Source: The Globalist
Alexander Mirtchev and Norman
Bailey
In the wake of the global
economic crisis, the world is trying to chart an economic path to the future
and find a "new normal." As Alexander Mirtchev and Norman A. Bailey
explain in the first installment in their series "The Search for a New
Global Equilibrium," inflation as a factor of global economic security has
the innate capacity to upend carefully laid plans and further upset the
equilibrium.
“Inflation
is always and everywhere a monetary phenomenon.” — Milton Friedman
For as long as there has been
the systematic issuance of currency, there have been governments keen to
control that currency. Some policies, of course, have been effective, while
others decidedly less so.
Exemplary of the latter category
is the attempt of the Roman emperor Diocletian (284-305 AD) to find a solution to
the socio-economic turbulences besetting his world. Faced with Barbarian incursions,
domestic unrest, declining production and rising prices, the emperor imposed price
controls and debased the currency, the silver denarius. These measures resulted
in shortages, even more rapidly increasing prices, a barter economy with a
growing black market and concomitant social hardship and unrest.
Diocletian’s successor,
Emperor Constantine (306-337 AD), famous for his conversion to Christianity and
for founding the city of Constantinople, was, in his time, probably at least as
famous for his monetary reform.
He introduced a series of bold
policies and measures, some comparable with the modern understanding of fiscal
discipline, epitomized by the replacement of the debased denarius with a gold
coin, which he named the solidus, in a brilliant early example of
public-relations spin. This currency remained “solid” for 700 years, a span of
time unrivalled by any other currency at any time. Notably, hoards of these
coins are still found as far away from Rome as China.
History’s lessons have a
tendency to repeat themselves. In response to the financial meltdown and in
pursuit of recovery, governments around the world have adopted policies
reminiscent more of Diocletian than Constantine’s vision.
Confronted by multiple
challenges in the wake of the global financial and economic crisis, governments
have adopted a series of policies almost as a matter of course, with one of the
notable ones being so-called quantitative easing — increasing money supply to
ramp up liquidity.
Some central banks, most
significantly the U.S. Federal Reserve, are maintaining the policy of directly
monetizing the federal debt (also known as quantitative easing) — considering
it, if not non-inflationary, then as a preferred remedy for the possibility of
deflation.
In November 2010, the Fed
introduced a $600 billion program for the direct purchase of Treasury
securities over six months in order to drive down long-term rates and thus
stimulate recovery from the “great recession” and begin to lower unemployment
rates.
The Bank of England also has
continued a program of asset purchases to the tune of £200 billion, despite an
increasing divergence of opinions within the Monetary Policy Committee. The
European Central Bank has been conducting an extensive program of asset
purchases that are still ongoing.
However, as noted by Adam
Fergusson in his book “When Money Dies,” quantitative easing could be
considered a “modern euphemism for surreptitious deficit financing in an
electronic age” which “can no less become an assault on monetary discipline”
that increases inflationary momentum.
In another important line of
post-crisis developments, a number of other countries have also succumbed to
the perceived economic advantages of policies that could also contribute to
inflationary build-up. Some, like China, are conducting a pegged exchange-rate
policy that affects their money supply.
Meanwhile, India and Turkey —
although pursuing a floating exchange rate policy — are susceptible to the
effects of global quantitative easing. Indeed, several high-growth emerging
economies, in particular Brazil, are responding to the massive influx of
short-term cash into their economies by putting in place restrictions on
foreign investment and other capital controls.
Without trying to divine
considerations that were relevant centuries ago, Constantine would have
probably questioned such approaches.
The bottom line is that,
irrespective of various policies, in the West to the BRICs and elsewhere,
inflation concerns are surfacing worldwide. Although U.S. inflation seems to
remain within the forecast range, with persistent unemployment keeping labor
wage demands at low levels, rising commodity prices and other inflationary
pressures are applying opposing pressure.
Inflation in Britain rose to
4% in January 2011, double the government’s target. European Central Bank
inflation forecasts, although more optimistic than those in Britain, were still
raised to 2.3% from 1.8% on the back of oil price hikes. But in certain
countries, inflation has leaped over the EU average, such as the 3.2%
registered by Belgium in January 2011.
