Global Economy on Edge - Kam Hesari

The global economic landscape is undergoing a seismic shift, signaling the end of an era marked by low inflation and stable growth. Advanced economies now face the challenge of stagflation—a toxic mix of high inflation and stagnant economic growth reminiscent of the 1970s. Stagflation's unwelcome resurgence is prompting central banks and governments to rethink their strategies. Stricter monetary policies aimed at controlling inflation are reducing consumer spending power, further suppressing economic growth. Rising inflation, driven by an imbalance between available money and credit and the quantity of goods and services, is amplified by production bottlenecks and shortages caused by COVID-19 and geopolitical tensions.

High inflation is likely to persist due to a combination of supply-side factors such as de-globalization, geopolitical conflicts, aging populations, and demand-side factors. Structural deficits are expected to rise, potentially leading to debt crises or monetization, which would further fuel inflation. Achieving the 2% inflation target is becoming more difficult, prompting a need to reassess the target itself, as striving to maintain this target in a supply-constrained world risks stifling necessary growth. The parallels between the stagflation of the 1970s and today's economic conditions are undeniable, but with a huge twist as unprecedented levels of debt compound the issue. The U.S. government needs to sell a significant amount of bonds to fund its deficit, but weakened demand from major buyers like Japan and China has put upward pressure on interest rates, which needs to remain high to attract buyers. The Fed faces a dilemma, fighting inflation with aggressive rate hikes risks triggering a severe recession and financial crisis, while ignoring inflation could lead to persistent stagflation. In essence, the Fed is in a "damned if they do, damned if they don't" situation.

In addition to these economic concerns, the U.S. faces a looming debt crisis, as the national debt reached a record $34.7 trillion. Given the high levels of private and public debt, achieving a drastic reduction in inflation without inflicting severe economic pain seems increasingly unlikely. This massive debt burden, coupled with similar issues in other major economies like China, Japan, and various European nations, raises significant risks for global currencies. The Federal Reserve's approach, often criticized for its excessive reliance on past data, is under scrutiny. The central bank's data dependency raises concerns about policy lags, especially at critical economic inflection points. This "rearview mirror" strategy is proving inadequate in a rapidly evolving economic landscape, leaving central banks at a critical point where traditional monetary policy tools offer limited relief. Entering an economic contraction with historically high debt ratios and rising inflation poses a unique challenge. Unlike past recessions, where debt servicing ratios were low, the current scenario demands interest rate hikes to combat inflation. This could lead to the demise of zombie companies that survived previous crises, making the impending recession potentially severe, with the possibility of a financial crash looming.

In the face of these difficulties, there is growing concern that central banks may eventually find themselves in a position where they must monetize public debt, which could have serious implications for monetary policy and the stability of the financial system. The path of most advanced economies towards either a soft or bumpy landing will depend on several factors. Such as, the delayed effects of monetary policy tightening, the burden of debt refinancing, and the potential for geopolitical shocks.

The Rise of "Secure Trade"

The global economy is facing unprecedented turmoil marked by escalating geopolitical tensions and a significant shift towards de-globalization. The ongoing Russia-Ukraine war threatens to disrupt vital energy and commodity supplies, while potential conflicts over Taiwan could further destabilize the already fragile global economy. In response to these geopolitical tensions, nations are re-arming and decoupling from rivals. This shift marks a significant move from economic integration to "secure trade" based on geopolitical alliances. The shift towards de-globalization implies higher costs as efficient global supply chains are replaced by more resilient regional networks, with nations focusing on reshoring, near-shoring, and friend-shoring. Essentially, a compromise is being made between productivity and durability, as global supply chains operating on a just-in-time basis give way to just-in-case arrangements. Industrial policies, subsidies, and secure trade are becoming more common, signaling a departure from the era of free trade. Even without a direct conflict between the U.S. and China, a colder economic war could further fracture the global economy. Prior to his death, former U.S. diplomat Henry Kissinger issued a dire warning, suggesting that unless the U.S. and China find a new strategic understanding, they risk a collision course that could lead to outright war. This warning is echoed by Treasury Secretary Janet Yellen, who said that China's production capacity exceeds what the global economy can absorb, challenging China's export-led growth model. This excess capacity could intensify protectionist pressures in the U.S. and Europe, affecting global markets for goods such as steel, automobiles, and aluminum.

The Threat of De-Dollarization

The U.S. dollar, long considered the foundation of the global financial system, is facing unprecedented challenges that could threaten its status as the world's reserve currency. Aggressive money printing and the strategic use of the dollar as a foreign-policy tool through sanctions have sparked concerns about the dollar's future stability. Using the dollar as a foreign policy weapon, especially to contain China, adds another layer of complexity. While this strategy may achieve short-term geopolitical goals, it could ultimately devalue the dollar, triggering inflationary pressures. The fear of being targeted by sanctions has led some countries to reconsider their reliance on the dollar as a safe asset. This reconsideration is shifting the global economic landscape, as rivals are reducing their dollar reserves. Traditionally, the country with the world's reserve currency enjoys a dominant position in global trade and capital flows. However, the U.S.’s declining economic standing and the overuse of sanctions have eroded confidence in the dollar. As a result, other currencies are gaining traction for international transactions, further undermining the dollar's status as the world's reserve currency.

Conclusion

The U.S. dollar faces significant risks to its status as the world's reserve currency, pressured by depreciation from money printing and the geopolitical consequences of its weaponization. As U.S. rivals gradually reduce their dollar reserves and confidence in the currency erodes, the global economic landscape is poised for a seismic shift. The need for a stable, predictable currency in international trade has never been more critical, highlighting the delicate balance the U.S. must maintain in its foreign and economic policies.

Geopolitical tensions and de-globalization trends are accelerating this shift. As countries prioritize secure trade and self-sufficiency, the era of economic integration is yielding to a more fragmented and resilient global economy. These changes have profound implications for trade, investment, supply chains, and financial markets. The world is adjusting to a new reality where the balance between efficiency and resilience will be a defining feature of the global economic order.

The current economic climate, characterized by rising inflation and stagnating growth, presents a formidable challenge for central banks and policymakers. We are moving toward an era reminiscent of the 1970’s stagflation, when money lost value and investors turned to alternative assets such as gold and silver. Back then, while gold benefitted, silver emerged as the more lucrative investment, with its price skyrocketing over 3,800% within 10 years. Put simply, the next decade is expected to be extremely bullish for gold and especially silver!