by Damon de Laszlo, ERC Chairman
The turmoil of September continues and indeed seems to be increasing in many areas. The lack of stable governments in the UK and Europe, along with ineffective institutions and loss of the will to govern is hopefully reaching the bottom of the cycle. Whether one likes it or not, the re-election of President Xi for an unprecedented third term brings some relief. The direction of travel of China may not be to our liking but an unstable China at this time would be very undesirable, particularly as China’s own debt problems could easily get out of control without a strong government. This is the key problem for the West, on top of the inflationary crisis left over from Quantitative Easing and covid disruptions, compounded by Russia’s war on Ukraine.
Western financial institutions, whose mismanagement created the financial crisis of 2008, were bailed out by central banks pouring hundreds of millions into the system. The impact of the central banks’ largesse triggered asset price inflation, stock markets and property inflation, greatly benefitting, on paper at least, the already relatively wealthy and the very wealthy sections of the population, as well as enormously enhancing the wealth of those in the financial sector. This distortion has, and will continue to, precipitate political unrest and has also done considerable damage to the productive parts of the economy by misdirecting incentives. Q E itself did not, however, have much effect on ordinary inflation, that is the basic cost of living experienced by the majority.
Things changed with Covid, the crisis that affected countries’ populations as a whole and the fundamentals of the global economy. The destabilisation of international trade and the national lockdowns crippled economic growth. The banking system was itself again threatened as excessive debt built up around the asset price inflation, which threatened to unravel, causing central banks once again to come to the rescue with more Quantitative Easing. The impact of business closures on the day-to-day life of populations, in general, meant that governments had to act to provide cash directly into the hands of the population to stop the disintegration of the economy in general. This fiscal intervention, while necessary, was far more likely to precipitate inflation than the monetary intervention of central banks. It also increased dramatically governments’ need to borrow as tax income declined, triggering rising interest rates at the same time as central banks were trying to reduce them. The conflict between fiscal and monetary policy has yet to be played out. It was, however, certainly going to be inflationary. All this before Russia invaded Ukraine.
The impact of Russia’s terrorist activity, weaponising food and energy supplies along with other materials, is itself enormously inflationary. Here again, to protect their populations, governments are spending what is at the moment unquantifiable billions funding food and energy costs. In this economic whirlpool, where post-Covid supply chain disruptions have not yet settled, the Russians have added a food and energy supply crisis that will be solved, but take at least a year or more. We are not yet seeing the necessary fiscal and monetary coordination needed to ensure financial stability. Western government debt is growing rapidly, pushing interest rates up. Central bank monetary policy is to raise interest rates and engage in quantitative tightening, with the object of reducing inflation that is being caused by Russia and not by Covid induced fiscal or monetary policy.
While the Federal Reserve tightening has a chance of slowing the US economy as the country is much less dependent on Russian food and fuel supplies inducing a soft landing, Europe is very different. European central banks were slow off the mark after the financial crisis, slow to anticipate the supply disruption from Covid, and are now catching up with monetary tightening as we go into an economic crisis induced by Russia. The US will continue to invest in its productive industries while Europe is likely to run into a major recession and another banking crisis. The UK’s brief experiment with a populist Prime Minister who got elected by promising everything to everyone has been short-lived but showed up very starkly the vulnerability of the debt market. While the Bank of England has no remit for the pension fund industry, it was so worried that its liquidity problems would bring down the banks, that they had to intervene. The banking community had shown yet again its irresponsibility in creating unstable financial instruments in the pension funds.
Damon de Laszlo
24th October 2022