need simpler rules that take the economic reality into account. That is what France will be arguing for in the coming weeks."

The economic reality for eurozone countries is an average national debt of 100% of GDP. Only Luxemburg is currently meeting the two central requirements of the Maastricht Treaty: That national debt must be less than 60% of GDP and the deficit should be no more than 3%. For the moment, these rules have been set aside due to the coronavirus crisis, but next year national leaders must decide how to go forward and whether the rules should be reinstated in 2023.

Europe's north-south divide lives on

The debate looks set to be intense. Fiscally conservative countries, above all Austria and the Netherlands, are against relaxing the rules as they recently made very clear in a joint position paper on the subject. In contrast, southern European countries that are dealing with high levels of national debt believe that now is the moment to relax the rules.

Those governments are calling for countries to be given more freedom over their levels of national debt so that the economy, which is recovering remarkably quickly thanks to coronavirus spending and the European Central Bank's relaxation of its fiscal policy, can continue to grow.

Despite its clear stance on the issue, Paris hasn't yet gone on the offensive.

The rules must be "adapted to fit the new reality," said Spanish Finance Minister Nadia Calviño in Brdo. She says the eurozone needs "new rules that work." Her Belgian counterpart agreed. The national debts in both countries currently stand at over 100% of GDP. The same is true of France, Italy, Portugal, Greece and Cyprus.

Officials there will be keeping a close eye on the German elections — and the subsequent coalition negotiations. Along with France, Germany still sets the tone in the EU, and Berlin's stance on the brewing conflict will depend largely on what the coalition government looks like.

A key question is which party Germany's next finance minister comes from. In their election campaign, the Greens have called for the debt rules to be revised so that in the future they support rather than hinder public investment. The FDP, however, wants to reinstate the Maastricht Treaty rules exactly as they were and ensure they are more strictly enforced than before.

This demand is unlikely to gain traction at the EU level because too many countries would still be breaking the rules for years to come. There is already a consensus that they should be reformed; what is still at stake is how far these reforms should go.

Mario Draghi on stage in Bologna

Prime Minister Mario Draghi at an event in Bologna, Italy — Photo: Brancolini/ROPI/ZUMA

Time for Draghi to step up?

Despite its clear stance on the issue, Paris hasn't yet gone on the offensive. That having been said, starting in January, France will take over the presidency of the EU Council for a period that will coincide with its presidential election campaign. And it's likely that Macron's main rival, right-wing populist Marine Le Pen, will put the reforms front and center, especially since she has long argued against Germany and in favor of more freedom.

Rome is putting its faith in the negotiating skills of Prime Minister Mario Draghi, a former head of the European Central Bank. Draghi is a respected EU finance expert at the debating table and can be of great service to Italy precisely at a moment when Merkel's departure may see Germany represented by a politician with less experience at these kinds of drawn-out summits, where discussions go on long into the night.

The Stability and Growth pact may survive unscathed.

Regardless of how heated the debates turn out to be, the Stability and Growth Pact may well survive the conflict unscathed, as its symbolic value may make revising the agreement itself practically impossible. Instead, the aim will be to rewrite the rules that govern how the Pact should be interpreted: regulations, in other words, about how the deficit and national debt should be calculated.

One possible change would be to allow future borrowing for environmental investments to be discounted. France is not alone in calling for that. European Commissioner for Economy Paolo Gentiloni has also added his voice.

The European Commission is assuming that the debate may drag on for some time. The rules — set aside during the pandemic — are supposed to come into force again at the start of 2023.

The Commission is already preparing for the possibility that they could be reactivated without any reforms. They are investigating how the flexibility that has already been built into the debt laws could be used to ensure that a large swathe of eurozone countries don't automatically find themselves contravening them, representatives explained.

The Commission will present its recommendations for reforms, which will serve as a basis for the countries' negotiations, in December. By that point, the results of the German elections will be known, as well as possibly the coalition negotiations. And we might have a clearer idea of how intense the fight over Europe's debt rules could become — and whether the hopes of the southern countries could become reality.

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