A new period of inflation
In this provocative but calmly argued book, The Great Demographic Reversal, Charles Goodhart and Manoj Pradhan predict a new era of widespread and persistent inflation. Goodhart, who has been a respected expert on financial, monetary and central banking issues for decades, and Pradhan, a macroeconomist who studies global financial markets, express as “the highest belief” that “the world will increasingly turn away from deflationary tendencies to one that has a great inflationary tendency. “
This belief reflects their “main thesis” that “demographic and globalization factors have been largely responsible for deflationary pressures over the past three decades, but that these forces are now reversing, leaving the world’s major economies to be exposed to inflationary pressures again in the next three or so decades. “
Demographic factors include the end of the “positive supply shock” to China’s global labor supply over the past few decades. This is because “China’s working-age population has shrunk as a result of its rapidly aging population” and “the oversupply of rural labor is no longer providing net economic benefits [internal] Migration. ”“ So China will no longer be a global disinflation force ”and“ no longer stands in the way of global inflation ”.
A second key factor is that global birth rates continue to decline and life expectancy increases, promoting an aging society and increasing dependency rates. In this context, the authors point out that the average fertility rate in advanced economies has fallen well below the replacement rate. This includes the USA. For the foreseeable future, there will be an ever-decreasing ratio of active workers to dependent elderly people, with the enormous cost of support and health care for the elderly putting a strain on national budgets. They add this striking thought: “Our societies are still relatively young today compared to what is to come.”
These are longer term, not short term movements. The implication is that we can envision a slow, large cycle over decades of inflation and disinflation or deflation periods. The 2020s rise in inflation would mark a major reversal of the cycle, with perhaps a book like The Death of Inflation from 1996 symbolizing the previous reversal.
In another estimate of the length of the coming inflation period, Goodhart and Pradhan make it a little shorter: “The coronavirus pandemic … will mark the dividing line between the deflationary forces of the last 30-40 years and the resurgent inflation of the next two decades.” Whether it is two or three decades, the authors expect two or three decades, not two or three years, with significantly higher inflation.
The effects of such inflation, they write, would be “ubiquitous in finance, health care, pension systems, and monetary and fiscal policy,” and they certainly would be. For example, they propose: “It will no longer be possible to protect the real value of pensions from the effects of inflation.” Nominal rates will be higher, but “inflation will rise well above the nominal rate our political masters can tolerate” so that “negative real rates … will occur”. Here they should have written: “We will carry on” as we already have negative real interest rates and the yield on the 10-year US Treasury note is now below the inflation rate of the previous year.
Further: “The excessive indebtedness of non-financial corporations and governments will be blown away.” In other words, governments will implicitly default on their bloated debts through inflation, a classic strategy. Of the three alternatives the book names to deleveraging, “inflation, renegotiation, and default,” inflation is the easiest for a government with debt in its own currency.
As the authors say, “neither the financial markets nor the political decision-makers are prepared for such an inflationary future world”.
In a final chapter from 2020, Goodhart and Pradhan conclude that the government deficits and debts that have arisen in response to the coronavirus pandemic have exacerbated and accelerated the coming inflationary period. Government-mandated quarantines and lockdowns were “self-imposed [negative] A supply shock of immense proportions. To finance this, “the authorities rightly opened the floodgates for direct budget spending,” which in turn was financed by escalating debt and monetization.
“But,” they logically ask, “what will happen when the lockdown is lifted and a recovery occurs” – as it is now in full swing – “after a period of massive fiscal and monetary expansion?” To this question: “The answer will be, as after many wars, an increase in inflation.”
In line with the guidelines, I think this is a very good prognosis. We’re already seeing it in the first few months of 2021.
How Much Inflation Could There Be? They suggest inflation numbers will be high: “Probably more than 5%, or even on the order of 10% in 2021.”
Is 5% inflation possible? Well, from December 2020 to April 2021, the U.S. consumer price index rose at an annual rate of 6.2% when seasonally adjusted and 7.8% when not seasonally adjusted. Signs of rising inflation are common.
It seems to me that it fits naturally with the current system of pure fiat currencies in the world and with the burning urge of many politicians to spend and borrow, especially when they are provided with expansive central bankers. That the official prognoses and PR statements of these central bankers contradict the theory so much leads me to believe.
How about that 10%? Could we really get 10% inflation? It has happened before. The US had inflation of 10% or more in 1917-20, 1947, 1974, and 1979-81. Most of these followed inflationary financing of wars, but recent budget deficits and money pressures are as great as they were during a war.
The authors go on to ask, “How will the authorities react then?” and offer this prediction – made in 2020: “First and foremost, they will claim this is a temporary and once and for all slip up.” We already know that this prediction was correct.
Overall, is this theory of a new era of inflation plausible? It seems to me that it fits naturally with the current system of pure fiat currencies in the world and with the burning urge of many politicians to spend and borrow, especially when they are provided with expansive central bankers. That the official prognoses and PR statements of these central bankers contradict the theory so much leads me to believe.
With regard to central bankers, Goodhart and Pradhan note something important: “For the past few decades, central banks have been best friends with finance ministers [and Secretaries of the Treasury]Lower interest rates to ease fiscal pressures and stabilize debt service ratios. “But what will happen” when inflationary pressures rise again as expected “? Is the relationship becoming more strained or even more hostile? In other words, could the 1951 controversy between the US Treasury Department and the Federal Reserve be repeated and the famous “deal” between them come out in reverse: with the central banks, which are more submissive? “Inevitably,” the authors rightly say, “the central banks must be politically agile.”
Interestingly, the book comments on an implicit cycle in the looks of macroeconomists and macroeconomists. How credible are your statements and forecasts? “From the Korean War to about 1973 was a passing golden age for macroeconomics.” The 1960s demonstrated the misguided belief of macroeconomists that they could “fine tune the economy” and control inflation and employment using the “Phillips curve” they believed in. Sic Transit Gloria: “Everything went terribly wrong in the 1970s” when you got runaway inflation and high unemployment combined. And “the second golden period for macroeconomics (1992-2008) [also] went terribly wrong. “At that time, the ‘Great Moderation’ announcements that central bankers were honored to make turned into a big bubble and collapsed. The golden macroeconomic ideas of one era seem to be folly of the next.
When the new era of inflation predicted by Goodhart and Pradhan becomes a reality, the follies of the present will appear evident. Should we embrace their “highest belief” that this inflationary period is on the way? In my view, the economic and financial future is always shrouded in fog, but its reasoning is worth reflecting on and considering our reflections on the greatest economic risks.