In the world’s rapidly
developing economies, the situation is different — but the bottom line is
similar. China’s whirlwind return to growth has been accompanied by rising
consumption and wage pressure. When combined with the ongoing weakness of the
Chinese currency, it is hardly surprising that, according to government
figures, price levels climbed 4.9% year-on-year in January 2011.
Meanwhile, Russia’s consumer
price index reached 8.8% in 2010, exceeding the 5.5% the government had deemed
feasible at the end of the summer, and has now gone above 10%. And Brazil is
facing a rate of growth that is the envy of a number of economies, but with an
inflation rate that has been projected to reach 5.8%, well above the central
bank’s inflation target of 4.5% for the year.
While the “Great Recession” is
far from over, and another downturn is not inconceivable, commodity prices are
soaring, helped by drought (China), floods (Australia), civil unrest (throughout
the Middle East) and a number of other factors.
In the year from February 2010
to February 2011, all commodity prices were up 50% in U.S. dollar terms.
Companies from snack food producers to steel mills are suffering from
exponentially increasing raw-material costs. Such a build-up threatens to take
on a life of its own and acquire a dynamic beyond the scope of existing
contingency plans.
Governments everywhere are
responding by devaluing currencies, applying price restrictions, raising
interest rates or imposing currency controls — in a way, true to the legacy of
Diocletian. In some cases, they are attempting to obfuscate price increases —
by changing definitions, altering the composition of indices or applying
creative statistics. Few are fooled, however. Citizens know in real terms how
much they pay for food, fuel, household goods … the list goes on and on.
The response to these
challenges is predictable — growing uncertainty, discontent and rising tension.
Indeed, achieving the right policy balances faces a number of practical
impediments. Foremost among them are the political and economic pressures that
converge from the tectonics of modern history.
The simultaneous pressures of
both fragmentation and integration that emerge in a post-Cold War world driven
by globalization and wracked by recession have not only created befuddled
governments — but also hampered the ability of those governments to coordinate
for the mutual benefit of each other.
Instead, Diocletian-like
solutions are sought which are bound to produce economic externalities,
increasing political pressure. Notably, as “First World” countries fare better
than Second and Third, the finger-pointing begins, on the background of
disparate impacts being felt in particular in less-developed countries.
Admittedly, the Federal
Reserve’s position on the current comparative weakness of inflationary threats
as a result of U.S. quantitative easing is a legitimate view, which, however,
represents one end of the spectrum.
Another view that could turn
out to have even greater mid and long-term relevance is exemplified by comments
like those made by historian H. J. Haskell who noted, when comparing the Rome
of Diocletian to the United States of Franklin Roosevelt, that the impact of
inflation induced by quantitative easing are far-reaching and structurally
significant.
“The decay of character that
attended the sudden rush of great wealth undermined the Republic,” he said in
his book “The New Deal in Old Rome.” “Later, in a society unstable through
social bitterness, extravagant public spending proved fatal. … The spending for
unproductive public works, for the bureaucracy, and for the army, led to
excessive taxation, inflation, and the ruin of the essential middle class and
its leaders.”
Similar considerations emerge
with regard to the other vectors of dealing with the post-crisis turbulence.
Although far from being comparable with the situation in the 1920s Weimar
Republic, the inflationary trajectory can be seen as moving toward a tipping
point.
It is worthwhile noting that
inflation as a factor of global economic security has the innate capacity to
upend carefully laid plans and further upset the equilibrium, in particular
being a source of economic hardship that only a limited number of state actors
can affect via their national policies. Witness the underlying catalysts behind
the unrest in North Africa and the Middle East.
With the persistence of
strained growth prospects, the specter of inflation becomes all the more
worrying. In the present circumstances, the current wisdom simply will not do.
Should we be looking for the
new Constantine? So far, one has not stepped forward.
Dr. Norman A. Bailey is an
economic consultant, adjunct professor of Economic Statecraft at the Institute
of World Politics — and president of The Institute for Global Economic Growth.
He is professor emeritus of The City University of New York — and served on the
staff of the National Security Council during the Reagan Administration and the
Office of the Director of National Intelligence during the George W. Bush
Administration. Mr. Bailey's degrees are
from Oberlin College and Columbia University. He is the author, co-author or
editor of several books and many articles.
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