With the economy still savoring the ‘aftertaste’ of the quasi-deflation of 2020 and the pandemic still very present in our lives, a series of German economists dared to launch a warning that was branded as catastrophic and exaggerated: the economy is going to experience a mirage in the first part of the recovery after covid, which will end in a nightmare due to skyrocketing inflation, a product of ultra-expansive monetary and fiscal policies. More than a year and a half later, we can say that these German hawks were right this time.
German economists Hans Werner-Sinn, David Folkert Landau and Wolfgang Schäuble had been warning for years about the “dangerous” monetary policies implemented by the European Central Bank and, on occasion, also by the US Federal Reserve. Some of these pundits have not hesitated to accuse central banks of backdoor financing unsustainable fiscal deficits, blowing asset price bubbles , putting price stability at risk, or even accusing the ECB of being the biggest threat. for the Eurozone itself . Well, with the benefit of hindsight, today it can be said that they were not so far off the mark.
Today, inflation is at 8.1% (four times the ECB’s target), an all-time high in the euro zone and has not yet peaked. The rise in interest rates on bonds could soon call into question the sustainability of the debt, while the infighting in the euro block begins to take shape with the design of the new ECB tool to help Spain and Italy. Meanwhile, the Biden Administration is fighting against the current to stop uncontrolled inflation that is permeating wages and threatens to generate a price-wage spiral.
Chronicle of a crisis foretold
David Folkerts-Landau , chief economist at Deutsche Bank and global director of research at Deutsche Bank, claimed in February 2021 (inflation hadn’t even appeared then) that central banks and governments were creating with their policies a kind of mirage of prosperity that would go to more in the coming months, as the economic recovery takes shape and consumers return to the streets, but whose outcome would be a much higher inflation that will put an end to the markets’ party, said the expert.
“Central banks are doing their part by further extending their mandates and monetizing ever-higher public debt to provide liquidity. This policy mix works like a drug. market similar to that of the Roaring Twenties (or Roaring Twenties )”, assured the German economist. The truth is that this madness has been seen until the end of 2021, with the stock markets, cryptocurrencies, housing… reaching historically high prices and valuations.
However, Landau warned “this, and rising demand, will cause liquidity to flow from financial markets into the real economy. In turn, multiplier effects should boost growth enormously. The uptick is likely to continue into 2022.” However, as inflation expectations rise, questions will be raised about the sustainability of this trend, which could ultimately cause stock and bond prices to fall… when inflation runs out of control and they rise. guys, the party will be over”. This scenario has finally been unleashed this year with the invaluable help of the war in Ukraine, which has damaged the confidence of agents and pushed up prices even more, triggering an inflation crisis earlier than expected.
Landau concluded: “The result was a major disaster. We like to believe that we have learned from the past. So do we really believe that the trillions of dollars spent to support the economy will create sustainable prosperity? out of control and interest rates rise, the party will be over. And the question of who will pay for all this will be just as difficult to answer as it was a hundred years ago.”
Landau is one of the most critical ‘hawks’ with the European Central Bank. When half the world flooded with praise Mario Draghi, former president of the ECB, the chief economist of Deutsche Bank assured that his policies were the biggest threat to the euro zone. The argument is that negative interest rates and massive debt purchases could generate bubbles in assets and prevent the most vulnerable countries from implementing the necessary reforms to face the future with guarantees. Today, those vulnerable countries are even more vulnerable than in 2015-2016 (they have much more public debt), while the price of some assets may have gone too far.
Hans-Werner Sinn , Professor of Economics at the University of Munich and former President of the prestigious IFO Institute, also hit the mark with his analysis. “If the economy picks up and fiscal stimulus accelerates pent-up demand (post-pandemic), a lot of bank credit could suddenly surge out of central bank money. Price growth will start to accelerate and the ECB will have a very hard time keeping track of it.” stop it without having an inflation brake in place,” he said in an article in Project Syndicate from March of last year. With countries highly vulnerable to financial tightening, the ECB cannot raise interest rates as high as necessary to curb inflation.
The one that was the scourge of the ECB and the peripheral countries during the sovereign debt crisis returned to the fray, with more success than in previous omens. “A key source of inflation fears is the expectation that, once vaccines outpace the Covid-19 pandemic, pent-up demand will explode into an orgy of consumption. In addition, today’s unprecedented government bailout programs will have powerful inflationary multiplier effects. Who called for Greece to leave the euro, recently stated: “The Mediterranean countries of the European Union, whose debt has reached exorbitant levels, would have enormous difficulties in assuming new debt and renewing their existing liabilities. From this point of view, the Eurosystem would be exposed to the lack of a brake real to inflation when it matters.
Already in November his forecasts have become more gloomy, with inflation in the US giving its first claws: “It requires little imagination to see how Europe could end up in an environment of stubborn inflation similar to the 1970s , which could last the rest of the the decade and beyond. The economist predicts that the inflationary spiral will be unleashed after the summer, “unions will meet their wage demands, which will boost purchases of durable consumer goods, which will further accelerate inflation.” Last March he added an even more negative element to his forecast. “The food crisis will become even more acute in the fall and winter, with widespread social unrest likely to follow,” referring to developing countries.
Another of the nightmares of the southern countries was, in the previous crisis, Wolfgang Schäuble, German finance minister, from 2009 to 2017 in the Merkel government, and current president of the Bundestag. Just a year ago, when inflation was still thought to be transitory, he pointed out that “sooner or later, inflation always comes”, in an article in the Financial Times , quoting John Maynard Keynes. Although at first glance the two economists could not be further apart ideologically, he stressed that they both shared that the greatest threat to the economy was inflation and “its potential to overthrow the existing foundation of society.”
One of his accurate darts aimed at the euro. And that for those dates remained close to 1.2 euros. The complications that it created for the ECB by trading at such high levels were still present. “Currency values are under pressure in many regions of the world, including the EU,” Schäuble commented, but added “the money supply in the eurozone has increased massively, without it being adequately offset by an increase in the volume of goods and services. This boosts the inflationary expectations of businesses and private households. In this way, the eurozone risks a currency devaluation that could take on virtually unstoppable dynamics.”
One of the ECB’s problems is the weakness of the euro, as it is close to parity with the dollar, which adds greater inflationary pressure to the situation. “Most lenders to states are wealthy individuals and entities. Public borrowing increases their wealth, widening the gap between rich and poor. Keynes once warned that speculators would become objects of hatred. Now, the gap between the have and have-nots represents a great threat to social cohesion” , he stresses.
After years of warnings that failed to materialize, the scenario anticipated by these three German economists seems to have become a very dangerous reality. From Deutsche Bank they assure that this is, without any doubt, “the nightmare scenario that the ECB feared so much”.