Transcript
Speaker: Welcome to HSBC Global Viewpoint, the podcast series that brings together business leaders and industry experts to explore the latest global insights, trends, and opportunities.
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Speaker: The following podcast was recorded for publication on the 20th of April 2023 by HSBC Global Research.
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Speaker: Hello, I'm P.S.
Speaker: Butler and welcome to a special edition of the podcast.
Speaker: Today, we're going to be talking about all things inflation.
Speaker: Inflation has been dominating the headlines for over a year now, with prices accelerating at multi-decade high speeds
Speaker: in some countries.
Speaker: And despite aggressive rate rises by central banks, levels have remained persistently elevated.
Speaker: So where do we go from here?
Speaker: Well, Stephen King, HSBC's senior economic advisor, is on hand to help.
Speaker: He's just published a new book on the topic titled, We Need to Talk About Inflation, 14 Urgent Lessons from the Last 2000 Years.
Speaker: He joins me in the studio.
Speaker: Stephen, welcome to the podcast.
Speaker: Well, Piers, it's lovely to be here.
Speaker: So Stephen, firstly, a merculpa on my part.
Speaker: When you published an article in the Evening Standard in May 2021, warning that inflation wasn't going away, I was, as you refer to it, in camp transitory.
Speaker: And I didn't believe you, thinking you were being far too pessimistic.
Speaker: So what made you so sure?
Speaker: And was that the starting point of writing the book?
Speaker: Or was this something that you had already been working on?
Speaker: Well, Piers, you should show more faith in me.
Speaker: That's what I think I would say on this one.
Speaker: So I think it's fair to say that, obviously, at the beginning of 2021, talking about inflation was quite controversial because the general view was that with lockdowns and the collapse in demand, this would lead to disinflationary pressures or maybe even deflationary pressures.
Speaker: But what was changing at the beginning of 2021 was that there were
Speaker: Upside surprises beginning to come through in the inflation data, first of all, in the US, which was, I guess, blamed to a certain degree on the Biden fiscal stimulus, but in short order, also upside surprises in the UK and in the eurozone.
Speaker: So you had this sort of transatlantic story of inflation coming in.
Speaker: higher than expected.
Speaker: And as 2021 progressed, that story became more and more embedded because it was no longer a story about, say, semiconductor prices or second-hand car prices, which was the sort of big initial theme.
Speaker: You begin to see a whole raft of other goods prices rising and then service sector prices beginning to rise and then wage pressures beginning to come through.
Speaker: So it looked to me as though something more broadly had gone wrong.
Speaker: So the first point, I suppose, was
Speaker: observing that inflation was higher than people had thought, given the levels of economic activity.
Speaker: At the second point, we were really thinking, well, why has that happened?
Speaker: And how should we think about it in terms of policy and markets and so on and so forth?
Speaker: So you talk about some of the mistakes that were made in interpreting the data.
Speaker: And in particular, from the book I picked up, The Reverse of Globalization,
Speaker: the impact of COVID-19 scarring, incorrect comparisons to the Great Depression, and the changing role of central banks.
Speaker: So maybe let's sort of unpick some of those, firstly, in terms of the reverse of globalization.
Speaker: So there's this big thing called the Great Moderation.
Speaker: The Great Moderation was this idea that economic growth was more stable, more secure, and also accompanied by lower, more stable inflation rates than we had been used to previously.
Speaker: And many central banks have taken the credit for this Great Moderation.
Speaker: But when you look back at the original paper that was written about the Great Moderation,
Speaker: it was suggesting that rather than this being the consequence of why central banks, actually the rate moderation was more a series of lucky breaks.
Speaker: So it was effectively the incorporation of China and India into the global economy, and in particular their labour markets and the global economy basically meant that if you lived in the UK or the US or Europe, you could import cheaper and cheaper goods from those other areas of the world, which was inherently disinflationary.
Speaker: And I think even before the advent of the pandemic,
Speaker: Some of that sort of hyper-globalization theme was beginning to unwind.
Speaker: In particular, the relations between the US and China were more difficult than they had been.
Speaker: And it seemed to me that the great moderation was in danger of going into reverse.
Speaker: So what had been lucky breaks were becoming unlucky breaks.
Speaker: As far as the
Speaker: Comparisons of the Great Depression are concerned.
Speaker: Well, it's true that GDP or national income in many countries fell in 2020 and 2021 at the same amount of
Speaker: decline that we'd seen during the 1930s.
Speaker: So in that sense, it was pretty terrible.
Speaker: But at the same time, you didn't have the accompanying problems that we'd seen during the Great Depression.
Speaker: So there were no multiple bank failures.
Speaker: There were no mass bankruptcies.
Speaker: There was no mass unemployment.
Speaker: There was nothing in the way of collapsing asset prices or anything like that.
