The end of the new normal

 In Articles

In recent decades, western economies have struggled to recover from the recession. It seemed to take longer and longer for the economy to return to pre-recession levels. The recovery was given different nicknames in commentaries, such as ‘jobless growth’, ‘structural stagnation’ or the ‘new normal’. As so often, there are various explanations for this, but the most important, in my view, is increasing globalisation. Take a multinational with three factories: one in the United States, one in Europe, and one in China. When a recession cuts into demand, the multinational has to economise and that means closing one of the factories. It is obvious that the factory with the highest unit cost will close, and nine times out of ten it is in the United States or Europe. In the recovery from the recession, demand picked up and jobs were created, but in this case only in China. As a result, China could become an increasingly large part of the global economy. Besides this effect of globalisation, a problem in the financial system (1990 Japan, 2000 Nasdaq, 2008 US housing market) always takes longer to recover. Especially the credit supply has difficulty getting going after a recession caused by financial imbalances. Banks are then temporarily out of action. Central bankers step in and try to plug the leak via the capital markets. However, this requires more and more debt to achieve the same result.  

Yet the recovery from this recession differs from the recovery phases following the recessions of the past decades.  Instead of slow growth with hardly any inflation, growth is now so strong that it threatens to overshoot inflation as well. First, we were surprised by the Super-V scenario, an economic growth that threatens to exceed even the pre-Corona trend growth, now we are surprised by sharply rising inflation. And yet we have been conditioned to ignore inflation over the past decades. Everyone under 40 believes inflation is dead because of globalisation and the IT revolution. Even central banks no longer focus on controlling inflation. Inflation must go up, and to such a high level that there is never again a risk of deflation. Inflation is even allowed to be above the target for a long time, with the argument that it has also been below the target for a long time. Secretly, they like more inflation, which is a tried and tested means of reducing sky-high debt. 

The average central banker is convinced that inflation is much easier to fight than deflation, remarkably often citing the Japanese example. More inflation is good, even if it is in fact nothing more than a tax on savings. Financial repression worked at the beginning of the 20th century, after the Second World War, so why shouldn’t it work now? Inflation is a creeping transfer from creditors to debtors, something that is particularly sensitive within the eurozone. Now there is widespread talk of ‘temporary inflation’, which makes it easy to trivialise the problem. It is a bit like central bankers saying that the ‘subprime problem is under control’. But inflation is not a pilot light that can be turned into a flamethrower and then quickly withdrawn. Karl Otto Pöhl of the Bundesbank compared it to a tube of toothpaste: once you take it out, you can’t put it back in. The illusion that inflation is easy to control is probably due to the same Pöhl who, together with the great Paul Volcker, put an end to a long period of stagflation in the early 1980s. This required a double-dip recession and many more unemployed. Only then did citizens regain confidence in central bankers as guardians of purchasing power. Volcker raised the interest rate to 21.5 percent. In the current environment, that should be enough to control any inflation, especially since the debt burden is incomparably greater than in the early 1980s. 

It will probably take some time for central bankers (apart from PBoC, which is increasingly becoming like the Bundesbank these days) to get used to the fact that inflation will be above 2 percent for a while. Meanwhile, the shortage of people in the labour market is hurting businesses. The number of vacancies is increasing. Many of these workers have barely made any progress in the past twenty years. In the 1970s, powerful trade unions were able to mobilise these people, but nowadays, this is done much faster via social media. Moreover, in this knowledge society, the (mobile) Internet ensures that there is much better insight into the development of wages, especially at competitors. Companies start competing with each other to hire staff. Bonuses are already being paid when entering the workforce, secondary employment conditions are being polished up, but wages are also rising. The wage-price spiral is less far off than everyone thinks. Perhaps we will go back to the old normal, or some people will call it the new, new normal.

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