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Wednesday, January 2, 2008

Inflation and Recession, seconded by Joseph Stiglitz

Joseph Stiglitz is the preeminent economist of our day. It was an evil delight this observer (to use a Nouriel Roubini construction) took reading Stiglitz piece today at Project Syndicate. Evil because the prediction entails the misery the misery of billions in a downturn whose dimensions cannot be known. You may, or may not remember one of the first posts here after transferring in from Northwest Progressive Institute was just such a call.

Stagflation cometh, by Joseph Stiglitz, Project Syndicate:
The world economy has had several good years. Global growth has been strong, and the divide between the developing and developed world has narrowed... Even Africa has been doing well, with growth in excess of 5% in 2006 and 2007.
But the good times may be ending. There have been worries for years about the global imbalances caused by America's huge overseas borrowing. America, in turn, said that the world should be thankful: by living beyond its means, it helped keep the global economy going, especially given high savings rates in Asia... But it was always recognised that America's growth under President Bush was not sustainable. Now the day of reckoning looms.
Comment: Bill Clinton left office with one earnest plea: Maintain fiscal responsibility. Bush II used the excuse of 9-11 to throw all responsibility out the window.
America's ill-conceived war in Iraq helped fuel a quadrupling of oil prices since 2003. ... Until now, three critical factors helped the world weather soaring oil prices.
Comment: It is often stated that oil prices don't matter as much as they used to, since oil is a much smaller percentage of GDP than it used to be. The same could be said of all inputs, including labor, where a 70% rise in manufacturing output over the past 40 years has been performed by five million fewer workers. In addition, we import the energy component of products with those products, but we don't import directly the oil itself. Oil prices lead all energy prices, including natural gas and electricity. The price of oil matters, and it matters more than a little.
First, China, with its enormous productivity increases ... exported its deflation. Second, the US took advantage of this by lowering interest rates to unprecedented levels, inducing a housing bubble... Finally, workers all over the world took it on the chin, accepting lower real wages and a smaller share of GDP.

That game is up. China is now facing inflationary pressures. What's more, if the US convinces China to let its currency appreciate, the cost of living in the US and elsewhere will rise. And, with the rise of biofuels, the food and energy markets have become integrated. Combined with increasing demand from those with higher incomes and lower supplies due to weather-related problems associated with climate change, this means high food prices - a lethal threat to developing countries.
Comment: The Chinese have hocked their environment for the economic growth they have seen over the past two decades. Now fully two hundred million of its citizens depend on agriculture that is not sustainable due to ground water mining.
Prospects for America's consumption binge continuing are also bleak. Even if the US Federal Reserve continues to lower interest rates, lenders will not rush to make more bad mortgages. With house prices declining, fewer Americans will be willing and able to continue their profligacy.

The Bush administration is hoping, somehow, to forestall a wave of foreclosures - thereby passing the economy's problems on to the next president, just as it is doing with the Iraq quagmire. Its chances of succeeding are slim. For America today, the real question is only whether there will be a short, sharp downturn, or a more prolonged, but shallower, slowdown.

Moreover, America has been exporting its problems abroad, not just by selling toxic mortgages and bad financial practices, but through the ever-weakening dollar... Europe, for instance, will find it increasingly difficult to export. ...

At the same time, there has been a massive global redistribution of income from oil importers to oil exporters - a disproportionate number of which are undemocratic states - and from workers everywhere to the very rich. It is not clear whether workers will continue to accept declines in their living standards... In America, one can feel the backlash mounting.

For those who think that a well-managed globalisation has the potential to benefit both developed and developing countries, and who believe in global social justice and the importance of democracy (and the vibrant middle class that supports it), all of this is bad news. ...

Indeed, the ... world [is] facing depressed aggregate demand. For the past seven years, America's unbridled spending filled the gap. Now both US household and government spending is likely to be curbed, as both parties' presidential candidates promise a return to fiscal responsibility. After seven years in which America has seen its national debt rise from $5.6tn to $9tn, this should be welcome news - but the timing couldn't be worse.

There is one positive note in this dismal picture: the sources of global growth today are more diverse than they were a decade ago. The real engines of global growth in recent years have been developing countries.

Nevertheless, slower growth - or possibly a recession - in the world's largest economy inevitably has global consequences. There will be a global slowdown. If monetary authorities respond appropriately to growing inflationary pressure - recognising that much of it is imported, and not a result of excess domestic demand - we may be able to manage our way through it. But if they raise interest rates relentlessly to meet inflation targets, we should prepare for the worst: another episode of stagflation.

If central banks go down this path, they will no doubt eventually succeed in wringing inflation out of the system. But the cost - in lost jobs, lost wages, and lost homes - will be enormous.

- Joseph Stiglitz