We assume the main countries are doing enough now to start to bring inflation down later this summer – and will watch the progress carefully. If you allow inflation to surge and embed it can become a vicious inflationary spiral that will damage output, disrupt people’s lives and lead to empty shelves.
Whilst equities may be able to offer some protection against mild inflation they cannot flourish in a world of high and rising inflation. You do not need to read history books to see the damage rapid inflation can do.
The extreme case is that of Venezuela
Venezuela was well set up to become a moderately-prosperous country based on its huge reserves of oil. In the better days, when private enterprise and foreign capital were welcome to help bring these riches out of the ground, Venezuela had a good state revenue from its oil tax and plenty of dollars flowing in.
The advent of President Maduro’s policies produced a collapse in oil output over a period of years. Nationalisation, hostility to foreign capital and the loss of talent from the country as inflation took off meant a large reduction in oil output and the loss of large flows of dollar receipts and tax income.
Instead of tackling the underlying problem of a collapsing oil industry, the government opted to spend and borrow on a huge scale to try to offset the economic decline. The state printed huge quantities of bolivars, the local currency. The value of its currency plunged and prices of everything, especially imports, took off. The more the government introduced price controls and regulations to tackle the symptoms, the more output fell – making price rises worse owing to more shortages. Hyperinflation set in.
Food shops frequently have empty shelves.
It becomes difficult to construct a meaningful price index when prices are changing day-to-day by large amounts. There was a mass exodus of people from Venezuela, moving to Colombia, Brazil and other nearby places to seek a better future. This has denuded the country of many talented and skilled people, who saw they could be more prosperous abroad. Food shops frequently have empty shelves. It has even at times been difficult to find and buy petrol for the car in the country with the world’s largest oil reserves under foot.
Small step to price stability
Recently, the government has allowed people to buy and sell in US dollars to create some more price stability than the debauched local currency allows. Hyperinflation destroys an economy. It removes all sense of values. It leads to hoarding, to acute supply shortages and to the search for foreign currency and other stores of value. Venezuela has suffered a large loss of economic output and real income for all its people.
President Maduro and his government have been sustained in office by the support of Russia, Cuba and China. They have been prepared to lend money against oil and are seen as friends. The Venezuelan state sees the US and the leading world institutions such the World Bank and International Monetary Fund (IMF) as hostile. Their advice and loans linked to altered policies are spurned. The country has managed to get oil output up to around 700,000 barrels a day from lower levels but could produce several times that if technology and investment were applied to its oilfields.
Argentina has pulled back from the government borrowing and printing excesses of Venezuela and is now under an IMF/World Bank programme with access to their funds. The programme to reduce monetary growth and control the budget deficit only aims to get inflation down to the range 29-37% by 2024. The current rate is 55%.
There are protests against the rising prices. Argentina has been through several cycles of excessive money creation and state borrowing, followed by fast inflation. This leads to a debt restructuring and a new IMF programme to try to assert some discipline. At these levels of inflation, around 5% a month, people’s behaviour can include hoarding of essentials as a hedge against future price rises and holding foreign currency and other assets that are outside the inflation in the domestic currency.
Turkey a warning too
Turkey is the new inflation threat close to Europe’s borders. President Erdogan overrides its central bank and insists on lower interest rates. Inflation has now hit 70%, with the last month at 7.25%. Over the last year the money supply has risen by around a half, and the value of the lira has halved against the dollar.
If you allow such a large devaluation and an accelerating inflation on the scale we now see, you are more likely ending up with capacity shortages.
Its President thinks low-interest rates and a devalued currency Turkey can make its economy grow faster – with more exports, more tourist revenues and more investment. The evidence from elsewhere says that if you allow such a large devaluation and an accelerating inflation on the scale we now see, you are more likely to end up with capacity shortages as businesses fail to keep up with cost rises. You need to rein in substantially to end the inflation. Turkey has been hit badly by the war in nearby Ukraine. The further escalation in world energy and food prices is unhelpful.
Ukraine has been a recipient of World Bank and IMF loans and support in recent years and was tied to a programme to limit budget deficits and get inflation down. In the second half of last year, before the war, inflation was around 10% and it has now of course headed higher. The World Bank and IMF have recognised the need to help Ukraine with more financial support to see it through the war. The IMF has offered a stand credit facility. At the same time the European Bank for Reconstruction and Development, the European Investment Bank and the Council of European Development Bank have issued a joint statement of support with the IMF and have made facilities available.
Caution all around
The IMF has been cautious in its advice to countries on how to handle the latest upward twist in inflation stemming from energy and food disruption from the war. It says: “Policymakers need to take decisive action to rein in rising inflation and address financial vulnerabilities while avoiding a disorderly tightening of financial conditions that would jeopardise the post-pandemic economic recovery.
Some businesses and households may need short-term fiscal support to navigate the consequences of the war”. In other words, the judgement of how a state balances the need to control inflation with the need to avoid a sharp downturn is left to the judgements of central banks and governments.
What is not in doubt is those who do not take inflation seriously enough – and go on printing money and borrowing to excess – end up with a disaster. It ends with collapsing output, migrating people and empty shelves. The world needs more capacity to bring prices under control, as well as sensible levels of state financial discipline. We are watching carefully as most advanced countries raise interest rates and send signals that they wish to bring price rises under control. They seem to recognise the need to find a mid-point between being too tough and triggering a recession, and being too weak and allowing more inflation.
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