Inflation on the way?

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Even more support

Last week, the incoming President of the United States unveiled a new 1900 billion dollar economic stimulus plan. This would come on top of the $900 billion plan already approved by Congress. That makes a new injection of money into the US economy of 2 800 billion dollars. Earlier in 2020, a sum of USD 3 000 billion had already found its way into the economy. In addition to these exorbitant support packages, the Federal Reserve, the US central bank, also put its shoulder to the wheel with an unprecedentedly generous monetary policy. In the European Union, the financial authorities also played their part. Although the amounts were slightly less impressive, unprecedented sums of money were allocated to support the economy. So it is hardly surprising that the stock exchanges ended 2020 with profits despite the pandemic.

Monetary bonanza

As a result of this monetary bonanza of historic proportions, government debts have soared and interest rates on many 10-year government bonds are negative. According to the OECD, the average national debt of its 37 members will rise from 104 per cent in 2019 to 122 per cent in 2021. However, even according to a traditionally conservative organisation like the IMF, no one needs to worry about this debt at the moment. Although the deficits are increasing, the interest paid on them is actually decreasing. From 1.8 percent in 2019 to 1.3 percent in 2021. In fact, in more and more cases, governments are earning on their debt as a result of the negative interest rate. The uncrowned king of this debt carousel is Japan. The land of the rising sun has a national debt of 266 per cent of GNP, but earns on half of this outstanding debt as a result of negative interest. 

A lottery without staples

However, the financial markets are beginning to show some concern about the consequences of these generous support measures. Partly because of the reassuring words of the central banks, the consensus is that interest rates will remain low for a long time. Moreover, the Federal Reserve and the ECB have been struggling for years to steer inflation in the direction of the desired 2 per cent. The Fed, through Governor Powell, has indicated that even if inflation rises above 2 per cent it will not take action, i.e. it will not raise interest rates. Investing therefore seems to have become a lottery without staples. Corporate profits can be discounted at negative real interest rates until the end of time, resulting in ever-higher valuations for shares.

A lot of savings

However, there are dangers lurking. Most consumers did keep their jobs and their income during the pandemic. Those who did lose their jobs have not seen their spending power completely evaporate yet, thanks to the generous corona aid. In the United States, fewer companies went bankrupt in 2020 than in the previous year. The total number of bankruptcies even reached the lowest level in 35 years. While most consumers maintained their income, their spending options decreased significantly. As a result, the savings surplus has grown enormously. It is estimated that the total savings in the United States now amounts to 1500 billion dollars more than before the pandemic. A combination of rising stock and house prices and this huge amount of savings has contributed to household wealth in the United States being 11 per cent higher than in 2019.

A spending spree

It is expected that once the vaccinations have gained some steam and the economy gets back on its feet, this wall of money will flow back into the economy. On the one hand, the capacity of the economy will not have been restored to its former glory, but on the other, there will be strong pent-up demand. A huge wave of spending is then to be expected. Prices could rise sharply and fears of rising inflation are certainly not unfounded. It would put central banks in a huge dilemma. Raise interest rates to fight inflation? It would cause the stock markets to collapse and the burgeoning economic growth to be snapped up again immediately. Rising inflation is seen as the possible black swan of 2021.

Justifiable fear of inflation?

But is this fear justified? It might not be as bad as all that. It is very questionable whether the expected spending spree will lead to an overheated economy. For example, the Federal Reserve of New York found that less than 30 per cent of the 2020 support package was converted into actual consumption. As much as 36% was saved and the remaining 35% was used to pay off debts. The crisis is far from over and will not disappear from consumers’ minds any time soon. People are likely to remain cautious about spending for some time to come. In addition, rising inflation does not seem likely as long as unemployment is still sky-high. Wages cannot rise quickly. Nor can inflation. A temporary spending spree need not unleash a wage-price spiral.

Inflation? Later, perhaps

It will take some time before the economy has fully recovered from this pandemic. Only when unemployment is back to pre-pandemic levels will there be room for rising monetary depreciation. And then it remains to be seen whether it will really take off. After all, the underlying forces that have contributed to the long-term low inflation and interest rates have not disappeared: globalisation, ageing and digitisation. They will still be there after the pandemic. Perhaps inflation will pick up a little in the course of this year, but hyperinflation? No, probably not. At least not in the short term. Later, in 2022 and 2023, the markets may start to feel the effects of this historic period.

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