The end of the era of economic calm scared American analysts: what is the role of the Ukrainian conflict

– Yury Nikolayevich, what are we talking about when the Americans talk about a fundamental shift in the global economy? What has moved and where? And has it really moved?

– Moved – from a relatively predictable world to a world characterized by greater instability. The Economist published an editorial on October 6, 2022: “A new macroeconomic era is dawning. How will it look like?”

– Indeed, curious – and how it will look like?

– For my aesthetic taste – not very attractive. The authors of the article write: “For several months, there have been turmoil in financial markets and growing evidence of stress in the global economy. This marks the painful emergence of a new regime in the global economy — a shift that could be as important as the rise of Keynesianism after World War II and the turn towards free markets and globalization in the 1990s.”

Let me remind you that there was such a scientist-economist Keynes, who strongly warned against excessive reparations in the 1920s from defeated Germany. Allegedly, this will lead to an unpredictable economic revenge of Germany and to the Second World War. What happened. Now, according to some American analysts, this “Keynesian prophecy” can be superimposed on the history of anti-Russian sanctions. Agree, there is a similarity?

– And what do the authors of the publication in The Economist write about this?

They don’t exude optimism. According to them, clashes are coming in the markets of an unprecedented scale for the current generation. Global inflation is in double digits for the first time in almost 40 years. The US Federal Reserve (Fed) is now raising interest rates at the fastest pace since the 1980s, while the dollar is at its strongest level in two decades, causing havoc outside of America. If you have an investment portfolio or a pension (we are talking about American retirees), this year has been terrible. Global equities are down 25% in dollar terms, their worst year since at least the 1980s, and government bonds are on track for their worst year since 1949.

– Why did this happen?

– According to the authors of the article, everything turned upside down when globalization receded, and the energy system split after the outbreak of the military conflict in Ukraine. All this marks the final end of the era of economic calm in the 2010s. After the global financial crisis of 2007-2009, the performance of rich economies became sluggish.

Economic growth has been sluggish and inflation low. As the private and public sectors did little to stimulate more activity, central banks became the sole player. They kept interest rates low and bought massive amounts of bonds at any sign of trouble, expanding their influence in the economy.

On the eve of the pandemic, the central banks of America, Europe and Japan held a staggering $15 trillion in financial assets. But the extreme challenge of the pandemic has led to extraordinary actions that have helped unleash today’s inflation: wild government stimulus and aid, a temporary distortion in consumer demand patterns, and a confusing supply chain caused by the lockdown. Since then, this inflationary momentum has been reinforced by the energy crisis as Russia, one of the largest exporters of fossil fuels along with Saudi Arabia, has isolated itself from its markets in the West. Faced with a major inflationary challenge, the Fed has already raised rates from a high of 0.25% to 3.25% and is expected to bring them up to 4.5% by early 2023. Most monetary authorities around the world are also tightening measures.

This is the picture they draw.

And what do they think will happen next?

They don’t expect anything good. One of their immediate fears is a crash as a financial system accustomed to low rates becomes aware of skyrocketing borrowing costs. There are other dangers in a new financial system that relies less on banks and more on volatile markets and technologies.

The good news for them is that the deposits are not going to burn out. The bad news is that this system of financing firms and consumers is opaque and hypersensitive to losses.

Meanwhile, investment funds, including pension funds, suffer losses on their portfolios of illiquid assets. The treasury bond market has become more volatile, while European energy companies have faced insurmountable collateral requirements on their hedging companies. The British bond market has been thrown into chaos by obscure pension fund derivatives rates.

If markets fail to run smoothly, stifling credit or threatening contagion, central banks may intervene. The Bank of England has already reversed and started buying bonds again, abandoning its simultaneous commitment to raise rates.

A related belief that central banks will not have the resolve to go through with their tough announcements is behind another big fear – that the world will return to the 1970s with runaway inflation. In a sense, this is alarmist and excessive. Most forecasters believe America’s inflation will ease from its current 8% to 4% in 2023 as energy price increases subside and higher rates sting. However, while the chances of inflation reaching 20% ​​are negligible, the glaring question is whether governments and central banks will ever be able to bring it down to 2%.

– Can they really?

