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AB 2000 studies

Alain Boublil Blog

 

Volcker is back

The inflationist crisis that the Western countries are now knowing and the envisioned remedies are inevitably sending back to that one of the Seventies final years, generated by the second oil shock, itself provoked by the war in Iran. During near forty years, the developed world was thinking it had put an end to inflation and was even starting to be worried by a deflation risk. In the United States, it is the appointment, at the end of 1979, of a new chairman at the Federal Reserve, Paul Volcker, which constituted a real turnaround. To fight against inflation which was overpassing 10%, he proceeded to massive interest rates increases during the year 1980. Effects on economic activity were not immediate but the occurred recession in 1982 (-1.9%) was one of the deepest of the Post-War period for the country.

The first consequence of his action was a spectacular reevaluation of the dollar. Its yearly average rate went from 4.20F in 1980 to 8.98F in 1985, before starting to withdrawing after the Louvre Agreements and to come back to 6.93F in 1986. Such fluctuations would seem today to be impossible. They were not without consequences on the other economies, through especially a brutal increase of the imported fossil energies prices. It was thought for a long time that the rebound policy decided in France in 1981 had been at the origin of the country foreign trade deficit rise in 1982. We know today that it is the increase of the oil bill resulting from the dollar rise which was its cause.

The near-disappearance of inflation since the Eighties did not obviously have, as its origin, the American monetary policy but was the result of the joint of two essential factors. Technological innovation with the digitalization of many activities has allowed to reducing their costs and the new production and transportation technics of the fossil fuels which put at the world disposal more resources at lower prices plaid a very important role. The second factor has been the globalization and the generalization in the developed countries of the competition. Consumers have then benefited from productivity gains and from low production costs in the whole world, especially in China but also in South Korea and in Taiwan. Innovation in sea transportation with the development of containers has at last made possible the construction of efficient and stable supply chains.

It is this whole economic model which has just been disrupted with first the sanitary crisis and its current rebound in China, which has put into question the structure of the supply chains, and the invasion of Ukraine, with the sanctions adopted against Russia, which have brutally reduced the fossil fuels supply and the production of foods commodities. Inflation today is not caused by a monetary phenomenon but by external factors. But to fight against it, we come back to traditional solutions. Year on year in the U.S., it has overpassed 8%, i.e. a little more than in Germany (7.8%) and in France (5.3% according to the harmonized European prices index). Time has now come to question the desirable evolutions of the monetary policy in every main economic zone. Major divergences are already observed and we are now going from a cooperation logic to an everyone for itself one.

In China, the priority is still to support economy and the central bank is multiplying initiatives in favor of the enterprises financing and to consolidate the banking system at a time when private indebtedness has reached a peak, especially in the real estate sector. In Europe, the European Central Bank is hesitating, and even procrastinating and the divisions inside its board are starting to reappear. The second version of the “whatever it costs”, as the principle of a mutualization of the financings dedicated to the support of the economies after the pandemic, had been adopted without excessive difficulties. But the situation is evolving, even if its president has announced a first interest rate increase to occur in” some weeks”.

We are coming in Europe into a quantitative tightening which prefigurates the interest rate increases. The Public debt Purchasing Program on the market has been progressively reduced and has contributed, in an inflationist rebound context, to long-term interest rates increase. The 10-years French bond rate has passed in six months from -0.5% to 1.5%. This evolution is very inferior to the inflation one which went, during the same period, from 2% to more than 5%. But it is significant. The Bundesbank chairman, who is a member of the ECB board, has just asked for an interest rate increase, as soon as in July, because inflation in the euro zone has reached 7.5%, i.e. near four times more than the 2% objective inscribed in its mandate. It would be the first increase since 2011. The issue is going to be permanent at the center of the institution deliberations and a majority is standing out to think that it is better to act moderately sooner than brutally too late.

In the U.S., to the opposite, the Federal Reserve went through the step and is following the Volcker line. It benefits from the support of the White House which is more fearing the immediate political repercussions in the mid-term elections of a purchasing power diminution due to inflation than the consequences, at a longer term, of a likely recession. A first 0.5% rate increase has been decided and a second one could occur in July. The rhythm may accelerate during the year. Consequences have been immediate on the currencies market, even if they have not been as brutal as forty years ago. In three months, the dollar appreciated itself against the euro as against the yuan by more than 5% and many are funds managers who see the dollar coming at parity with the euro before the end of the year, which will not slow the inflationist tensions in Europe because fossil fuels imports are paid in dollar.

A soft landing of the American economy is not impossible but to reach the objective to carry back the inflation rate at a level near 2%, the action to slow demand and economic activity will have to be vigorous, when even the origin of inflation is, for a large share of it, outside the American economy. The risk of heavy consequences on the financial markets, and so on household assets and on people consumption behaviors is real, which would increase pressures on the economy without, in this case, completely excluding inflationist tensions and could, as during the sub-prime crisis, affect the whole Western world.

Today, the situation is different because there are the structural factors which had allowed to get out from inflation during more than thirty years which have been affected. It will need a lot of time to rebuild supply chains in the industry which will be less sensitive to the difficulties occurred in such or such continent and to reorientate the exchanges flows of energy and agricultural commodities. The monetary policy will have so, in the US. as in Europe, to be aware of its limits.

The central banks cannot do everything and the method used by Paul Volcker is not necessarily the best solution. Political leaders are tempted to shift the responsibilities which consist, to the opposite, to find the new instruments adapted to a world which has changed. It is urgent they become conscient of that.              

 

        

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