Prospects for 2022

So we all think the pandemic or climate change are the greatest short term threats facing us. Look again - perhaps it is asset inflation. Why? Because it is a problem compounding itself and ready for a correction that may be all the worse for having been delayed. To save the 'system' (essentially late liberal capitalism with its continuously expanding globalisation and post-enlightenment values system), policy-makers quite rightly have engaged in 'quantitative easing' - that is, pumping monetary value into the Western economy - and this effectively was the same as driving down interest rates. After all, what do you do when you cannot push interest rates down any further - you have to give money away and formal negative interest rates would be a true sign of policy failure. Quantitative easing - sanctified asset inflation for prosperous households - is not an unintelligent response to a crisis.

Low interest rates sound good but they continued long after the 2008 crisis had been 'resolved' because the post-2008 world could not maintain the economic momentum triggered by the Reagan-Thatcher 'reforms'. That is another story but those 'reforms', while containing room for corrections, were at the very root of what happened in 2008 and were ultimately an unsustainable basis for long term growth once the initial benefits of restructuring had been received. Ideological Thatcherism is as useful as ideological Marxism in the long run - in short, not very.

But who actually benefited from long term low interest rates? In the event, largely corporations and businesses who felt that they could rely on future low interest rates to pile up debt which was often productive but equally allowed a lot of bad companies to survive on borrowed money. The amount of 'bad' private sector operations tends to accumulate if there are no corrections within the market able to punish over-enthusiasm. Low interest rates also enabled middle class households to increase their wealth through asset purchases (property and equities in pension funds) whose asset inflation (which has been significant during the pandemic) they used as the basis for 'forward buying' what they wanted and desired as consumer debt. There was no malice or stupidity in maintaining this sense of security in the purchasing middle classes at a time when it might be reasonable to believe that the pandemic could result in serious economic problems and a collapse in demand but central banks seem to have hung on to their fears for far too long and created new problems that will have to be addressed in the coming months And in case you think this is just my opinion, this is Rana Forohaar in the Financial Times recently on the US situation:

" ... the Federal Reserve has been stretching out the business cycle artificially for decades, preventing the sort of healthy culling of unproductive loans and businesses that would ordinarily have been happening every few years. The problem is that when the music stops, there will be pain. About two-thirds of the US economy is consumer spending. But people’s spending patterns are not based on their income alone. Our personal consumption is also linked to our expectation of wealth held in assets such as stocks and bonds. What’s stunning is how utterly dependent American fortunes have become on the inflation of those asset prices."

Largely generated by energy inflation (which is likely to be sustained by the transition from a fossil fuel to a renewables economy because investment in the former is plummeting and the technological and infrastructural basis for the latter is still many years away), consumer inflation is back and driven also by high consumer spending based on an increase in those asset values during the pandemic as well as by the widely advertised supply chain problems. These latter are slowly easing but not at a fast enough rate to avoid levels of inflation that are reaching 30-40% in (say) Ethiopia, 8% in Kazakhstan, 7% in the US, 4-5% across Europe including the UK, way above the 2% target that central banks actually had wanted not so long ago as a measure of targeted economic growth and could not achieve.

You see the problem? Central banks understand that underlying the inflation is the potential not only for a return to the situation after 2008 which arguably led to the political shocks of 2016 but for a more active deflation based on digitalisation, AI and other technologies. And yet, more immediately, inflationary pressures are getting out of control with two destabilising electoral cycles on the horizon - in the Spring in Europe (France, Hungary, Italy) and the mid-terms leading up to the Autumn in the US, as well as there being at least one serious and immediate international relations crisis (Ukraine) that could send energy prices soaring temporarily, perhaps permanently if seriously mishandled, through the roof if we leave the foreign policy wonks to decide things for us.

Central banks have been incredibly nervous about increasing interest rates since the Autumn. The arrival of Omicron will certainly have blind-sided them late last year. This caution is despite the massive asset inflation that sits behind the more harmful consumer inflation and the more benign wage inflation. They have, in fact, been getting it consistently wrong in their predictions for the last six months and yet they persist in believing that these problems are 'temporary' (that may be partially so) and not structural. However, it is quite possible that there is a darker and more structural aspect to this story that tells us that our system may be more 'on the edge' than we had thought.

