As 2021 dawned, we were all inevitably thinking thank Goodness 2020 is over. And fair enough. But I felt a little less easy when friends went on to say, 2021 can’t be any worse. Actually, how can we know? Think of January 1666: was the average Londoner – say, a baker on Pudding Lane – thinking, thank Goodness 1665 is over?
1666 subsequently brought the Great Fire of London. What’s been playing on my mind recently is whether this pattern is about to repeat itself. Not literally, of course – but metaphorically. Might we yet see a post-Covid conflagration in financial markets?
I’m uneasy because everything – from a markets point of view – seems so easy. I can’t be the only person who finds the current calm in financial markets decidedly eerie. Uncanny. We’re experiencing socially distanced mayhem in the real economy, while financial markets seem to be sailing off smoothly into an alternate reality. True, there was a sharp crash in stock markets last March, but the recovery was almost as quick as the crash. Even property markets have been handling the social instability with a surprising amount of price stability. If anything, markets have prospered during this turndown.
How can that be?
The main reason for the stability is the main reason I’m uneasy: the wall of cash that governments and central banks have been throwing at their economies and their financial markets. Borrowing is increasing at the fastest rate since the war. The number are vertiginous. Global debt across all sectors (governments, households, and corporates) rose by a staggering $20 trn through the year. Much of this was financed through ‘Quantitative easing’ (QE). That’s the polite term to describe how central banks inject cash into the system by purchasing government bonds and other assets. The less polite description is that they’ve been ‘printing money’ and how: QE rose by roughly $8 trn in 2020.
Now if you’re suspecting this article is going to be another old-school warning about the perils of inflation – with faintly scary allusions to Zimbabwe and Weimar Germany – then the answer is Yes... But perhaps not in the way you might be thinking.
Let’s start with the economic consensus. Economists are relaxed about the inflationary risk. Sometime in the 90s the inflation genie was put back in its bottle and has remained there ever since. Look at Japan: it’s been borrowing as if its life depended on it and has experienced deflation not inflation. Now look at lockdown: people and businesses are hoarding their cash, not spending it. The net result is continued price stability. So far, the economic consensus is holding.
But here’s the first of two points I want to make in this article. It’s not lockdown that we should worry about, but the recovery. When lockdown eventually ends, the economy picks up, and people and businesses start to spend again, will the extraordinary expansion of credit during 2020 drive inflation? All paradigms shift eventually, it’s what they do – and they're particularly likely to do it during periods of tumultuous change. So might the economic consensus be misguiding us?
Answer: nobody, of course, knows.
One could try to model this mathematically, but I suspect that would miss the point. Monetary and fiscal stimulus has become such an addiction – with so many sectors of so many societies around the world completely hooked on it – that governments will continue printing the money until they can’t anymore. Until they’re stopped. One thing that might stop them is of course a healthy broad-based economic recovery, which would be great; the other thing is inflation.
This brings me to the second point I want to make. Let’s imagine that the economic consensus is correct and that the inflationary risk is small. Well, proper risk management means we should gauge both the likelihood of a risk (apparently small), but also its magnitude. If this unlikely thing called inflation were to happen, how big a deal would it be? Here again, I fear the consensus may be misjudging it.
I recently attended an online event with some eminent economists and this question was asked by a nervous participant. The answer she got was all blithe reassurance. She was told that a bit more inflation might be a good thing and that economists were starting to think we should be targeting 4% inflation, not 2%. Higher inflation means debt is eroded more quickly.
Fine… But the forest is tinder dry.
My concern is that if inflation takes hold, instead of getting a smooth adjustment to, say, 4% inflation, it could in fact run away from us into a full-blown currency crisis. Why? Three things. Firstly because of the credit expansion that I referred to above – all that money that was created during 2020. Secondly, because there will be huge political pressure to keep borrowing and printing money to support all the sectors that have become so dependent on it, even while that stimulus pours fuel on the inflationary flames. Which leads to the third reason: the contagion factor. If inflation starts to move, it’s easy to see the major societies – after all the money printing – starting to lose confidence in their currencies. As people start to expect inflation, they start to demand higher prices and higher wages – which generates even more inflation. To return to my original metaphor: conflagration.
I no longer work in financial markets. I’m a writer these days. In my satirical novel, How to Buy a Planet, I imagine a world where the post-Covid debt burden is so great that the world’s leaders decide to sell the planet. I studiously avoid taking sides on the inflation debate: whether the debt burden brings us Japan-style deflation or runaway inflation – either outcome is undesirable. But the point I’d make here is that even if the likelihood of runaway inflation remains low, the impact it would have – were it to happen – is huge. And for that, we should be better prepared.
This blogpost was subsequently published in City AM on 13th February, 2021, under the title, 'Runaway inflation might not happen. But what if it does?'