[TOP STORY] What is stagflation and is it rearing its head?

‘When stagflation shows its teeth, it can bite and it can hang on for a long time… it embeds itself, it entrenches itself, and it becomes systemic’: Adrian Saville of Genera Capital.

SIMON BROWN: I’m chatting today with a favourite of the show, Dr Adrian Saville from Genera Capital, a favourite because he answers some of our hard questions. He sometimes spooks us. I still remember the deflation debate, where my salary was going to get cut. Fortunately, we didn’t see that. The new word which keeps popping up, and folks refer to it as the ‘S’ word and don’t even want to say it, is stagflation. Adrian, I always appreciate the time…. let’s kick off with an understanding of what stagflation is.

ADRIAN SAVILLE: Well, Simon, it’s a word that is an amalgam of two things that you don’t want in the world of economics and business – and its stagnation and inflation. It was popularised in the 1970s and really came to the fore in the 1980s, where a number of the world’s biggest economies were dealing with those twin evils of economic stagnation and inflation. Put them together in there and you have stagflation. It doesn’t necessarily refer to collapsing economies or receding economies, but just economies that are directionless, inefficient, they’ve lost energy, they’ve lost lustre. Then add into the mix inflation that is high single digit or possibly double digit, and there you have the ingredients.

Read: Why stagflation is an economic nightmare

SIMON BROWN: I suppose we get the risk, the worries around inflation. It hurts consumers. Central banks will raise rates. We understand that part of the component, and typically in terms of economic growth we worry about negative GDP. But you’re saying even if it’s just low GDP, it’s not enough to get the economy going, not enough to really see the population getting richer, I suppose, and growing ahead of population growth?

ADRIAN SAVILLE: Well, absolutely, that component. So you find it translates into a job market, a labour market that is struggling to create new work, new positions to keep up with population growth. Certainly that’s less of a problem in the advanced economies today than it was in the 1970s/1980s.

But if we’re going to characterise stagflation, it’ll be an environment in which the economy is struggling to keep up with population growth, so you have rising unemployment rates going on behind the scene.

If we refer to the events of the oil crises of the 1970s, you also have this runaway inflation or double-digit inflation, where not only is it hard to get a job, but the job that you’ve got battles to keep up with inflation in terms of employment, so you have falling real wages.

Then, alongside that, in sort of a cat-and-mouse type arrangement, with policymakers trying to defeat stagflation, a first move often among policymakers is for higher interest rates. So this cocktail gets another element of toxicity with inefficiencies and rising tax rates.

SIMON BROWN: Yeah. Of course, rising interest rates and the fear around that, and I know there’s been a lot of talk—

ADRIAN SAVILLE: Most definitely.

SIMON BROWN: Of potentially recession. We sit here now in 2022, and of course we’ve seen great GDP numbers, but that’s been the base effect of 2020 sort of unwinding itself. I suppose growth was going to moderate. Potentially the war in Europe takes some of that growth out of the picture, and we’ve already got the inflation. US inflation is the highest since the eighties.

Read: Powell ramps up US inflation fight in economy tough enough to cope

ADRIAN SAVILLE: There’s talk – you and I have spoken about this before, but there’s talk that this inflation is transitory. I’m not as sympathetic to that as many other commentators [are], but you’ve got a triple-witching in that you have demand-side spending that has come out of fiscal policy, wage relief programmes, governments providing a lot of spending support to the economy. You also have supply-side inflation through the supply chains, which have become choked and blocked. Then you have the abundant money with interest rates in many places sitting at zero or very close to zero, notwithstanding the fact that the first hikes have been made. Each of those in and of themselves is capable of producing inflation. You now have all three in place, and that leaves me very cynical about this inflation disappearing anytime soon, and rather taking the form of becoming more entrenched.

I think it’s premature to be talking about ‘galloping’ inflation, but it certainly looks like it’s here to stay for longer rather than shorter.

SIMON BROWN: Yeah. If you stay with the horse analogy, it’s definitely trotting, I think, sort of halfway between a walk [and galloping].

ADRIAN SAVILLE: I’ll go with that.

SIMON BROWN: What do policy makers do? As you point out, in Economics 101, high inflation, raise the interest rates, no problem. That’s fine if you’ve got growth. What is the tonic?

ADRIAN SAVILLE: Well, that’s the curse of stagflation. If you’ve got an economy that’s at least in reasonable shape, you can reach for that interest-rate lever with comfort, and take the heat out of the economy. But we are now in economic stall mode in terms of growth, and the inflation just isn’t going away. If you use the conventional tools of monetary policy to guide where interest rates should be, things like the Taylor rule or the Manchu rule, it’s easy to suggest that the Fed, as the lead monetary policymaker globally, is in the region of 5% behind, perhaps even more, 6%, 7% behind the ideal interest rate for this inflation environment.

In other words, the Fed in economic language is a long way behind the curve, and we should be bracing ourselves for a series of rate hikes. Some of the modelling suggests seven hikes are in the blocks.

SIMON BROWN: It almost seems as if we are heading towards it. As you define stagflation, and as we see what’s happening out there, we’ve already got some components of it clearly in place. Is it that this is what we’re going to see over the next 12 to 18 months, not just locally, but I’m thinking [in] those developed economies – Western Europe, North America?

ADRIAN SAVILLE: One of the real problems with stagflation, Simon, is that it refers to a structural component rather than a cyclical component. In other words, it embeds itself, it entrenches itself, and it becomes systemic. That was an attribute that characterised the European economies far more in the 1970s and eighties, then the US. But when stagflation shows its teeth, it can bite and it can hang on for a long time. To my mind, the real concern is not that this is sluggish growth and a bit of inflation that passes out of the system, but rather, if we’re going with throwaway terms, [that] this is here to stay.

It has a permanence about it that gives it the shape of many years, maybe a decade.

SIMON BROWN: My last question. In South Africa – and let’s go pre-pandemic, sort of the last decade up until 2019 – we had a lot of that ingredient. Our inflation was fairly under control in terms of the Reserve Bank band of 3% to 6%, but it was sitting at 4% or 5%. We had GDP stuck, what, at 2% if I’m generous, and we’ve got the unemployment.

ADRIAN SAVILLE: Yeah. Well, South Africa has one of those components, as you point out, the stagnation in bucket loads. It is deeply entrenched. That’s the urgency of the structural reforms, which gives you a clue about what might be needed in other markets to help the stagnation component.

South Africa urgently needs those structural reforms [with] unemployment sitting at 35%, per capita income the same today that it was 10 years ago. What has been a relief component is the missing inflation. But that bet may be off, given where oil prices have gone, where food prices have headed.

That quickly translates into imported inflation, some domestically grown inflation. I think it would be a little too spooky to be talking about rampant double-digit inflation for South Africa, but these things move quickly, and I wouldn’t take that off the cards until the oil price and food inflation components are better calibrated or better known.

SIMON BROWN: I take your point. For me it’s that structural component. It becomes almost embedded within the economy, and that’s then really, really hard to shake off.

So in stagnation we are smarter and perhaps a little more spooked by it. Adrian Saville of Genera Capital, I always appreciate the time.

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