Stagflationary global debt crisis looms – and things will get much worse

 


The global financial and economic outlook for the year ahead has soured rapidly in recent months, with policymakers, investors and households now asking how much they should revise their expectations, and for how long. That depends on the answers to six questions.

First, will the rise in inflation in most advanced economies be temporary or more persistent? This debate has raged for the past year but now it is largely settled: “Team Persistent” won, and “Team Transitory” – which previously included most central banks and fiscal authorities – must admit to having been mistaken.

The second question is whether the increase in inflation was driven more by excessive aggregate demand (loose monetary, credit, and fiscal policies) or by stagflationary negative aggregate supply shocks (including the initial Covid-19 lockdowns, supply-chain bottlenecks, a reduced US labour supply, the impact of Russia’s war in Ukraine on commodity prices, and China’s “zero-Covid” policy). While demand and supply factors were in the mix, it is now widely recognised that supply factors have played an increasingly decisive role. This matters because supply-driven inflation is stagflationary and thus raises the risk of a hard landing (increased unemployment and potentially a recession) when monetary policy is tightened. That leads directly to the third question: will monetary-policy tightening by the US Federal Reserve and other major central banks bring a hard or soft landing? Until recently, most central banks and most of Wall Street occupied “Team Soft Landing”. But the consensus has rapidly shifted, with even the Fed Chair, Jerome Powell, recognising that a recession is possible, and that a soft landing will be “very challenging”.

Moreover, a model used by the Federal Reserve Bank of New York shows a high probability of a hard landing, and the Bank of England has expressed similar views. Several prominent Wall Street institutions have now decided that a recession is their baseline scenario (the most likely outcome if all other variables are held constant). In the US and Europe, forward-looking indicators of economic activity and business and consumer confidence are heading sharply south.

The fourth question is whether a hard landing would weaken central banks’ hawkish resolve on inflation. If they stop their policy-tightening once a hard landing becomes likely, we can expect a persistent rise in inflation and either economic overheating (above-target inflation and above potential growth) or stagflation (above-target inflation and a recession), depending on whether demand shocks or supply shocks are dominant.

Most market analysts seem to think that central banks will remain hawkish but I am not so sure. I have argued that they will eventually wimp out and accept higher inflation – followed by stagflation – once a hard landing becomes imminent because they will be worried about the damage of a recession and a debt trap, owing to an excessive buildup of private and public liabilities after years of low interest rates.

Now that a hard landing is becoming a baseline for more analysts, a new (fifth) question is emerging: Will the coming recession be mild and short-lived, or will it be more severe and characterised by deep financial distress? Most of those who have come late and grudgingly to the hard-landing baseline still contend that any recession will be shallow and brief. They argue that today’s financial imbalances are not as severe as those in the run-up to the 2008 global financial crisis, and that the risk of a recession with a severe debt and financial crisis is therefore low. But this view is dangerously naive.

There is ample reason to believe that the next recession will be marked by a severe stagflationary debt crisis. As a share of global GDP, private and public debt levels are much higher today than in the past, having risen from 200% in 1999 to 350% today (with a particularly sharp increase since the start of the pandemic). Under these conditions, rapid normalisation of monetary policy and rising interest rates will drive highly leveraged zombie households, companies, financial institutions, and governments into bankruptcy and default.

The next crisis will not be like its predecessors. In the 1970s, we had stagflation but no massive debt crises because debt levels were low. After 2008, we had a debt crisis followed by low inflation or deflation because the credit crunch had generated a negative demand shock. Today, we face supply shocks in a context of much higher debt levels, implying that we are heading for a combination of 1970s-style stagflation and 2008-style debt crises – that is, a stagflationary debt crisis.

When confronting stagflationary shocks, a central bank must tighten its policy stance even as the economy heads toward a recession. The situation today is thus fundamentally different from the global financial crisis or the early months of the pandemic, when central banks could ease monetary policy aggressively in response to falling aggregate demand and deflationary pressure. The space for fiscal expansion will also be more limited this time. Most of the fiscal ammunition has been used, and public debts are becoming unsustainable.
 
Moreover, because today’s higher inflation is a global phenomenon, most central banks are tightening at the same time, thereby increasing the probability of a synchronised global recession. This tightening is already having an effect: bubbles are deflating everywhere – including in public and private equity, real estate, housing, meme stocks, crypto, Spacs (special purpose acquisition companies), bonds, and credit instruments. Real and financial wealth is falling, and debts and debt-servicing ratios are rising.

