Coming era of stagflation and wealth destruction will be boon to working class

The world is entering a period of stagflation, with inflation significantly above the economic growth rate. The world’s major central banks are unlikely to halt the trend by raising interest rates aggressively. Instead, they will remain behind the curve and tighten monetary policy slowly to avoid a recession.

The US dollar-renminbi peg is an anchor for currency stability, reducing the urgency to fight inflation. Tighter monetary policy will be sufficient to trigger asset deflation, though, reversing the trends of the past two decades and causing a downturn in global capital expenditure.

Labour shortages will lead to rising wages, which can support consumption. The combination means we will see slower growth than in the past 20 years, with growth likely to be halved.

Money and inflation are reconnecting after decades of easy monetary policy failing to lead to significant inflation. China joining the World Trade Organization was the disruption that disconnected the two. With vastly more available labour, new infrastructure and wages far below those of developed economies, global capital poured into China to take advantage of the gap.

Now the average yearly wage in China is around 30 per cent of the average for members of the Organisation for Economic Cooperation and Development, and China is also facing a shrinking labour force. Opportunities for arbitrage in China are nowhere near what they once were as any production that could have relocated to China has done so.

Employees work on a car seat assembly line at Yanfeng Adient factory in Shanghai on February 24 last year. China’s entry into the WTO two decades ago opened the door to global capital drawn to the country’s pool of low-cost labour. Photo: Reuters

The China story has become firms trying to take a bigger slice of the current pie rather than upgrading their existing production in China. This fundamental shift is reconnecting inflation to money supply.

Lack of worries over inflation has turned central banks into Santa Claus, printing money for all sorts of reasons. Bailing out the speculators who wrecked the global economy in 2008 and paying people to stay home during the Covid-19 pandemic are among the main factors driving up global debt from less than 200 per cent of GDP in 2007 to 256 per cent in 2020.

Withdrawing this massive monetary overhang is impossible as higher interest rates would risk bankrupting many major governments around the world. Inflating away large portions of existing debt – hopefully in an orderly manner – is the only way out.

Even though central banks are going slow, a shrinking pool of liquidity will put pressure on asset markets. Some might argue that inflation should make assets more valuable, but this ignores the relative starting points for inflation and asset prices. Decades of easy money have fostered a speculative frenzy, making most assets grossly overvalued.

Office buildings in Hong Kong central business district. Hong Kong property prices have been a beneficiary of decades of easy money. Photo: Bloomberg

When the price of something is spiralling even before inflation sets in, it still has plenty of room to fall even given the effects of inflation. For example, a 5 per cent rate of inflation cannot wipe out the massive overvaluation of US stocks or Hong Kong real estate. I suspect both of these markets will see large corrections in 2022.

The wave of excess liquidity has even led to the creation of speculative assets out of thin air, with cryptocurrencies and non-fungible tokens some of the notable examples. The amount of wealth destruction in the coming years could reach tens of trillions of dollars. The process might finally be over when the media stops mentioning the net worth of the people who attend the Davos summit.

Labour shortages are giving the struggling working class a needed break. The “Great Resignation” in the United States would not have happened if people did not feel it would be easy to find another job. This is shifting bargaining power to labour – whose share of income growth in the global economy has been declining for decades – and owners of capital will have to share more with labour to stay in business.

It appears that the pendulum is finally swinging in the other direction. Wages are rising everywhere but not keeping up with inflation. The odds are that wages will rise in tandem with, or even above, inflation in 2022.

This could be the beginning of a trend that lasts for decades. Strong wage growth could be a bright spot in the global economy as it supports global consumption.

Falling asset prices are likely to trigger a downturn in investment. China’s property sector is a harbinger for many parts of the economy, and highly speculative sectors could experience a sharp fall in their ability to attract speculative capital. Weakening in capital expenditure and luxury spending, which have been the froth in juiced-up growth, will drag down the global economy.

Customers walk past a store of French luxury brand Louis Vuitton inside a shopping mall in Beijing on September 19, 2020. Luxury spending has been the froth in China’s juiced-up growth. Photo: Reuters

For example, China’s growth rate is likely to remain stuck around 4 per cent for several years amid the downturn in speculative investment. Stronger consumption among the working class could stop the world from sliding into recession, but any growth in consumption would be fairly weak. When the global economy is weighted at market exchange rates, growth in consumption would be lucky to be around 2 per cent.

While some will complain about the consequences of the era of easy money coming to an end – pointing at vanishing wealth and slowing growth – the world will be a healthier place for it. Falling birth rates, for example, are partly driven by shrinking real incomes and rising home prices.

Reversing the trend is vital for the future of the world. This bubble economy has enticed the world’s best and brightest into unproductive activities such as internet start-ups and financial misadventures. Now wages for engineers in the manufacturing sector are on the rise while internet whizz kids and financial gurus are seeing thinning returns. If these trends continue, the world will be a better place.

Andy Xie is an independent economist