Forget Inflation, Stagflation May be the Bigger Threat

From a crippling global pandemic to a war of aggression and spiraling inflation, it seems that no matter which corner investors turn, there’s a new reason to be pessimistic and stuff our heads in the sand.

Understandably investors may want to hunker down with cash stuffed in mattresses and wait it out before resurfacing but even that has its costs – no less than 6.3% per year, depending on which measure of dollar inflation one selects.

And now, the World Bank is cutting its global economic expansion forecast for 2022 further, warning that several above-average years of inflation and below-average years of growth lie ahead.

The World Bank reduced its global growth estimate for this year to 2.9% from 4.1% in January and down from 3.2% in April, due to a surge in energy and food prices, supply disruptions triggered by Russia’s invasion of Ukraine and central bank tightening.

World Bank officials are increasingly concerned that the world is plunging into a period of stagflation (low growth and high inflation) reminiscent of the 1970s.

In the 1970s, the U.S. Federal Reserve had to resort to raising interest rates as high as 20% in 1981 to rein in inflation, which by 1980, had soared to 14% from 8.8% in 1973.

Headline inflation in the U.S. now sits at 8.3%, the highest in four decades, and investors will be waiting for Consumer Price Index data out on Friday to see if the Fed’s policy tightening measures will have had any effect.

Nevertheless, investors must be prepared that the associated rise in global borrowing costs and exchange rate depreciations, already demonstrated in the precipitous fall of the Japanese yen, could trigger financial crises, as they did back in the early 1980s.

Unemployment also soared to 10% in the U.S. as Paul Volcker’s Federal Reserve was forced to respond to soaring prices with a series of rate hikes.

It is possible however that inflation may already have peaked and major global central banks would be able to engineer a soft landing, but right now the risks are escalating on a daily basis that there is no soft landing to be had.