The fading specter of the inflationary threat

Just as the world begins to recover from the impact of the pandemic recession, the so-called “specter” of inflation is said to be rearing its head over the global economy.

Janet Yellen, President Joe Biden’s treasury secretary, spooked financial markets last week when she hinted that interest rates might have to rise “to make sure our economy doesn’t overheat,” but this was just the latest in a pattern of warnings that the cost of living was bound to rise as the global economy gets back on its feet.

Ever since governments — led by the US but enthusiastically followed by the rest of the world — began pumping money out to compensate for the COVID-19 lockdowns, there has been the risk that this would inevitably lead to a surge in inflation.

Biden’s spending spree - $1.9 trillion committed and $4 trillion to go - is just the latest and biggest injection of financial adrenalin into the global economy left semi-comatose last summer.

At the G20 summit under Saudi Arabia’s presidency last year, the leaders congratulated themselves that they had spent $11 trillion in anti-pandemic stimulus measures, and that figure has certainly risen since then.

A lot of that stimulus, especially in the US, has gone on propping up asset values via central bank purchases in bond markets, which is great if you are seeking to head off an impending collapse — as seemed possible for a lot of last year — but which is more problematic when trying to steer the economy back to recovery.

Asset prices, whether in stock and shares, real estate valuations, or bond prices, risk entering “bubble” territory in these conditions, which could endanger the whole recovery if they were to suddenly burst. It’s a delicate balancing act.

Yellen’s relatively mild warning was obviously designed to send a message to the people in charge of US monetary policy at the Federal Reserve that they should tread carefully in lashing out at the stimulus, and connect it to real growth and productivity improvements.

It is true that economic life could become uncomfortable in a few years’ time if the stimulus continued uncontrolled, and the thought of large-scale devaluation of the purchasing power of wages and salaries is frightening.

The hyperinflation of the 1920s and 1930s seems to have left a permanent scar on the human consciousness. When relatively high levels of inflation returned to Western economies in the 1970s, they were greeted with cries of horror and a knee-jerk into monetary austerity.

But these days inflation has lost a lot of that threat. Central bankers and other economic policymakers have developed tools to deal with it (hence Yellen’s comments about interest rates).

Perhaps most important is we have examples of the damage that can be done by the opposite of inflation, in the moribund economies of deflationary Japan for the past three decades and elsewhere.

Saudi Arabia has had some spikes in inflation in the past, usually connected to a particular surge in oil prices or output but, overall, the Kingdom has not had to tackle rising prices as an existential threat along Western lines.

There were some dire predictions made last summer when the VAT rate was tripled, adding to the cost of living burden for some. But these have proved short-lived.

The International Monetary Fund (IMF) is usually on the lookout for signs of inflationary pressures, but the most recent reports have almost ignored rising prices in their analysis of global economic trends.

For Saudi Arabia, the IMF’s comments were restricted to one neutral sentence: “CPI (consumer price index) inflation increased in July 2020 with the higher VAT rate but has eased in recent months and is projected at 2.8 percent in 2021 (3.4 percent in 2020).”

The Kingdom’s economy can live with inflation at those levels. In fact, some economists believe that a little bit of inflation is a good thing, adding zest to economic activity.

Yellen is surely right to warn about the dangers of inflation, especially for the US economy, but the rest of the world is probably more concerned that higher interest rates would derail the post-pandemic recovery.

The old specter has lost a lot of its sinister power.

• Frank Kane is an award-winning business journalist based in Dubai.

Twitter: @frankkanedubai