The first aspect is something that they can do little about. Raising interest rates will not do anything about energy inflation (which is politically generated, a combination of superpower politics, oligopoly in the fossil fuel economy and the green agenda). This is the main component of current inflation. Nor can they do much about supply chain issues which are pandemic-related and will adjust in the right direction slowly but surely. They can only do something about the inner workings of late liberal capitalism which are fundamental but where activity may not have more than a relatively minor effect on headline inflation while having other serious unintended commercial, social and political effects.

If they raise interest rates even by small amounts to send signals, the effect on middle class assets will be noticeable - businesses on the edge with high indebtedness may not be able to cope, equities are likely to fall, household debt payments will have to increase just as households see massive increases in energy costs and the property market will start to seize up (because too little housing stock is held by too few people who are hanging on to that stock as a pension pot). The combination of inflation (regardlessly continuing if at a lower level) and asset correction could well reduce demand significantly and reverse the recovery.

On the other hand, if nothing is done about inflation at all by failing to use interest rates as a tool, it could spiral out of control, add to political instability within the West (which is intrinsically bad for business), damage working class and lower middle class households in significant and observable ways and threaten an even more intense flight into the sort of assets that are already over-inflated. As we saw in 2008, the longer you leave a correction, the worse it becomes. What is likely to be a 10-15% correction this year in some form at some stage could be a 30% correction or more if delayed into the next two years. Such a correction could trigger a post-pandemic depression under conditions where we still do not have a clear handle on the pandemic (restrictions and supply chain issues actually saw the German economy centred on export marginally shrink in the last recorded quarter). 2008 should be a lesson ... if the inherent problems in the market had been noted and dealt with decisively only months before Lehman Brothers collapsed, the resulting shock would have been much less. Capitalism only works if it is allowed to correct itself or if the authorities act to correct the bad consequences of their own policy decisions as in the 2008 case.

What are central banks worried about here? Everything probably but the class element is important. Although technocrats are independent of any class except that of technocrats, technocrats are essentially 'middle class' with middle class values and property concerns. They have been nervous for well over a decade about encouraging or instituting minor corrections in order to restrain asset inflation on the assumption that we might be able to return to a world of constant neo-liberal growth. They have wanted the middle classes to feel and be rich to try and drive demand. This was probably inherently flawed conceptually but the ball could be constantly kicked forward and fingers crossed for a self-sustaining return to growth so long as there were no shocks to the system. And then a) the pandemic happened and b) the value system of that same class introduced us to a radical transition from the fossil fuel economy equivalent to the traumatic transition from coal, iron and steel to grid electricity, autombiles and aviation but without a war to justify the necessary levels of investment and inflation or the brutalist politics of a Stalin.

Inflation now takes place in unstable democracies with interactive social media and atomised and fragmented populations who cannot be mobilised in some maniacal patriotic fervour in favour of either sacrifice or war. The upper middle classes who have 'had a good war' during the pandemic are political narcissists who expect and demand asset growth to pay for their desires and who can take levels of inflation that allow them to put up their own prices and wages that households further down the pecking order cannot. They have no idea what a major correction could do to them as those who experienced the 1929 crash had no idea what could happen to them. Meanwhile, the working and lower middle classes are getting angry in a fluid and inchoate way, not understanding exactly what is going on but seeing their standard of living drifting downwards with every household bill.

We should also bear in mind that the wider shift to inflationism is a political decision and has its long term positive aspects. It is an admission that the old order has failed - the only thing on which populists and the centre-left can agree as they struggle to control the levers of power over an institutional technocracy that is the old order. Much of the centre-left strategy (Biden and the European Commission and even Boris fall into this category much to the chagrin of the traditional Tories trying to oust him at the moment) is to undertake significant expenditures on education, training, technology and infrastructure that are inflationary in the short term but which will be deflationary in the very long term. This has its logic. It is also designed to encourage saving over debt-fuelled growth in order to attain sustainable long term growth. It is a long term play in a world of short term market movements, short term headlines and short term electoral cycles. Biden's current approval ratings tell you just how poorly his strategy and the mental maps of the American electorate are meshing.

