Economist JM Keynes famously remarked, “In economics there are no miracles, only consequences.”
What are often described as miracles, like the East Asian Miracle, are in fact, consequences of good policies. Similarly, there can be externalities, which are the unintended consequences of certain policies. Externalities can be positive or negative. But, consequences are inevitable.
Presently, we are witnessing unprecedented and humongous monetary and fiscal stimulus, globally, in response to the COVID-19 induced economic crisis. Governments and central banks are doing the right thing since this unprecedented extraordinary crisis needs unprecedented extra ordinary responses. But, it is important to understand that this massive stimulus will create unintended consequences and we have to be prepared for that.
Inflation now is not a printing press phenomenon
When the world’s central banks, led by the Fed, unleashed QE (Quantitative Easing) in the wake of the Global Financial Crisis of 2008 and the Great Recession that followed, their plan was to roll back the stimulus and rebalance their balance sheets within a few years.
It was feared that the surplus liquidity will trigger inflation, and unless managed promptly, high inflation would cause macro economic instability. Going by previous experiences, this concern was not misplaced.
Whenever money supply expanded in the past it had caused inflation. Nobel laureate Milton Friedman, after studying the monetary history of the US for 100 years along with Anna Schwartz, famously concluded: “Inflation is a printing press phenomenon.” Friedman was right in that historical context.
But the global economy had changed disproving Friedman’s monetary thesis. Inflation, at least consumer price inflation, is no longer a ‘printing press phenomenon.’
China and e-commerce giants killed inflation
The massive infusion of liquidity under QE by the Fed, the ECB, the Bank of England and the Bank of Japan, following the Global Financial Crisis of 2008, surprisingly didn't raise inflation. In fact, most central banks failed to achieve their inflation targets. Why?
Mainly two factors killed inflation in developed countries. One, China emerged as the factory of the world and mass-produced goods at incredibly low rates. Two, modern e-commerce giants like Amazon, assisted by technology, out-sourced goods from all over the world and sold them at rock bottom prices and razor thin margins.
Globalization and expansion of trade played a crucial role in bottling the inflation genie.
Liquidity is fuelling asset price inflation
But QE produced another kind of inflation: asset price inflation. Central banks printed money but were powerless in deciding where this money would go. That decision was taken by the market.
Money flowed into assets like bonds and equity. Around $14 trillion are presently invested in bonds yielding negative returns. And, money flowing into stocks pushed stock indices to record levels. S&P 500 rose from 756 on March 13, 2009 to 3,386 by February 19, 2020, and is hovering around 2,990 presently in this COVID struck world. In brief, while consumer price inflation was killed, asset price inflation became the norm.
Going forward, the global economic scene is likely to change. An emotional and economic backlash against China, aggravated by the coming presidential elections in the US, is likely. Consumer preferences might change and an aversion to low-priced Chinese goods, though irrational from the perspective of consumer rationality, is likely. So, a dominant factor that killed inflation is likely to weaken.
Expect stock markets and inflation to rise
This will bring back inflation by 2022. The QE unleashed by the leading central banks is mindboggling. The Fed's balance sheet is expected to explode from $4.3 trillion in April 2020 to $10 trillion by the end of the year and ECB’s balance sheet is likely to spike to 6 trillion Euros by the year-end.
The inevitable consequence would be a rising stock market in a crashing economy. Consumer inflation held in check during the last decade is likely to rise fuelled by the humongous liquidity created by monetary and fiscal stimulus, the like of which the world had never witnessed before. So, prepare for a rising stock market and the return of inflation.
(The author is Chief Investment Strategist at Geojit Financial Services.)Disclaimer: The views and investment tips expressed by investment expert on Moneycontrol.com are his own and not that of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.