US, Europe to fall behind Asia if stagflation grips the West

London

ASIAN economies are likely to outperform US and European nations if stagflation takes hold in the West.

The bailouts of Western banks, zombie companies and inadequate direct investment in plants and equipment - even before the Covid-19 pandemic - have had a negative impact on productivity, especially in Europe, economists said.

But erratic foreign capital inflows and outflows into Asia, both during and after the novel coronavirus pandemic, could cause currency and financial instability.

So far, economists are debating whether disinflation and deflation will remain after the pandemic or whether inflation will accelerate in tandem with economic recovery.

But stagflation, the combination of relatively stagnant and low economic growth, and rising inflation are typically not within the models of most economic forecasters.

Economists are concentrating on the deep recession and worst unemployment in decades, causing disinflation and deflation.

According to latest projections by the International Monetary Fund (IMF), the inflation of the Group of Seven leading industrial nations will average at only 0.53 per cent this year and rise to 1.58 per cent in 2021.

Singapore is experiencing deflation, while the inflation of emerging and developed Asian nations is just under 3 per cent.

"Unemployment is exceptionally high. When the lockdowns are relaxed, it will be partly matched by exceptionally high vacancies. It is hard to see a strong wage push on the horizon," said Olivier Blanchard, a senior fellow at the Peterson Institute for International Economics and the former chief economist at the IMF.

"Commodity prices have fallen, oil prices have collapsed, putting downward pressure on inflation. Pent up demand will lead to a burst of spending, and some inflation," he added.

"If it happens, it is unlikely to be large and long enough to destabilise low inflation expectations, and it is likely to disappear quickly."

In contrast, Brendan Brown, a partner at Macro Economic Advisors and senior fellow of the Hudson Institute, foresees US inflation rising to around 5 per cent in two to three years' time.

Once the pandemic is resolved via a vaccine or other means, households and businesses will catch up on spending and demand will exceed inadequate supplies, he said.

Spending on capital equipment, infrastructure and construction would also increase; and inevitably prices would follow, Mr Brown said.

But the US Federal Reserve and other central banks will continue with zero or negative interest rates and easy money.

Due to their lax monetary policies and the US's huge borrowing, the US dollar could weaken leading to further inflation. There would be competitive devaluations, and weak sterling and euro would raise inflation in the UK and Europe, analysts said.

Meanwhile, the global discontent with China's regime would encourage US and other importers to build local factories. Potentially, globalisation could become less fashionable as well, they added.

Tim Congdon, the chairman of the Institute of International Monetary Research at the University of Buckingham, agreed that the surge in money supply in the US could lead to inflation of around 5 per cent in the next few years.

On the other hand, Lacy Hunt, an economist at US Treasury bond fund manager Hoisington, warned that excessive debt is overhanging companies and households.

This burden curbs spending and leads to low velocity or turnover of money, causing inflation to remain low, she said, adding that this has been the trend since the 2009 global financial crisis.

Marrying both sides of the debate, economies may well end up with stagflation. History shows that the last serious stagflation took place in the 1970s.

There was an oil price shock soon after the Yom Kippur War in 1973. Middle Eastern and other oil producers - notably Organization of the Petroleum Exporting Countries (Opec) members - raised the oil price from US$3 a barrel to US$12 within a few months.

In 1978, the Iranian revolution began, and the former Shah of Iran had to abdicate in 1979. Oil production fell in Iran and due to the uncertainty, the oil price trebled to US$39 a barrel.

The result of these shocks was that Western and other economies experienced periodic recessions and limited virtually stagnant recoveries during the 1970s and early 1980s.

Meanwhile, inflation accelerated and interest rates rose. Gold and other commodity prices soared, bond prices fell with US 10 year treasury bond yields peaking at 13-14 per cent in 1981. During that lengthy period, stock markets tumbled, recovered slightly and then fell again.