Speaker: So it seemed to me that although the lockdowns had led to falls in GDP, that you'd not seen the same kind of
Speaker: financial and economic contagion that had come through during the Depression.
Speaker: But monetary policy in 2020 had responded as if there was another Great Depression.
Speaker: And I think one of the sort of lasting conclusions of the 2020-2021 period is that monetary policy was eased too far and left too loose for far too long.
Speaker: by which time inflation was already heading upwards.
Speaker: And so in many ways, what central banks have tried to do subsequently is to fix what they themselves contributed to being effectively policy errors in the early stages of the pandemic.
Speaker: So as with a lot of your work, you look at history for some of the lessons that we can gather from that.
Speaker: And for much of the last three decades, both policymakers and investors have focused more on deflation
Speaker: But you and I are old enough to remember the inflationary 70s and 80s.
Speaker: And you talk about your childhood experience of book buying and multiple stickers as prices sort of kept changing.
Speaker: Yes.
Speaker: And you talk about the sort of 14 urgent lessons of 2000 years of history.
Speaker: Can you give us some illustrations from that from that long stretch of time?
Speaker: I'm not going to go through all 14 lessons because it's a relatively short podcast.
Speaker: But so one of them is that during periods of inflation is often a desire for price controls of one kind or another, that somehow you can pick out the particular prices that are going up quickly and control those and everything else will be absolutely fine.
Speaker: One example of that was actually during Roman times, Emperor Diocletian imposed his price edict, which included, oddly enough, a maximum price for a male lion, which I thought was quite an amusing aspect of the story.
Speaker: But the issue there is, did the price controls work?
Speaker: Well, not really, because...
Speaker: At the same time, the emperor was in the business of debasing the currency, so effectively printing money.
Speaker: If you're printing lots of money and imposing price controls, the price controls merely camouflage, which is an underlying problem.
Speaker: Another example is during the French Revolution, the creation of new kinds of money.
Speaker: You could even say this was a kind of early experiment with quantitative easing, which went very, very badly wrong eventually.
Speaker: It wasn't intended to go wrong, but it did go wrong.
Speaker: Third example will be during the American Civil War, where, indeed, in the Civil War's aftermath, where the Union states wanted a gold standard, effectively low inflation.
Speaker: and the Confederate states wanted a silver standard, which effectively meant high inflation.
Speaker: And the very simple reason for those differing preferences is that the northern states were creditors and the southern states were debtors.
Speaker: And typically, inflation is the debtor's friend and deflation is the creditors' friend.
Speaker: Now, the importance of that is that it's actually remarkably similar to the debate that we see today in the Eurozone, where high inflation certainly suits the likes of Italy because it means that
Speaker: Its government debt is now on a more sustainable path than it would otherwise have been.
Speaker: But of course, the consequence of that is that German cash savers are now much worse than they would have been because German inflation is horribly high by German standards.
Speaker: So there's a kind of almost a replay in a more peaceful setting, to be fair, of what happened during the civil war.
Speaker: and its aftermath in the 19th century.
Speaker: And then perhaps the most obvious one is the 1970s, where our folk memory of the 1970s is that much of the inflation was caused by higher oil prices, first of all, in 73, and then secondly, in 1979.
Speaker: When you look at the 1970s, you realize that inflation was already completely out of control before the 1973 oil price increase.
Speaker: The policy had been left too loose.
Speaker: People were too relaxed about inflation.
Speaker: They were too happy to give excuses of external shocks for explaining why inflation was so high.
Speaker: And there are remarkable echoes of that today in terms of much of the discussion we're seeing about inflationary pressures in different parts of the world.
Speaker: There is a fascinating chart in your book that tracks the evolution of a real pound from the 1900s to the current day.
Speaker: Can you just illustrate that for us?
Speaker: Yeah.
Speaker: So if you think about inflation, one way of defining inflation is not so much in terms of the rising price of goods and services and wages.
Speaker: It's actually just the falling value of money.
Speaker: And throughout much of history, money has fallen in value and risen in value.
Speaker: The periods of inflation, periods of deflation.
Speaker: What's been striking about the 20th century and beyond is that almost all the time you've had inflation.
Speaker: In the words, that money has lost value.
Speaker: So if you held a pound in 1900 for the next 100 years,
Speaker: it would only be worth two pence a hundred years later.
Speaker: So it just goes to show that persistent inflation is a mechanism that effectively destroys cash savings.
Speaker: So people who've got cash savings are hugely vulnerable to that idea of inflationary persistence.
Speaker: The latest headlines in the UK imply inflation have peaked and as a consequence so have interest rate hikes.
Speaker: Are we being lulled into a full sense of security?
Speaker: Well, I think here the issue is partly about trade-offs.
Speaker: Yes, we know that energy prices are likely to fall or have fallen already and likely to push headline inflation lower during the course of this year.
