*stagflation: an economic situation in which prices keep rising but economic activity does not increase.
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Opinion: Opinion: High debts and stagflation will bring mother of all financial crises - MarketWatch
Project Syndicate
Opinion: High debts and stagflation have set the stage for the mother of all financial crises
The end of the easy-money era rips the mask off the insolvent zombie economy.
The explosion of unsustainable debt implied that many borrowers were insolvent “zombies” that were being propped up by low interest rates.
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Moreover, investments in “capital” can also be risky, whether the borrower is a household buying a home at an artificially inflated price, a corporation seeking to expand too quickly regardless of returns, or a government that is spending the money on “white elephants” (extravagant but useless infrastructure projects).
Overborrowing
Such overborrowing has been going on for decades, for various reasons. The democratization of finance has allowed income-strapped households to finance consumption with debt. Center-right governments have persistently cut taxes without also cutting spending, while center-left governments have spent generously on social programs that aren’t fully funded with sufficient higher taxes.
And tax policies that favor debt over equity, abetted by central banks’ ultraloose monetary and credit policies, has fueled a spike in borrowing in both the private and public sectors.
Years of quantitative easing (QE) and credit easing kept borrowing costs near zero TMUBMUSD10Y,
Insolvent zombies
The explosion of unsustainable debt ratios implied that many borrowers—households, corporations, banks, shadow banks, governments, and even entire countries—were insolvent “zombies” that were being propped up by low interest rates (which kept their debt-servicing costs manageable).
During both the 2008 global financial crisis and the COVID-19 crisis, many insolvent agents that would have gone bankrupt were rescued by zero- or negative-interest-rate policies, QE, and outright fiscal bailouts.
But now, inflation—fed by the same ultraloose fiscal, monetary, and credit policies—has ended this financial Dawn of the Dead. With central banks forced to increase interest rates FF00,
For many, this represents a triple whammy, because inflation is also eroding real household income and reducing the value of household assets, such as homes and stocks SPX,
Worst of both worlds
Worse, these developments are coinciding with the return of stagflation (high inflation alongside weak growth). The last time advanced economies experienced such conditions was in the 1970s. But at least back then, debt ratios were very low. Today, we are facing the worst aspects of the 1970s (stagflationary shocks) alongside the worst aspects of the global financial crisis. And this time, we cannot simply cut interest rates to stimulate demand.
After all, the global economy is being battered by persistent short- and medium-term negative supply shocks that are reducing growth and increasing prices and production costs.
These include the pandemic’s disruptions to the supply of labor and goods; the impact of Russia’s war in Ukraine on commodity prices; China’s increasingly disastrous zero-COVID policy; and a dozen other medium-term shocks—from climate change to geopolitical developments—that will create additional stagflationary pressures.
Unlike in the 2008 financial crisis and the early months of COVID-19, simply bailing out private and public agents with loose macro policies would pour more gasoline on the inflationary fire. That means there will be a hard landing—a deep, protracted recession—on top of a severe financial crisis. As asset bubbles burst, debt-servicing ratios spike, and inflation-adjusted incomes fall across households, corporations, and governments, the economic crisis and the financial crash will feed on each other.
To be sure, advanced economies that borrow in their own currency can use a bout of unexpected inflation to reduce the real value of some nominal long-term fixed-rate debt. With governments unwilling to raise taxes or cut spending to reduce their deficits, central-bank deficit monetization will once again be seen as the path of least resistance.
But you cannot fool all of the people all of the time. Once the inflation genie gets out of the bottle—which is what will happen when central banks abandon the fight in the face of the looming economic and financial crash—nominal and real borrowing costs will surge. The mother of all stagflationary debt crises can be postponed, not avoided.
Nouriel Roubini, professor emeritus of economics at New York University’s Stern School of Business, is the author of “MegaThreats: Ten Dangerous Trends That Imperil Our Future, and How to Survive Them” (Little, Brown and Company, 2022).
This commentary was published with permission of Project Syndicate — The Unavoidable Crash
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