The world’s problem is not merely inflation any more. A new type of recession must be included, adding up to a situation described by a mixed term (circa 1965 UK), “stagflation.” I will embellish the idea, making it Stagflation 2.0. It is a problem existing right around the world, in Asia as well as the West.
The recession portion of version 2.0 is, oddly enough, accompanied by, at least so far, relatively low unemployment, but high levels of citizen complaint and general dissatisfaction. Consumers have jobs and money, sometimes money for which they did not even have to work to get. But store shelves are often empty, while packages and serving sizes shrink.
In Asia, dollar earnings from sales of goods exported to the US don’t buy as much as they did formerly, because of American inflation. US interest rates, slated to rise beginning in March, will depress the value of fixed-rate Asian investments in US debt instruments, those funds having been earned and accumulated in days before then-president Donald Trump’s tariffs began to make it marginally more difficult for Asian companies to sell things to Americans.
Trump believed (and said so) that the tariffs would be paid by China because President Xi Jinping’s government would cheapen Chinese money, so that US consumers could buy enough Chinese money to avoid themselves having to pay the Chinese price plus the tariff. Trump was correct for a while during his term in office. The exchange rate moved in favor of the US, going from 6.68 yuan to the dollar in February 2019 to 7.17 in September 2019.
At that time, China experienced lower “terms of trade”: it had to export more goods and services than before in order to maintain the international purchasing and investing power of their export earnings. But ever since September 2019, the yuan has strengthened. The average exchange rate during 2019 turned out to be 6.91.
During President Joe Biden’s term in office the rate has moved about 2.3% in China’s favor, from 6.47 in January 2021 to 6.32 in January 2022. However, during the year 2021 US inflation was about 7%, more than erasing China’s exchange-rate gains in US purchasing power. US inflation hurts the rest of the world.
In December last year, China’s domestic inflation rate was 1.2%, but that reported number excludes food and energy costs, whose rise has negative effects on Chinese public opinion of government policy. (At year-end, China’s vegetable prices were up 6.8% compared with November 2020, according to the US business network CNBC.)
To the extent that China’s gross export sales to the US brought $457 billion into China during 2021, American inflationary monetary policy has contributed to Chinese inflation.
There is an interesting similarity between China and the US in terms of the peculiar nature of the recessionary element in Stagflation 2.0. Much of the (inflationary) US government spending that has recently taken place has caused new money to be paid to “factors of production” (workers, investors, suppliers, landowners) who, in turn, produced “infrastructure” or who were being recompensed for losses sustained by them because of the Covid-19 pandemic.
The problem is that, irrespective of whether or not such spending constituted good policy, the result was production of a special kind of national income (new roads, bridges, hospital ships steaming into New York Harbor, citizens whose Covid sufferings and losses were partly alleviated) that was not, could not, be market-purchased by consumers who came into possession of the money originally paid out to produce this “public goods” income.
In other words, new money paid out to produce public goods is not quickly absorbed because that non-marketed output is obtained “free” by all, but the money remains in circulation, thereby increasing buying pressure on market-purchased private goods.
In China too, the Stagflation 2.0 version of recession exists (or at least does as a potential source of fully employed consumers’ dissatisfaction). In China, much national expenditure since the reforms that began in 1979 has been devoted to public goods.
The export-led growth strategy given impetus by Deng Xiaoping also creates the problem of money being paid to factors of production whose output is sent abroad; however, as valued in GDP terms, those employed factors do not produce private output purchased in Chinese markets.
Those factor payments must somehow be reabsorbed or else they produce inflationary pressures in domestic markets where goods are purchased normally. But Chinese social stability requires, if not immediately at least in the near term, full consumer shelves. In the East as in the West, empty shelves are not a good policy outcome. Fully employed workers who become dissatisfied consumers are a problem.
East and West Stagflation 2.0 will present a serious challenge to policymakers. Higher levels of employment, if occurring with, for example, the goal of retarding global warming, may worsen the problem of empty shelves, or at least put goods on those shelves that are less valued by consumers than were the goods that formerly were for sale.
And so, economic numbers in the East and West that sound good co-exist with citizen dissatisfaction, even social unrest.
The US economic growth rate between October and December 2021 was 6.9%; US unemployment in December was 3.9%; China’s economic growth rate averaged 9.23% between 1989 and 2021, but was 4.0% in the fourth quarter 2021. Unemployment currently runs at about 5.0% but is said to be 11-14% for persons between 15 and 24 years of age.
The International Monetary Fund’s “World Economic Outlook” for January 2022 says the current world economic growth rate of 5.9% will fall this year to 4.0% and to 3.8% by 2023. Reports by the Organization for Economic Cooperation and Development say the current 5.5% unemployment rate there shows that there are 1.5 million more unemployed persons than was the case pre-Covid in their statistical area.
These numbers, while mixed, do not explain the degree of general dissatisfaction that may be seen all around the world.
Stagflation 2.0 suggests that a large fraction of world Covid-related and indeed a good part of the money spent on other non-marketed “public goods” ranging from global warming/green programs to ever-more inclusive health and welfare programs everywhere have put people to work, have given rise to investment projects (such as electrifying the American car and truck inventory) that, whatever the degree of public support (or lack of it) behind this new allocation of economic effort, has not, and is unlikely to, put goods on empty shelves, or reverse the poll numbers that show, in many nations, a lack of support for existing political programs and the persons who sponsor them.
Public-goods spending is inflationary whether it is financed by debt or new taxes. The choice of financing does not fix the underlying problem, which is that new money is paid out to the factors of production who produce (for example) a flood-control dam, but the dam’s services are not sold in the market.
Existing marketable goods must absorb the “shock” of the new money, and unless brand-new marketable goods appear, prices for existing goods will rise as the excess money is absorbed. Tax finance might slightly reduce inflationary pressure, but only if the taxes permanently remove from circulation the money spent to buid the dam.
Taxes would take spending power away from persons so taxed, reducing inflationary pressure. But in today’s real world, public-goods spending is financed by debt. The debt is undertaken by central banks, which lend by issuing de facto paper money: The banks buy up government debt that is issued to pay, for example, for the building of infrastructure.
Also, debt (domestic government bonds) is bought up by foreigners, whose purchase money then enters circulation in the borrowing nation, raising prices. Possibly prices fall in the home countries of the lenders, but modern international bond purchases are financed by overseas central banks, whose citizens are unlikely to feel the liquidity loss personally.
There will no quick end to this problem. Covid spending will fade away, with a lag, as the disease itself becomes part of the “background radiation” of existing health risks (like the flu).
But the increasing degree to which government spending is focused on public goods, and the associated degree to which economic output is “abstract” or remote from the view of ordinary households (such as “green spending” that might improve world temperature, but not until year 2062) means that future economic statistics, however abstractly “good,” will not produce the level of citizen satisfaction needed to produce “good” political poll numbers.
Tom Velk is a libertarian-leaning American economist who writes and lives in Montreal, Canada. He has served as visiting professor at the Board of Governors of the US Federal Reserve system, at the US Congress and as the chairman of the North American Studies program at McGill University and a professor in that university’s Economics Department.