Had to double check the dictionary definition but for me it’s persistently high inflation and falling or stagnant output.
Guess we are seeing the debate between the inflationistas and the deflationistas, but as yet the stagflationistas have hardly entered the fray.
The deflationsistas have been dominant so far, as this has been the dominant view for nearly three decades, essentially because we have been living in an era of sustained low inflation in the DM world at least, and increasingly the EM world has been joining the club there. And I guess those arguing that inflation risks are just over the hill have always been called out as boys that’s cried wolf. It’s been very hard to sustain this view when inflation has stayed very low for a very long time.
And I guess also because there has been much logic to it – based on the combination of globalisation, unleashing billions of EM workers to global supply chains, technology and in particular the internet which imposes near perfect and global price discovery. We can add in years of now orthodox monetary policy – or up at least until the GFC.
But I would argue that a number of things are challenging this narrative
First, ESG which is adding a huge cost push, and arguably moving the global supply curve to the left and up.
This is here to stay, and as someone on the hard end of it I can say that it imposes huge costs on business, with uncertain rewards.
Second, perhaps partially related, climate change. And I get that the E in ESG is key to addressing climate change in the longer term, but [global warming] is producing gyrations in climate which we have never seen, and major disruptions to agro climatic conditions, this means risks of drought, floods, and more volatility in food prices. It also perhaps comes as agro food price regulation has been easing off in recent years. The risk is we see hog price cycles, or the cobweb theorem in agro food prices. This means more volatility, higher highs, and lower lows. I don’t think it’s a surprise that we are seeing higher food prices generally globally this year.
Geopolitics should not be forgotten
The pre-Trump world was a friendly multilateral one, where it was all about working together to reduce barriers to trade, for win wins and this was key to the globalisation story. Now we found out that globalisation was not all win – win. Big wins for the Davos elite, not such big wins for traditional working classes in DMs. And they fought back. Oh how they fought back with Trump, Brexit, at al, egged on by the likes of Putin.
Suffice to say post Trump we are not seeing a return to default settings – Biden is not dismantling China trade tariffs, but if anything the competition with China is deepening. This means a more autarkic world trade order, and hence additional costs to business.
I was going to use Brexit as a separate point, but it fits in with the geopolitical angle. Populism has bred Brexit, and it’s ironic now that bread supplies in the UK are under threat. Brexit has disrupted supply chains and is causing supply and price distortions which don’t just look transitory. And this will impact not just the UK but economies it trades closely with.
We can also add Western – Russia relations, or the deterioration herein. Why are gas prices rising in Europe? Because Russia is trying to impose its geopolitical hegemony, seeking to secure NS2 approval. This is causing gas supply shortages and higher prices.
Global hit from Covid in terms of disruptions to supply chains looks to be long term
Covid is making a huge impact on how we work, where we live, whether we want to work, where we shop, buy, and it is proving to be extremely disruptive. Likely it will further the move to autarky in trade.
And autarky in trade means that goods may not be produced to the same economies of scale, at the most efficient point of production, and inevitably at a higher cost.
Markets will take time to settle to the new post Covid order, and this means likely a very extended period of higher prices. It’s a market disruption I would argue on a scale equivalent to the 1970s oil price shock.
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So what about stagflation?
Well I think we got a taste of this this week with the European gas supply shock. The huge rise in gas prices, Covid related, but also Russian energy supply related, has shown us the law of unexpected consequences in a hugely inter-related world. Did anyone imagine that the three fold increase in gas prices would make fertiliser production uneconomic? That is bad for agriculture as fertiliser prices will rise, which means lower use, lower yields, and higher food prices over the next few seasons. And as Co2 is a by product of fertiliser production, it also means the loss of key ingredients to food storage, and again risks of disruptions to food supply. But the input channel here is that in this globalised world much of business operates on very thin margins, if one bit of the supply chain gets hit with higher prices, production can easily become uneconomic, production shuts down and there is the impact on output. The hope is that output shut down is not lost, but can easily be brought back on line, but that will not be the case each time. Some companies will be forced to shutter permanently and it will time for new entrants to appear. Again this suggests an extended time of supply and price disruptions and risks to output and recovery.
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This all begins to get a feel of the 1970s oil price shock which yielded a period of stagflation.
But putting all this together, I think it is quite possible to construct a non transitory inflation story, with real risks of stagflation. This is through large and prolonged inflation shocks, disrupting production, and in fact stalling production. Wages and costs increase, the supply curve moves up and to the left. And I have not even got into a discussion of the huge monetary and fiscal stimulus being rolled out by the US, and DM, and then the impacts of the Evergrande saga on the outlook for Chinese growth, and it’s potential to cause wider shocks to the global economy.
* Please note that any views expressed herein are those of the author as of the date of publication and are subject to change at any time due to market or economic conditions. The views expressed do not reflect the opinions of all portfolio managers at BlueBay,
or the views of the firm as a whole. In addition, these conclusions are speculative in nature, may not come to pass and are not intended to predict the future of any specific investment. No representation or warranty can be given with respect to the accuracy
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