That brings us to the final question: will equity markets rebound from the current bear market (a decline of at least 20% from the last peak), or will they plunge even lower? Most likely, they will plunge lower. After all, in typical plain-vanilla recessions, US and global equities tend to fall by about 35%. But because the next recession will be stagflationary and accompanied by a financial crisis, the crash in equity markets could be closer to 50%.

Regardless of whether the recession is mild or severe, history suggests that the equity market has much more room to fall before it bottoms out. In the current context, any rebound – such as the one in the last two weeks – should be regarded as a dead-cat bounce, rather than the usual buy-the-dip opportunity. Though the current global situation confronts us with many questions, there is no real riddle to solve. Things will get much worse before they get better.

There is ample reason to fear big economies such as the US face recession and financial turmoil writes Nouriel Roubini in The Guardian

Self-fulfilling prophecies can be harnessed for good

But some predictions are false, no matter how much we wish they were true writes Tim Harford in The FT

It's 1963. A young psychologist named Bob Rosenthal conducts an experiment in which his assistants place rats in mazes, and then time how long it takes the rats to find the exit. They are housed in two cages: one for the smartest rats and one for rodent mediocrities. 

The assistants are not surprised to find that the smart rats solve the mazes more quickly. Their supervisor is — because he knows that in truth, both cages contain ordinary lab rats. 

Prof Rosenthal — he would go on to chair Harvard’s psychology department — eventually concluded that the secret ingredient was the expectations of his assistants: they treated the “special” rats with care and handled the “stupid” rats with disdain. When we expect the best, we get the best — even if we expect it of a rat. 

The story is well told in Rutger Bregman’s new book Humankind. His interest in Prof Rosenthal’s work is not hard to explain. Mr Bregman argues that people are fundamentally friendly and self-motivated. But he also argues that when we expect more of each other then, like the rats, we rise to the occasion. If schools, police or corporations believe that people are sluggish, dishonest or lazy, they may be proved right. 

Prof Rosenthal coined the phrase “the Pygmalion effect”, the name inspired by Ovid’s account of a sculptor whose infatuation with a statue brings it to life. But the Pygmalion effect is just one example of what the sociologist Robert K. Merton called “self-fulfilling prophecies”. 

There’s the placebo effect and its malign twin, the “nocebo effect”: if the doctor tells you a drug may produce side effects, some patients feel those side effects even if given an inert pill. 

Self-fulfilling prophecies are a staple of economics. A recession can be caused by the expectation of a recession, if people hesitate to spend, hire or invest. And a bank run is the quintessential self-fulfilling prophecy. 

The self-defeating prophecy is just as fascinating, and a problem that bedevils economic forecasters. If I credibly predict a surge in the price of oil next year, the surge will happen immediately as oil traders buy low now to sell high later. The forecast goes awry precisely because people thought it was accurate. 

The coronavirus era has brought us a vivid example. A vocal minority argues that Covid-19 is not much worse than the influenza we ignore every winter, so both mandatory lockdowns and voluntary precautions have been unnecessary. 

A glance at the data gives that argument a veneer of plausibility. The UK has suffered about 65,000 excess deaths during the first wave of the pandemic, and 25,000-30,000 excess deaths are attributed to flu in England alone during bad flu seasons. 

Is the disparity so great that the country needed to grind to a halt? 

The flaw in the argument is clear: Covid was “only” twice as bad as a bad flu season because we took extreme measures to contain it. The effectiveness of the lockdown is being used as an argument that the lockdown was unnecessary. It is frustrating, but that is the nature of a self-defeating prophecy in a politicised environment. 

One might say the same thing about Fort Knox. Nobody has ever tried to steal the gold, so why bother with all the guards? 

Self-fulfilling prophecies can be pernicious; writing in 1948, Prof Merton focused on racism. For example, some said African Americans were strikebreakers who thus should not be allowed to join trade unions. Prof Merton pointed out that their exclusion from unions was the reason they had been strikebreakers. Sexism also drips with self-fulfilling prophecies. Since our leaders were usually straight white men in the past, it is all too easy to favour such people for leadership roles in the future. 

Such prophecies can also be harnessed for good. Bob Rosenthal took his ideas into schools, where he found that what is true of rats being respectfully handled is just as true of pupils. Persuade a teacher that a pupil has hidden talents and the child will soon flourish. 

Yet one can put too much faith in the self-fulfilling prophecy. Fervent excitement about the dizzy ascent of Tesla’s share price should help the company sell cars and raise funds but, in the long run, the value of a Tesla share will be determined by Tesla’s profitability. 

