SYDNEY and KUALA LUMPUR, March 29 (IPS) – The specter of ‘stagflation’ threatens the world once again. This time, the risk is a direct result of political provocations and war, not simply of unchangeable economic forces.
Inflationary?
Stagnant inflation is a compound word that implies inflation with stagnation. Stagnation refers to weak, “near-zero” growth, inevitably worsening unemployment. Inflation refers to rising prices – not high prices, as is often implied.
In 1965, he told the UK Parliament that in a context of “rapidly rising” incomes and “absolutely stagnant” production, “we are now in the worst of both worlds. We have a kind of stagnation of inflation.”
The term emerged in the 1970s, when high inflation and unemployment ended an economic era dubbed ‘The Golden Age of Capitalism‘ describes the post-World War II (WW2) outbreak.
Usually, during a recession, the inflation rate – that is, the overall rate at which prices rise – falls. As unemployment rises, wages are pressured, consumers and businesses spend less, reducing demand for goods and services, slowing price growth.
Likewise, when the economy booms, the labor market tightens, pushing up wages, which in turn drives consumers through price increases. As a result, inflation rises and unemployment falls during boom times.
However, stagnant inflation poses a dilemma for central banks. Usually, when economies stagnate, central banks try to stimulate growth by cutting interest rates, encouraging more borrowing and thus spending.
But that could also drive prices further up and inflation higher. On the other hand, if they raise interest rates to keep inflation in check, growth could slow even further, exacerbating unemployment.
Inflation stagnated in the 1970s
The growth of world trade after World War 2 increased demand for the US dollar, the de facto world currency under the Bretton Woods (BW) international monetary agreement of 1944. The United States financed heavily supported reconstruction after World War 2 to expand the sphere of influence of the ‘Free World’ at the start of the Cold War.
Throughout the 1960s, US economic growth was increasingly sustained by government social and military spending. Increased spending on both ‘defence’, particularly the Vietnam War, and on social programs, for example by President Lyndon B. Johnson’war against poverty‘ and ‘Great society‘.
Like LBJ used to be reluctant to acknowledge the rising costs of the Vietnam warit is difficult to raise taxes to pay for ‘sword and plowshare‘ spending. Instead, spending is financed by government debt, from the sale of US Treasuries. As a result, the world financed US government spending, including war.
By January 1967, Johnson was under pressure to cut the growing budget deficit. But it took a year and a half for the US Congress to pass his new budget with tax increases. When it was finally passed in mid-1968, the US federal debt grew even more as spending on both ‘guns and butter’ did not decrease.
U.S. monetary policy is forced to expand. Not surprisingly, inflation spiked from 1.1% in 1960-1964 to 4.3% in 1965-70. Higher inflation also erodes the competitiveness of the United States, exacerbating its balance of payments deficit.
Inflation also undermined the ability of the US to live up to BW’s commitment to maintain full convertibility to gold at $35 an ounce. This obligation has gone unnoticed by foreign governments and currency speculators.
As inflation rose in the late 1960s, US dollars were increasingly converted to gold. In August 1971, US President Richard M. Nixon ended foreign central banks’ exchange of dollars for gold, effectively violating its BW pledge.
One last attempt to save the international monetary system – through a short time The Smithsonian Agreement – failed immediately. By 1973, the international monetary arrangements after World War 2 BW were effectively implemented.
Disruption of goods supply
Exporting oil, Europe and other countries with reserves denominated in US dollars suddenly found their assets to be worth much less. With Venezuela, the Organization of the Middle East Petroleum Exporting Countries (OPEC) responded by abandoning its previous intention of keeping oil prices low.
In October 1973, the ‘nationalist’ King Faisal of Saudi Arabia embargoed oil exports to pro-Israel countries shortly after President Anwar Sadat attempted to retaliate after the defeat of Egypt. Egypt predated Israel in 1970. The price of oil almost quadrupled – from $3 to nearly $12 a barrel when the embargo ended in March 1974.
This steep rise in oil prices parallels increase the price of other goods during 1973-74. Besides gasoline, prices of other primary commodities more than doubled between mid-1972 and mid-1974. Meanwhile, prices of some commodities – such as sugar and urea – increased more than fivefold.
Goods supply shocks and higher commodity prices increase the cost of production, consumer prices, and the unemployment rate. As rising consumer prices cause demand for higher wages, these in turn raise consumer prices. Thus, the wage price spiral accelerates price growth and inflation.
The Iranian revolution of 1979 caused a second oil price shock. Result ‘great inflation‘saw prices in the US rise by more than 14% in 1980. In the UK – then considered ‘the sick man of Europe’ – inflation averaged 12% a year between 1973-75, peaked at 24% in 1975while inflation in West Germany and Switzerland exceeded 5%.
During the 1960s, unemployment in seven major industrialized countries – Canada, France, West Germany, Italy, Japan, Great Britain and the United States – rarely exceed 3.25%. But in the 1970s, the unemployment rate never dropped below that level. By mid-1982, it had risen to 8%, exacerbated by rising interest rates, ostensibly to combat inflation.
The growth slowdown of the 1970s – with rising unemployment and inflation – in the major industrial economies caught many economists off guard. Economic thinking then saw inflation and unemployment as alternatives.
The Phillips curve implies that low unemployment comes at the expense of higher inflation and vice versa. This crude and static caricature of Keynesian economics made a major attack on its influence. The attack on the development economy is collateral damage in this ‘counter-revolution’.
Peace is our best choice
In October 2021, the International Monetary Fund, the European Central Bank, the US Fed and others believed that the factors driving inflation were temporary. None of these authorities perceive the urgent need for a rate hike.
But in the last month, the war in Ukraine and sanctions against Russia have sent prices of commodities like wheat and oil up. This will exacerbate rising inflation in most developed countries. Undoubtedly, the threat of stagnant inflation is now a reality more than six months ago.
By October 2021, Google searches for ‘stagflation’ reach their highest level since 2008. Mentions of stagnant inflation in online news stories increased to more than 4,000 weekly in mid-March, up from more than 200 at the start of the year.
This time around, ‘stagflation’ is a direct consequence of political choices, especially over war, not an inevitable economic trend. Developing countries are learning quickly where they really stand in the unequal world of endless war, e.g. from Europe’s treatment of Ukrainian refugees.
So peace is imperative. The alternative is the barbarism of great power conflict for which most of us have no vested interest. Our common hope lies instead in ensuring peace, focusing instead on the common challenges facing humanity.
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© Inter Press Service (2022) – All rights reservedOrigin: Inter Press Service
