Rising Prices: Inflation is toxic

2022-01-23T18:57:01.512Z

In the US, the central bank could raise interest rates for the first time this week – a bit late, but still. In Europe we are far from that far. This could prove to be a momentous mistake.

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Photo: UCG / UCG/Universal Images Group via Getty Images

Not so long ago, the head of the US Federal Reserve occasionally made speeches that didn't even mention the word inflation.

Jerome Powell then spoke about inequality, injustice and inclusion, about technical progress, innovation and artificial intelligence.

All important topics, no question - but certainly not core tasks of the Fed.

In November, when consumer prices in the USA had already risen by more than six percent compared to the previous year, the most powerful central banker in the world managed the feat of not even touching on the problem of inflation.

For months, the Fed and its boss acted as if the accelerated rise in prices didn't concern them much.

That has changed.

In the meantime, the US Federal Reserve has focused on its core issue again.

Powell recently told the US Congress that high inflation is a burden for citizens.

The Fed will do everything "to prevent inflation from solidifying".

It will be interesting to see whether this will succeed.

Wasting valuable time first...

As the European Central Bank (ECB) has done to this day, Powell's Fed has long claimed that the current inflation is only a "transitory" phenomenon - the result of temporary market tensions in the wake of the corona pandemic, lockdowns and of the following openings. Another way of looking at it is that the Fed wasted valuable time. Had it faced accelerating inflation sooner, it would not have to hit the brakes so hard now.

Now it's chasing a price dynamic that's taking on a life of its own: the US labor market is running out of people, so wages are rising;

on the financial markets, higher inflation expectations are gradually driving yields higher.

The scenario of a wage-price spiral accompanied by a collapse in stock market prices seems anything but absurd.

It is quite possible that the ECB will feel the same way in a few months: that Europe's central bank will then also have to demonstrate its ability to act - the later, the more decisively.

...then step on the brake pedal

Powell and his people have had to change course and language quite radically in the past few weeks.

Instead of waiting calmly for price momentum to slow down on its own, they are now trying to curb monetary momentum.

They want to raise interest rates at least three times this year, maybe more often.

The Fed wants to reduce securities purchases to zero by the end of March, after which it may start gradually selling off its gigantic securities holdings – in order to withdraw liquidity from the financial markets.

The Washington Federal Reserve will decide on its next steps on Wednesday.

Since the outbreak of the pandemic alone, the Fed has bought up securities worth five trillion (!) US dollars.

Now she hits the stop button.

The consequences will be felt worldwide, not just on the stock exchanges.

Political collateral damage

Europe may be closer to a similar monetary braking maneuver than the ECB is suggesting. So far, announcements by President Christine Lagarde and her team have amounted to no rate hikes this year, not even an end to the penalties that commercial banks have to pay on their central bank deposits (“negative deposit rates”). The ECB only wants to reduce its purchases of securities by the end of March, but not to zero: The ECB remains active in the market, because Lagarde & Co. insist that the euro zone is far from over the mountain and will need support for a long time to come.

However, inflation has also risen sharply on this side of the Atlantic.

In the euro zone, consumer prices have recently increased by more than 5 percent compared to the previous year, not quite as fast as in the USA, but life is also getting more expensive here.

The current surge in inflation is primarily affecting the Eastern European euro states, especially the Baltic States, which are close to Russia.

(Pay attention to how the conflict in Ukraine is progressing this week.) In southern European countries including France, inflation rates have so far risen more slowly, but according to the latest Eurostat figures, prices are also rising sharply there.

Inflation expectations of citizens and investors are increasing.

So what is the ECB waiting for?

In any case, the risk that inflationary frustration will result in political collateral damage cannot be dismissed out of hand.

This is not a quirk of the supposedly stability-fixated Germans.

Across the euro area, rising living costs are a nuisance, Eurobarometer surveys show.

The topic is politically explosive and could have a say in the outcome of the French presidential elections in the spring.

Trump: "Inflation will devastate America"

Inflation is a toxic issue.

When income and financial assets erode, trust in institutions suffers.

The decline in purchasing power exacerbates distribution conflicts and turns citizens against the state and against each other.

Phases of high inflation rates are therefore typically associated with social and political instability.

