As an economist, you are taking on a great deal of professional risk by even pronouncing “the i-word” (inflation) at this point in time, the risk of being publicly ridiculed due to the fact that the status quo revolves so heavily around combating the exact opposite of inflation (on dealing with deflationary forces) that the very mention of inflation as a potential threat brings about amusement more so than legitimate concern, with those who “dare” do just that quickly being associated with more or less shady gurus who predict that hyperinflation is coming to Western nations within a month.
But what if it’s not hyperinflation that worries you as an economist but rather simply serious inflation?
In the opinion of this author at least, hyperinflation is most definitely not a legitimate threat for Western nations in 2020, as mentioned on other occasions. Why? Simply because we do not have a precedent involving a country going from prosperous to devastated as a direct result of hyperinflation. In all documented cases (yes, including Germany after World War I), economic devastation was brought about by other forces and it was only after a country became genuinely weakened that hyperinflation emerged.
As such, no, the likelihood of having hyperinflation in the US or even China anytime soon is fairly close to zero. But, and therein lies the nuance many experts are missing, you do not need actual hyperinflation (for example the dollar going from $4.2 to $4.2 trillion marks) to generate nightmares economically speaking. In my country (Romania) for example, we had very high inflation in the nineties but definitely nowhere near hyperinflation territory. Did that stop people from essentially seeing their wealth wiped out? Of course not. High inflation is far, far more insidiously dangerous than meets the eye and it therefore perplexes me that economists are not paying anywhere near adequate attention to this phenomenon.
Fast-forward to the present and we have the question which constitutes the title of this post most likely making readers wonder how exactly the Covid-19 white or black swan (depending on whom you ask) can ultimately lead to inflation-related problems. If anything, isn’t the exact opposite true, in light of the deflationary market crashes caused by such white/black swans?
From a short-term perspective, yes.
From a longer-term one and especially the situation China as well as pretty much every other nation finds itself in… let’s just say things are far more complicated.
What keeps me personally up at night is represented not by your “status quo” deflationary shock scenario but rather by something more specific: deflation, which leads to “more of the same” in terms of how the authorities react (central banks lowering already-low interest rates and injecting money into the system on the one hand and governments providing fiscal stimulus on the other) and is eventually followed by runaway inflation, as the market “digests” what happened and decides that enough is enough, losing confidence not just in one particular currency such as the Renminbi but rather in currencies in general.
Did this happen after Alan Greenspan responded to the Dot-Com Bubble’s aftermath by lowering interest rates from roughly 6.5% to a (staggering at that time) 1%?
No, it did not.
However, the market got let’s say accustomed to this type of “help” and when the next financial crisis hit (the Great Recession), it demanded more… much like a drug addict demands an ever-increasing dose to remain somewhat functional.
Did it receive what it wanted?
Ultimately, yes, with Ben Bernanke lowering interest rates all the way down to zero and over in the European Union as well as Japan, them even entering negative territory. Furthermore, lowering interest rates alone was no longer enough, with unorthodox options having to be chosen which involved monetary easing or if you will, injecting money in the financial system to the tune of $85 billion per month in the United States and even more in the EU as well as Japan at the height of their respecting easing journeys.
Do we have runaway inflation this time around?
Once again, no.
Simply because while the measures were indeed unprecedented, most of the money ended up as reserves in the banking system and quite a bit simply chased financial assets. As such, the end result was the formation of various bubbles across many asset classes or if you will, asset price inflation rather than consumer price inflation.
In light of the serious economic problems brought about by the Covid-19 situation, the market is once again demanding stimulus and we have every reason to believe that just like with the Great Recession compared to the Dot-Com Bubble, governments and central banks will be pressured into offering an even more substantial “dose” of monetary as well as fiscal stimulus.
Will there be inflation problems next time?
While nobody can know for sure and those who claim they do are simply lying, let’s just say the probability is greater this time around. This is primarily a result of the fact that central banks seem to have limited “ammunition” in light of how low interest rates currently are and as such, the market will place more and more pressure on the fiscal side as well. What this means is that as opposed to the Great Recession response, there is a greater likelihood of monetary easing (most likely considerably more than last time around) ultimately leading to money finding its way to the “real” economy and thereby generating inflationary effects.
As far as deflation is concerned, we have had more than enough experience with it in the 21st century across Western nations but when it comes to inflation, the exact opposite is true, with quite a bit of time passing since the let’s call them stagflation days. Therefore, worrying about inflation as well as deflation at this stage is, in the opinion of the ChinaFund.com team at least, the rational thing to do, in China as well as the West.
Is inflation likely to affect China more severely?
Most likely, in light of the fact that as mentioned on other occasions, China is not yet considered a safe haven destination. As a general rule: the weaker a nation is, the more vulnerable it is to inflation-related problems, from countries such as Zimbabwe and Venezuela which are hyperinflation candidates to the world’s most robust economies, where the likelihood of hyperinflation occurring is close to zero but serious wealth-altering inflation problems representing anything but an impossibility. The bottom line is this: we firmly believe that absolutely everyone needs to start paying more attention to inflation at this point in time and should you and/or your organization require assistance with just that, the ChinaFund.com team is here to help.