The Banking Executive Magazine - September Issue 2022

The Great Stagflation fully weaponized for strategic and national-security purposes, its posi- tion as the main global reserve cur- rency may begin to decline, and a weaker dollar would of course add to the inflationary pressures. A fric- tionless world trading system re- quires a frictionless financial system. But sweeping primary and secondary sanctions have thrown sand in this well-oiled machine, massively in- creasing the transaction costs of trade. On top of it all, climate change, too, is stagflationary. Droughts, heat waves, hurricanes, and other disas- ters are increasingly disrupting eco- nomic activity and threatening harvests (thus driving up food prices). At the same time, demands for decar- bonization have led to underinvest- ment in fossil-fuel capacity before investment in renewables has reached the point where they can make up the difference. Today’s large energy-price spikes were thus in- evitable. Pandemics will also be a persistent threat, lending further momentum to protectionist policies as countries rush to hoard critical supplies of food, medicines, and other essential goods. After two and a half years of COVID-19, we now have monkey- pox. And owing to human encroach- ments on fragile ecosystems and the melting of Siberian permafrost, we may soon be dealing with dangerous viruses and bacteria that have been locked away for millennia. Finally, cyberwarfare remains an un- derappreciated threat to economic activity and even public safety. Firms and governments will either face more stagflationary disruptions to production, or they will have to spend a fortune on cybersecurity. Ei- ther way, costs will rise. On the demand side, loose and un- conventional monetary, fiscal, and credit policies have become not a bug but rather a feature of the new regime. Between today’s surging stocks of private and public debts (as a share of GDP) and the huge un- funded liabilities of pay-as-you-go social-security and health systems, both the private and public sectors face growing financial risks. Central banks are thus locked in a “debt trap”: any attempt to normalize mon- etary policy will cause debt-servicing burdens to spike, leading to massive insolvencies, cascading financial crises, and fallout in the real econ- omy. With governments unable to reduce high debts and deficits by spending less or raising revenues, those that can borrow in their own currency will increasingly resort to the “infla- tion tax”: relying on unexpected price growth to wipe out long-term nominal liabilities at fixed rates. Thus, as in the 1970s, persistent and repeated negative supply shocks will combine with loose monetary, fiscal, and credit policies to produce stagflation. Moreover, high debt ra- tios will create the conditions for stagflationary debt crises. During the Great Stagflation, both components of any traditional asset portfolio – long-term bonds and US and global equities – will suffer, potentially in- curring massive losses. the BANKING EXECUTIVE 30 ISSUE 165 SEPTEMBER 2022