The Democrat strategy is probably the only way to kick-start public/private co-operation in the transition to the 'green economy' - you might think of it is trying to transform the West as Stalin transformed Russia but without the nasty bits. Unfortunately there are always nasty bits and those who suffer from the nasty bits have votes and are not interested in a big picture that seems to serve others. The costs of transition can be very real on vulnerable people and households and the invulnerable middle classes still deeply resent the potential 'theft' of a future security that they believe they worked hard for. Redistributive strategies may be essential to keeping this plan on an even keel but that begs the question of redistribution from whom to whom. The resistance of the upper middle classes to increased taxation (including the prospect of wealth taxes that would quickly strip away all those asset value gains that justified living high on the hog of debt) is a political problem because, though a minority, these are the classes who control the commanding heights of the information economy and culture.

So the central banks have some tough decisions to make. All the signs are that they are still hedging, sending signals of rate increases in the Anglo-Saxon world to try to moderate behaviour, hanging on to the belief in the temporary nature of the crisis in Europe, but with the probability of small corrective increases in rates from the Spring in the US and UK forcing the pace much later in the year in Europe if things do not improve. Avoidance of interest rate infection which could get as out of control as inflation and cause stagflation really means a settlement with Russia, the populists being chased off in France in April, the pandemic easing substantially and a degree of intelligent compromise in the implementation of the green agenda. The ECB seems to be doing little more than continuing its policy of crossing its fingers and hoping, perhaps until one of their own is securely lodged back in the Elysee Palace.

Populism may force the pace a little since the class war between the asset holders and businesses on one side and working households (with many of the middling sort being both) on the other is potentially real. Its outcome comes down to the former's control of those commanding heights of politics (hence the vicious attempt to oust Johnson in the UK, Biden's temporary abandonment of parts of the Green Agenda to try and drive down inflation and the heated exchanges and cultural war on the populists in France) and mainstream media narratives. The logic is compromise - to save the system, small corrections and government dole-outs and gestures (such as the paltry BBC licence fee announcement in the UK) are offered to buy time until normal service can be resumed - if it can ever be resumed.

No one is looking though at the fundamentals - that a Western economy (and increasingly a Chinese economy) built on debt may be reaching the limits of its inherent viability much as past imperial economic systems have done, that the fossil fuel transition is massively disruptive and cannot be done on the time-scale required by activists without adopting extreme and socially and politically destructive methods, that new technologies are inherently redistributive and deflationary but also tend to concentration of power in technologically advanced corporate structures, that democracies have become inherently unstable because of technological change and that globalisation is showing all of its internal contradictions under the pressure of a temporary existential crisis. The scenario of a tumultuous 2022 subsiding into stagflation or deflation is as likely as the model of a return to sustained growth in which the middle classes detach themselves from the rest of humanity on a cloud of ever-increasing asset-based wealth.

The slow process of moving us from this to a sustainable economy which can be secure and stable for the bulk of its members and which may be run by states or corporations or by some hybrid of the two (because it is not going to be run, except negatively through the threat of protest, by free populations) is a matter of many years, perhaps decades. But the failure to allow constant small corrections and manage the over-expectations of the actual and aspiring middle classes based on the dream of constant Panglossian expansion may be what future historians will agree did for the old order of things some day.

Fortunately, policymakers are not entirely blind to these issues. A moderation of globalisation to take account of its failures is definitely on the agenda. Aggressive liberal internationalist expansionism is on the wane even if it stands its ground where it has gained it. An attitude of see what I do rather than do what I say is emerging, allowing peaceful co-existence as an alternative to confrontation. The Ukraine crisis is a test of new boundaries in this context. Greater global regionalisation (taking China as a region in itself) seems to be on the cards in order to manage supply chain shocks and energy issues. Globalisation 2.0 may be what we should have had in the first place but then we are a species that moves forward by screwing up and then learning from what we screwed up rather than thinking things through in advance. A degree of long term optimism is permissible - the short term may be a roller-coaster.