This time it's different! We are at the cusp of a gigantic stagflationary storm, and add the debt crisis then we may not see, but the wrecking train is upon us.
During the 1970's stagflation, there was no problem of high debt-ratios for most countries and, therefore, no debt crisis. The 2007-08 financial crisis resulted from high debt ratios (public plus private), which resulted in the bursting of housing bubbles. The recession that followed led to low inflation. It was aggregate demand that was affected via a credit crunch.
Today, across the world, the central banks have resorted to loose monetary and fiscal policies. As a result, the ultra-low interest rates and adverse aggregate supply shocks have started to show high inflation, which is getting entrenched. So, we are close to a scenario of stagflation plus a debt crisis.
It seems all the central banks have lost their independence. The speed with which they are monetizing the fiscal deficits from developed to emerging economies forebodes a debt crisis of gigantic proportions. Both public and private debts have been rocketing, leading to veritable debt traps. So here is the catch, as inflation starts getting entrenched somewhere, the Central banks will begin pulling the trigger on the policy rates. We may land up in a situation where rates start rising and thus triggering debt crisis, therefore, recession.
Look around what loose monetary and fiscal policies have done – create asset & credit bubbles. As a result, we see unrealistic PE ratios, housing bubbles popping up, tech companies soaring market caps, the frenzy around SPACS, crypto, and PE boom.
Add to this is the Sino-American tug-of-war, which started before the pandemic now baton-charged by the new Biden administration.
All these are the tools of subsequent supply shocks, as post covid protectionism is on the rise, tariffs are the new weapon, and there is a trust deficit on the international trade side. Almost all countries are looking toward reshoring manufacturing, even if moving to high-cost locations. This de-coupling has already started via the US-China route. There is a total loss of confidence, and it would require global leadership to restore the balance, which looks distant as China wants to seize this covid-induced moment to occupy central space in global dominance.
Is the scenario avoidable: everything will depend on the trajectory of the pandemic. At the moment, with the variants wreaking havoc, the recovery looks weak and prolonged. Again, the developed economies are to be blamed- make no mistake, the world is highly interconnected. Any mutation in one part of the world reaches the other side in no time. The global leaders of the developed world have failed by holding on to the vax supplies and were unable to vaccinate their entire adult population.
There is an imminent and clear danger that the 1970 type-stagflation will hit the 2008-type debt crisis. As these two fast moving trains collide world may see a mother of all recession and the repercussions will be long-drawn. What is more scary is that many non-economic unknowns are there in this equation; will there be another pandemic, what-if the present one refuses to go away. More and more policy makers are hiding behind the central banks to bail them out without taking harsh decisions and history has shown that central banks have traditionally been behind the curve.
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