They say a week is a long time in politics. It is true for the global economy too. Harold Wilson’s quip during the Sterling crisis of 1964 resonated across UK and global financial markets this week. The sterling (pound/cable) cost two dollars and 80 cents in 1964. This week His Majesty’s pound was, well, pounded down to a dollar and three cents by King Dollar.
Context matters for policy – particularly when regimes lean on history to reincarnate economic growth. In 1942 John Maynard Keynes observed, “Anything we can actually do, we can afford….” We are immeasurably richer than our predecessors.” Britain was ruch. In 2022 its GDP ranks below India and its economy depends on what Mark Carney described as ‘the kindness of strangers’. Keynes was advocating the engineering of policy to create public goods, not private enrichment. The policies unveiled by the Liz Truss government validated what Rishi Sunak dubbed fairy tale economics and triggered a rebuke from the IMF, a ratings review by S&P and panic in the markets.
The turmoil saw liquidity evaporate, forcing three large economies to intervene. In the UK a meltdown in the pension funds following a crash in the value of bonds forced the Bank of England to fork out 65 billion pounds. Earlier, the Bank of Japan intervened to halt the precipitous slide of the Japanese Yen past 145 per dollar. In China, the People’s Bank of China stepped in and warned markets’ not to gamble on one-way depreciation’ as the Yuan plunged to 7.24 per dollar.
In the United States, yields on the benchmark 10 year paper nudged past 4 per cent triggering fears in emerging markets. A stronger dollar has impacted earnings of listed multinations. Equity indices in the US recorded the third successive quarter of declines – the benchmark S&P, Nasdaq 100 and Dow Jones are down 21 per cent this calendar year.
The crux of the carnage is the persistence of inflation. The burden of easy money printed in developed economies during the pandemic is roasting economies across the globe. Even as central banks struggled to contain inflation, aggravation arrived in the form of over $ 500 billion in ‘consumer protection’ inducted by governments in Europe and the UK – this week, Germany cleared a 200 billion Euro package. In August 1975, Milton Friedman published the seminal tome ‘There’s No Such Thing as a Free Lunch. A year later, in 1976, Margaret Thatcher famously said socialist governments always run out of other people’s money. The lessons have come home to haunt - ironically, in 2022, Britain is running out of money under a Tory regime.
By definition, inflation is too much money chasing too few goods. It is true that earlier supply chain disruptions, higher energy prices and food scarcity impacted inflation. That, though, is no longer the case. Supply shortages have eased – companies like Nike are wrestling with higher inventories. Energy prices are down with crude oil in the mid-eighties. Energy prices are down with crude oil in the mid-eighties. The villain now in the popular commentary is the tight labour market. The US Federal Reserve is trying to lower inflation by pushing unemployment higher – it is estimated that unemployment would have to rise to around 6 percent in the US alone for inflation to be tamed.
What is not being debated is the workforce gap and demographic challenge faced by the US, Europe and post-Brexit Britain. Wage costs also depend on demand and supply. A study by Giovanni Peri and Reem Zaiour at the University of California, Davis shows that “by the end of 2021, there were about 2 million fewer working age immigrants in the US than there would have been if the immigration trend had continued unchanged”.
The front loading of steep interest rate hikes to curb demand and engineer unemployment to tamp down inflation comes with risks. Since March, the US Federal Reserve has hiked interest rates from 0.25 to 3.25 per cent and aims to touch 4.5 per cent. To appreciate the pace of hikes, one must consult history. The last rate hike cycle stretched from 0.25 per cent in December 2015 to 2.5 per cent in December 2018. In effect, the US Fed has hiked rates higher in six months of 2022 than it did in three years! Yet inflation continues to rage. It is now feared that the systemic shock to financial stability witnessed in Britain could knock on the doors of developed and vulnerable markets.
Beyond the systemic risk, the approach has implications for global trade and growth and, therefore, the Indian economy. The RBI has expended over $45 billion, its reserves are down to $ 537 billion and the rupee has slid from 79.94 and is hovering around 82 per dollar. This week the Reserve Bank of India hiked repo rates by 50 basis points to take it to 5.9 per cent and trimmed its growth projection to 7 per cent. In an exhibition of verbal callisthenics, the RBI has stated that the repo rate is lower than pre-pandemic levels and has hinted that it may have to raise rates further.
India is better placed, but it cannot afford to be sanguine. Yes, it needs to recast its macro fundamentals to guardrail the economy and illuminate its relative merit. The larger question is can the circumstance of competitive rate hikes persist? The world cannot lurch from the brink of one crisis to another. This December India assumes the presidency of G20. The risk of systemic shocks and export of rate hike recession must find place on the agenda.
The Third Eye
Shankkar Aiyar
Author of The Gated Republic, Aadhaar: A Biometric History of India’s 12 Digit Revolution, and Accidental India
shankkar.aiyar@gmail.com