The unleashed rise in consumer prices is now one of the central domestic political problems in the USA.

Ex-Treasury Secretary Larry Summers has already warned that anger over inflation could pave Donald Trump's way back into the White House.

For the painless populist, for his part, the crumbling purchasing power of the dollar is a penalty he doesn't want to forgive: "Inflation will devastate America," he tones - even though the expansive financial policy of his own government has at least contributed to the current inflationary dynamics.

The insane ex-president and his supporters like to overlook the fact that Trump tried to publicly intimidate Fed Chair Powell during his term in office in order to persuade him to adopt an even more liberal monetary policy.

Back in the blame game

Inflation is highly political, especially in a country with high income inequality like the US.

Wealthy are less affected by rising costs of living than poorer citizens;

People with higher education suffer less from it than those with lower qualifications, according to a survey by the polling company Gallup.

Republican supporters are more likely to be affected by inflation than Democrat supporters.

Blame is poisoning the climate.

Republican supporters hold the Joe Biden administration and the Fed primarily responsible, as a recent study of American “inflation narratives” suggests.

Supporters of the Democrats, on the other hand, see big business and the greed of the rich as price drivers.

The Blame Game is in full swing.

According to a study by the Washington think tank Brookings, inflation is a burden for the Democrats, who rule with a narrow majority, and poorer white voters who won over the Democrats in the past elections may prefer the Republicans next time.

Rising prices are likely to help decide the US parliamentary elections in the fall and the next presidential election in 2024.

Neither short nor painless

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Henrik Mueller

Short-cut politics: How permanent outrage destroys our democracy

Publisher: Piper

Number of pages: 256

Publisher: Piper

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In already divided societies, inflation tends to widen the gaps even further.

We haven't got that far in Europe yet.

Public support for the euro is high, even if inflation expectations are rising, a survey of euro-citizens in late autumn shows.

And yet: inflation that has gotten out of hand will eventually require harsh countermeasures – sharp interest rate hikes and real income losses for employees.

Delayed stabilization phases are neither short nor painless, but recent economic history offers plenty of illustrative material.

But this time, the monetary stabilization operation is particularly delicate, as most Western societies are heavily indebted.

Companies, governments and private households have taken on enormous liabilities in the belief that inflation rates and interest rates will be permanently low.

At the same time, the valuations of many assets are extremely optimistic: stocks, real estate, government bonds - prices are high because cheap money has to go somewhere.

The potential for a setback is now correspondingly large.

If interest rates rise rapidly, financing models that may have seemed solid up until now could no longer prove to be viable.

The result would be a wave of bankruptcies, coupled with enormous upheavals.

Better not to let it get that far in the first place.

Early, gentle countermeasures could take the top out of the crash scenario - if it's not too late for that.

The most important dates of the coming week

Expand areaMonday

Rome -

Draghi's next role

- Beginning of the presidential elections in Italy.

The favorite is Mario Draghi, current Prime Minister and former head of the ECB.

The inevitable Berlusconi is also promoting himself.

The procedure is complex and can cause surprises.

Frankfurt –

Price Questions

– Online discussion event of the Banking Association and the German Economic Institute on the subject of inflation: “Rising inflation – is it here to stay?”

Earnings Season I

- Fiscal numbers from Philips, IBM, Halliburton.

ExpandareaTuesday

Munich -

Mood barometer

- The Ifo Institute presents new figures on the business climate in German companies.

Washington -

Global Perspective

- The International Monetary Fund presents its winter forecast for the global economy.

Reporting Season II

– Financials from Microsoft, Johnson & Johnson, American Express, Verizon, Lockheed Martin, General Electric, Texas Instruments, Ericsson, Remy Cointreau.

ExpandareaWednesday

Washington –

Change of course

– The US Federal Reserve decides on interest rates and asset purchases.

Afterwards, Chairman Powell will present the resolutions at a press conference.

Strasbourg -

Green Atoms

- The EU Commission is expected to decide on the classification of investments in various energy production processes ("taxonomy").

According to the plans, both modern nuclear and gas-fired power plants should be considered eligible.

Berlin -

Redefinition of economics

- Robert Habeck, the first Green Federal Minister of Economics, presents the annual economic report.