Self-fulfilling prophecies are particularly tempting for politicians. It is all too easy to paint a project such as Brexit in Tinker Bell terms: if we clap our hands and believe in Brexit, it will not disappoint. Conveniently, all setbacks can be blamed on “Remoaners”. 

The fact is that some things are false no matter how fervently we wish them to be true. We often plunge into projects with rosy views of how long they will take and how successful they will be, but our optimism only gets us started. It does not finish the job. 

I think we should try to treat each other with kindness and respect, and not just because it worked for Bob Rosenthal’s rats. But there are limits to the power of sheer positive thinking. Even in the cartoons, Wile E. Coyote eventually feels the tug of gravity.

Will the next Pope be the last one - Yes, says St Malachy The Ominous

A 12th century clairvoyant has foretold the end of papacy!

 

Pope Benedict’s sudden resignation has stunned the world, and pundits are searching for motivations beyond his plea of old age. To complicate matters, there’s also a strange 900-year-old prophecy involved.

According to a famous prophecy made by St Malachy in the 12th century, there would be 112 more popes. Pope Benedict, who resigned, was the 111th. And whoever is elected Pope in the next few days will be the 112th. During the papacy of this final pope, says the prophecy, Rome—and the Church—will be wiped out! To quote its ominous words: “The City of Seven Hills shall be destroyed, and the dreadful Judge shall judge the people.”

Rubbish, one might say. We’ve heard a lot of lunatic Doomsday predictions, and the Mayan prophecy is still fresh in our minds. But this time there’s one small difference: St Malachy actually described each of the 111 popes till date with eerie accuracy, summing up each one with a vivid Latin phrase. And so far he’s never been wrong.

For example, he described Pope Paul VI (1963-78) as ‘Flos Florum’, meaning ‘Flower of Flowers’. Paul VI’s coat of arms, as it happened, featured three iris blossoms. His successor, Pope John Paul I, was described as ‘De Medietate Lunae’, or ‘Of the half moon’. This was puzzling, because the description just didn’t seem to fit. But one month later, when John Paul I suddenly died, one realised that he’d become pope at the time of the half moon and died by the next half moon. His successor, Pope John Paul II, was described as ‘De Labore Solis’, or ‘Of the eclipse of the sun’: it turned out he was born during a solar eclipse!

People have been talking about the prophecy of the popes with increasing frequency since the 1970s, as the end of the line drew closer. In 2005, when John Paul II, the 110th pope, died, people looked at the prophecy again, in anticipation, and found the next pope described as ‘Gloria Olivae’, or ‘The Glory of the Olive’.(Editor's Comments - the relation to Ratzinger is unexplained though!)  But what did this mean? Some people thought it somehow signified Israel; others said it meant the new pope would be a Benedictine, an order symbolised by the olive. Sure enough, the conclave ultimately elected Cardinal Joseph Ratzinger, a Benedictine priest from Germany, who—to seemingly reinforce the prophecy—took the name Pope Benedict xvi, after the founder of the order.

St Malachy, a clairvoyant bishop, while on a visit to Rome in 1139 CE, is said to have fallen into a trance and seen a vision of all the popes till the end of time. When his prophecies were published, the Vatican tried—for obvious reasons—to suppress them, but failed. In his final prophecy, St Malachy refers to a pope he calls ‘Petrus Romanus’, or ‘Peter the Roman’, adding darkly, “In extreme persecution, the seat of the Holy Roman Church will be occupied by Peter the Roman, who will lead his sheep through many tribulations, at the end of which the City of Seven Hills shall be destroyed, and the dreadful Judge shall judge the people.”

So which one of the current papal candidates is ‘Peter the Roman’? Sure enough, one of the front-runners is named Cardinal Peter Turkson, so it could very possibly be him! But, more importantly, what will be the ominous “many tribulations” that the people will be led through? What will be the events leading up to that ultimate “destruction”? And who is the “dreadful Judge” who will appear in judgement? Cardinal Turkson is now aged 65, so we can presumably expect the scenario to be played out anytime within the next twenty years—before, say, 2033.

Cardinal Turkson may not necessarily be the one, though, for Peter means ‘the rock’, and that could be a metaphor, not simply a name. As in the case of Nostradamus, St Malachy’s clues are sometimes cryptic, and become clear only after the fact. Pope Benedict XV, for example, was referred to as ‘Religio Depopulata’, or ‘Religion laid waste’, and when he became pope in 1914, nobody could understand the relevance of this. However, as his papacy unfolded, World War I and the Russian revolution made the meaning of the phrase terribly clear. But regardless of who the next pope will be, one thing is evident: the prophecy mentions only 112 more popes. There is no 113th.

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(The writer is an advertising professional.)