Is the world economy about to shift regimes from a deflationary to inflationary model in light of the Covid-19 recession? And if so, what would be the impact for investors?
In November 2020, Martin Wolf, from the Financial Times raised concern about a potential revival of inflation in his article Why inflation could be on the way back. He grounds his arguments from the book The Great Demographic Reversal, by Charles Goodhart and Manoj Pradhan in which the effect of ageing population and retreat from globalisation are analysed. For the last four decades, favourable demographic trends and the entry of China and Eastern Europe into the world’s economy have led to a deflationary trend. But will the reverse tendency bring back inflation?
The ageing population and decline of the workforce are putting pressure on the labour market in high-income countries. As the number of consumers rises relative to that of producers, inflationary pressure will increase. The weakening of globalisation, in particular in the production of goods, will also exacerbate the inflationary pressures.
Moreover, in the aftermath of the covid-19 crisis, central banks have swamped the markets with liquidity and the debt burden of developed countries has reached a high level. This money printing at all cost to stabilise the financial system could end up weakening confidence in its solidity and expose the world economy to hyperinflation.
Quantitative easing operated by central banks consists in massive buying back of public debt and financial assets to inject liquidity into the economy. It acts as an economic stimulus. While these accommodating monetary policies have enabled the financial markets to withstand the shock of the recession and the States to organise their fiscal stimulus, the counterpart is far from neutral. In particular, the price of assets does not reflect their intrinsic value and the trust in money may decrease.
Total assets of the Federal Reserve
Source: Board of Governors of the Federal Reserve System
The Federal Reserve’s balance sheet has expanded and contracted over time. During the 2007-08 crisis, total assets increased significantly from $870 billion in August 2007 to $4.5 trillion in early 2015. From February 2020, with the beginning of the pandemic, total assets started to shoot up again to reach $7.5 a year later.
The conjunction of the both monetary and fiscal stimuli - expansion of 'broad money' with new fiscal stimuli and expansion of 'base money' from Central Banks - is explosive particularly if the output gap is being filled by the post-Covid recovery.
Money, too abundant, no longer knows where to go, prompting investors to rush for all that glitters, while driving inequalities between those who have capital and the rest of the population. Investors might be turning to Bitcoin for inflation hedge, fearing that prices will rise a lot faster over the next decade than they anticipated a month or two ago.
"The bitcoin craze is a precursor of flight from money," said Georges Ugeux, CEO of investment bank Galileo Global Advisors and former executive vice president of the New York Stock Exchange (NYSE). Some investors are starting to lose faith in the strength of traditional currencies printed at will. As their value no longer corresponds to the wealth created by the real economy, businesses and individuals are tempted to look for new types of assets in an attempt to protect their savings. “When the currency suffers from a negative interest rate, one would have to be a fool not to look the other way,” Tesla boss Elon Musk said on Twitter on February 19. “Bitcoin is almost as stupid as fiat money, I stress the “almost”.
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