“Personally, I’m not sure. Like the authors of the article. In contrast to the 2010s, there is a structural increase in public spending and investment. Senior citizens will need more medical care. Europe and Japan will spend more on defense to counter alleged threats from Russia and China. Climate change and the pursuit of security will increase public investment in energy, from renewable energy infrastructure to gas terminals. And geopolitical tensions are forcing governments to spend more on industrial policy. And there are also demographic factors.

– Aging of the “golden billion”?

– Exactly. Even for rich countries, this is a serious burden. And not only because the elderly need to be supported – they will be able to feed themselves. As Churchill said, saving money is a useful thing, especially if your parents have already done it.

But there are some nuances here. As people get older, they save more, and this excess saving will continue to drive down the underlying real interest rate. Here is such a paradox.

As a result, the fundamental trends in the 2020s and 2030s are more government influence but still low real interest rates. For central banks, this creates an acute dilemma. To bring inflation down to their target of around 2%, they may have to tighten policy enough to trigger a recession.

This will result in job losses and a fierce political backlash.

As The Economist argues, if the economy deflates and finds itself trapped again in the low growth and low rates of the 2010s, central banks may once again run out of stimulus tools. The temptation now is to find another way out: abandon the 2% inflation target set in recent decades and modestly raise it to, say, 4%. This will likely be on the menu when the Fed begins its next strategy review in 2024.

– Are there other opinions?

– Not exactly different, but similar. In any case, they are just as unhappy. Take, for example, the recent speech by IMF Managing Director Kristalina Georgieva, “Landmarks in a More Unstable World,” at Georgetown University.

She lists the shocks: “First Covid. Then the military conflict in Ukraine. And climate disasters on every continent. These upheavals caused incalculable damage to people’s lives. Their cumulative impact is causing global price increases, especially for food and energy, leading to a cost-of-living crisis. We are experiencing a fundamental shift in the global economy – from a relatively predictable world with a rules-based system of international economic cooperation, low interest rates and low inflation, to a world characterized by more instability – higher uncertainty, more economic volatility, geopolitical confrontations and devastating natural disasters. , a world in which any country can deviate faster and more often from the intended course.

Global output losses of about $4 trillion are expected between now and 2026, she said. This is equivalent to the size of the German economy – a colossal loss for the global economy.

– Probably, she has an answer, how to get out of this situation?

“At the very least, she asks this question: what can we do to ensure that this period of increased instability does not become a dangerous “new normal”?

– And what?

– Kristalina Georgieva, let’s say, is not a very stupid woman and immediately correctly identified the cause of all the troubles. Overcoming them, she said, “is hampered by geopolitical fragmentation.” A series of shocks, she says, including the military conflict in Ukraine, have completely changed the picture of the economy. Therefore, she believes that, first of all, it is necessary to stabilize the world economy by solving the most urgent problems. The most important thing is to intensify global cooperation.

Of course, she writes out a bunch of correct recipes for the global and American economies. It’s all here. How to increase GDP, reduce and contain inflation, avoid or at least slow down a recession, lower interest rates so as not to deter investment growth, contain energy prices, tighten monetary policy … In general, there is enough reasoning and advice for several textbooks on banking and the economy in general. And, it must be admitted, sensible textbooks.

But the leitmotif is the same – you can’t build economic happiness in one single country. We are all too connected. Something needs to be done about world politics.

– Well, God bless her, with world politics. But people want to eat right now. Can’t the heads of state by a strong-willed, so to speak, decision, at least slightly improve the situation of the population?

– There are, shall we say, bold experiments. President of Belarus Alexander Lukashenko ordered from October 6 this year to introduce a ban on price increases in the country. It is known that the Belarusian leader held a meeting with the economic bloc of the government and with the leadership of both houses of parliament.

“From the 6th, any increase in prices is prohibited. For-pre-shcha-et-sya! From today. Not from tomorrow, but from today. So that prices do not go up overnight. Therefore, from today, price increases are prohibited. And God forbid, someone in the accounting department will carry out something retroactively, some calculations, recalculations, ”the Belta agency quotes him as saying.

Lukashenka also said that he was ready to guarantee the absence of a commodity shortage in the country. He stressed that products of good quality in a wide range should remain on the shelves.

“For the prices, you will answer everything with your head and others like you,” he addressed the officials present at the meeting.

The President of Belarus also advised his subordinates to forget the term “socially significant products” – such a division, according to him, no longer exists.

This is the first reaction to the new economic instability.