Speaker: But at the same time, depending on where you look in the world, you'll find that so-called core inflation, whether it be food or excluding food or energy prices,
Speaker: is still very elevated.
Speaker: Wage growth is quite firm in many parts of the world, certainly firmer than it had been.
Speaker: So there's been a kind of wage response to the price increases that we've already seen.
Speaker: And I think also there's a risk that perhaps we haven't fully recognised what has actually fundamentally changed in terms of inflationary risks in recent times.
Speaker: So in the book, I've got these four tests.
Speaker: Yes, tell us about those.
Speaker: And the first of those tests is really the idea of whether
Speaker: we've changed our institutional arrangements in the way that actually has increased the chances of having inflation when you're least expecting it.
Speaker: So one example of this actually is QE, is quantitative easing, because QE effectively is a way of nationalizing bond markets.
Speaker: And bond markets are always useful as a kind of early warning indicator of future inflationary pressures.
Speaker: But if you've nationalized them, you effectively got rid of your radar system.
Speaker: So it's a bit like sort of trying to
Speaker: deal with an enemy bombing raid when you haven't got any radar.
Speaker: You're going to be too late to deal with it.
Speaker: And in many ways, QE has led us into the same kind of position that inflation crept up and wasn't spotted because the bond markets were unable to respond because you had too much in the way of QE.
Speaker: That's one example.
Speaker: One test is, say, the idea that you had a
Speaker: a shift in the institutional arrangements.
Speaker: A second test is monetary expansion.
Speaker: It's true that in recent months money supply has contracted in various parts of the world, but it's a contraction that's followed a massive increase in 2020 and 2021.
Speaker: And the idea that somehow that massive increase would have no inflationary consequences seems to me to be
Speaker: absurd.
Speaker: But nevertheless, central banks, almost all of them, were ignoring monetary evidence back in 2020.
Speaker: It was just deeply unfashionable.
Speaker: And therefore, an early warning sign, I think, was missed at that particular point in time.
Speaker: A third test is
Speaker: We discussed this already, Piers, which is the issue of the great moderation.
Speaker: I think we've had a series of negative supply-side shocks.
Speaker: It's described now as nearshoring or reshoring and trying to reduce some of the risks associated with fragile global supply chains.
Speaker: All these things are happening, but they come with costs.
Speaker: Effectively, you're going to end up with higher prices for any given level of economic activity, so basically reversal.
Speaker: of the great moderation.
Speaker: And the final test is the idea that central banks have tried to use what I describe as time machines to solve their policy conundrums.
Speaker: Effectively what they do is they say, well look, we've got an inflation target, let's say 2%, we're going to forecast 2% in two years time, and we're going to hope that the public believe what we're saying, and the public believe us, and we'll probably hit 2% in two years time.
Speaker: The problem with that is that effectively using a time machine to go into a future which you have already defined as being a future of 2% inflation.
Speaker: The point there is that actually you don't really know in real time whether inflation will be at 2% in two years' time.
Speaker: The time machine argument is saying we have a perfect view of the future when in actual fact we're living in deep uncertainty.
Speaker: And the idea of perfection, I think, encourages a level of complacency that isn't ideal when you're having to deal with these inflationary risks.
Speaker: And just on central banks, apart from the perils of forecasting, you talk about the changing role of central banks and how that's potentially undermined their inflation-beating credentials.
Speaker: So they now have multiple objectives.
Speaker: If you go back to the sort of, I suppose, the good old days of the Bundesbank and its absolute prime, you always thought of the Bundesbank as a central bank that was focused on price stability and price stability alone.
Speaker: Admittedly, it might have had a secondary role as a lender of last resort, which most central banks have.
Speaker: But it wasn't as though it was having to think about price stability, maximum employment, maximum growth, low bond yields, green finance, financial stability of one kind or another.
Speaker: Central banks now have been given a range of of tasks or a range of objectives, which sometimes are mutually consistent with each other.
Speaker: but not at all times.
Speaker: And the problem with having multiple objectives is that when you discover that you can't hit all of them at the same time, you're then forced into what are effectively political judgments.
Speaker: And most central banks are ill-equipped to make those kinds of choices.
Speaker: It's politicians that need to make those choices.
Speaker: If you're asking central banks to do it, there's a significant danger that they make the wrong choices or that they end up with compromises that actually take them away from what I think should be their primary objective, which is price stability.
Speaker: Stephen, there's lots more to talk about, but I think we've run out of time.
Speaker: So thank you very much for your insights and for joining the podcast today.
Speaker: It's an absolute pleasure, Tiers.
Speaker: Thank you.
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Speaker: So that wraps up things for this week.
Speaker: Thanks again to Stephen King for talking to us about his new book.
Speaker: We'll be back again next week with another edition of the podcast.
Speaker: So please join us then.
Speaker: Thank you for joining us at HSBC Global Viewpoint.
Speaker: We hope you enjoyed the discussion.
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