“To govern is to destroy, to destroy the parasites, to destroy one’s troops, to destroy the enemy,” Shang Yang.
The enemy is the spiral of inflation. It’s Karl Otto Pölh’s toothpaste, to paraphrase the President of the Bundesbank, who “doesn’t come out of the tube anymore”. The weapon is the rise in price towards its neutral point; a very theoretical level at which the economy no longer overheats and full employment and price stability become compatible again.
Before resuming the presidency of people’s economic destinies and leading them into the nirvana of that state of platonic harmony where monetary policy is neither accommodating nor restrictive, central banks must first go through the painful period of financial hardening. As Janet Yellen says, “You can’t break inflation without a recession.” You have to blow out the economic cold to fight the fire.
By smothering the liquidity they have so plentifully injected, central banks are first destroying the bubbles they indirectly helped create. In the stock markets, the most expensive stocks are being massacred by a violent compression of their multiples: the GAFAs give up 1,000 billion in capitalization in 3 days. The Fed is no longer concerned with the destruction of cryptocurrencies, the market capitalization of which collapsed by 60% in a few days. It doesn’t matter if 40% of investors are now losing with their digital assets. They are parasitic assets in the eyes of those who have a legitimate monopoly on minting official or “fiat” money. The dollar’s revenge on Bitcoin, prophesied to return by 2021 as a tool to protect against the inflationary effects of the Fed’s reckless policies, has begun.
The major “fiat” currencies (euro, sterling, yen) are also unwinding and converging or, like the franc, even reaching parity with the greenback. At $1.04, the euro is performing more or less at the same level as the “cable” (sterling/dollar) did in 1985. In fact, the pound sterling was also testing parity with the greenback at the time, a far cry from what had prevailed up until then $2 Bretton Wood. In the US, Volcker was taming inflation at the time. The growth is strong. The interest rates serviced by American bonds fared better than gilts in what was then a thriving economy: capital flight bled the UK’s currency dry amid an economic slump. In many ways, the situation on both sides of the Channel is reminiscent of 1985: inflation is higher in Britain than in the United States, growth is slower, bond yields are lower than Treasury bills. The Bank of England has just admitted inflation is out of control at 10% and the UK economy is already headed for recession. Your room for maneuver is therefore limited. Interest rates will not be able to rise as much as necessary. If the economy collapses, the Bank of England will be forced to slow down.
The specter of stagflation
Unfortunately, there is nothing to suggest that the rise in interest rates and the recession linked to the shortage of energy, agricultural commodities or semi-manufactured goods will affect inflation. The British pound has lost 10% against the dollar since the beginning of the year, followed by the euro at -9% and approaching parity. Even on the old continent, basic needs are becoming increasingly scarce. Flour and oil are in short supply in supermarkets and consumers are feeling the effects of rising prices.
No improvement on the energy front: Germany’s gas supply is being physically restricted for the first time as a result of the war in Ukraine. Almost 3% of the imported volumes have disappeared.
Automakers Safran and Thalès, already suffering from shortages of Russian titanium, fear they may soon have to shut down certain production lines. New orders to the industry turn around. The European economies, especially Germany, could falter and slip into recession from the second half of the year.
It is this stagflation specter that is weakening the euro. The feeling that imported inflation will not end with the recession, the distrust of a central bank that is lagging behind the others. When most of them started to act, some with ambitions to go beyond the neutral rate, the ECB hesitated.
So the euro suffers, its weakness increases imported inflation. Worse, energy shortages, rationing in the event of a total halt to gas supplies can raise the existential question of the value of a currency that does not provide access to the most basic resources.
In 2020, the ECB and governments have done everything they can to avoid the job damage of “whatever it takes” lockdowns.
Whether it acts or not, we must face the facts this year: the policies of the ECB will demand sacrifices, from its own troops, from the countries of the South, from heavily indebted companies, from the most vulnerable consumers, from the middle class, likely to be caught between the erosion of their purchasing power and the contribution to solidarity and public debt at record levels.
Christine Lagarde will have to get used to the bitter thought that sometimes to rule is to destroy.
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