Markets are underestimating the risks of accelerating inflation

London

RISKS of accelerating global inflation have been widely underestimated.

Yellow lights are flashing because of the Trump administration's promised economic policies, global reflationary policies, continued easy money and effective currency wars. Indeed, latest numbers show that deflation appears to have ended and annual inflation rates are well above their recent lows.

Take some examples: The deflation in the US, Germany, the UK, France, Japan and China in the past two years has turned into inflation. In the US, it is 2.1 per cent; Germany, 1.7 per cent; the UK, 1.6 per cent; France , 0.6 per cent; Japan, 0.5 per cent and China, 2.1 per cent. Singapore's erstwhile negative inflation numbers have also transposed into a marginally positive inflation of 0.2 per cent.

Of course, these global consumer price rises cannot be regarded as excessive. The history of inflation, however, shows what the late economist Friedrich von Hayek, described as "catching the tiger by its tail"; in other words, once the inflation beast begins to rouse, it is difficult to control. As prices rise, businesses and consumers begin to anticipate further increases, leading to further purchases and price increases. It is also easier for unscrupulous business people to profiteer.

The UK is a classic current example. Following the steep devaluation of sterling since last June's referendum on Brexit, consumer spending has exceeded expectations. Economists, especially those who favour Brexit, have claimed that the economy has performed well, despite the uncertainty regarding departure from the European Union.

But anecdotal reports show that their optimism may well be shortlived. Consumers and businesses were stocking up in the second half of 2016 on expectations that the devaluation would raise prices of imported technology, pharmaceutical and other goods this year.

The question is whether demand will continue at the same pace this year. If not, growth could be disappointing. Meanwhile, energy and raw material prices have jumped; food prices have remained low because of supermarket price wars, and grocers have begun to lift prices of certain items.

Those who are sanguine about the dangers of inflation would argue that Brexit is a special case. Yet, following excessive monetary ease and devaluation of the euro against the US dollar, inflation, especially in low unemployment Germany, has been accelerating sharply. Since Germany suffered horrendous hyperinflation in the early 1920s, followed by depression and the ascent of Hitler, a worried public may well vote against Chancellor Angela Merkel.

The main inflation worry, however, is the US, still the main motor of the global economy. Market bulls have been cheering President Donald Trump's promised business-friendly proposals of taxation cuts and unspecified deregulation. On the other hand it doesn't take a mathematical wizard to calculate that threatened tariffs on imports from China, Mexico and some other parts of the world will raise prices for businesses and consumers.

Moreover, Mr Trump is looking at vast expenditure on infrastructure. Although this will take place over several years, construction companies will buy more steel, cement, metals and other materials. Since Trump protectionism could have downside implications for China's economy, its government may also decide on infrastructure projects to keep growth and employment stable. The result would be a rise in the demand for raw materials, which would raise prices and encourage speculation that would increase the global cost of these commodities even further.

Mr Trump's aim is to raise employment of his followers in the depressed parts of America. Overall unemployment, however, is already at low levels of 4.7 per cent. Since the President wants lower immigration, a shortage of skilled and low-skilled labour could well be followed by demands for higher wages, which in turn would boost inflation.

Those who are sanguine about US inflation contend that the Federal Reserve Board would raise interest rates, and bond yields would also rise. This in turn would lead to appreciation of the US dollar, which would counter higher imported inflation. If that were to happen, Europe and Asia would experience more inflation because of the depreciation of their currencies. Moreover, a rise in the dollar could limit US overall price increases by only a small extent as global commodities and technology are priced in US dollars.

Inevitably, inflation would bring in its wake higher short- and long-term interest rates that could precipitate a slide in bonds, stocks and real estate. The decline could lead to recession.

This, indeed, could be Trump's Law of Unintended Economic Consequences.