Echoes of the 1970s: The looming threat of inflation and stagflation

The role of supply chain disruptions

Supply chain disruptions have become a persistent challenge, causing shortages of goods and materials, leading to higher prices and eroding consumer purchasing power.

Refinitiv/CoreCommodity CRB Index (Source: Datastream)

These disruptions have also hindered production and slowed economic growth, further exacerbating the inflationary pressures.

The war in Ukraine and the Israel-Hamas War: Compounding the crisis

The war in Ukraine has added another layer of complexity to the supply chain crisis. Ukraine and Russia are major exporters of agricultural products, energy resources, and raw materials. The disruption of exports from these countries has sent prices soaring, particularly for food and energy.

The war has also caused uncertainty and risk aversion among businesses, leading to reduced investment and slower production. This has further strained supply chains and contributed to inflationary pressures.

The Israel-Hamas war, while shorter in duration, also had a significant impact on supply chains in the region. The conflict disrupted trade routes, caused port closures, and led to shortages of goods and materials. This had a ripple effect on global supply chains, as businesses that relied on components or materials from the region were forced to find alternative sources.

Similarities to the 1970s

The current economic environment shares several parallels with the 1970s:

US YoY CPI Growth in 1970s versus Today (Source: Datastream)

Supply-driven inflation: Just as the oil shocks of the 1970s disrupted energy supply and drove up prices, the current supply chain disruptions are causing shortages and price increases across various sectors.

Monetary policy dilemma: Central banks face a delicate balancing act between taming inflation and supporting economic growth. Raising interest rates too aggressively could stifle economic activity, while overly accommodative monetary policy could fuel further inflation. The most pressing question now is when central banks will halt their tightening cycle, and more importantly, when they will start lowering interest rates. Too late, too soon or just in time?

Stagflation risk: The combination of high inflation and stagnant growth could lead to stagflation, a scenario that plagued the 1970s and caused significant economic hardship.

Potential for a repeat

The current economic conditions have raised concerns about a repeat of the stagflation of the 1970s. While the exact trajectory of the economy is uncertain, the persistence of supply chain disruptions and the delicate balance of monetary policy suggest that the risk of stagflation cannot be dismissed.

Easing supply chain pressures: A glimpse of hope

While the potential for stagflation cannot be dismissed, recent developments offer a glimmer of hope. The New York Federal Reserve's Global Supply Chain Pressure Index (GSCPI), a measure of global supply chain stress, has fallen significantly from its all-time peak in December 2021.

Global Supply Chain Pressure Index (GSCPI) standard deviation from average value (Source: Federal Reserve Bank of New York)

This easing of supply chain pressures implies one of two scenarios. It could indicate an improvement from exceptionally low levels, underscoring the ‘base effect’, or it might suggest that the worst is possibly behind us. If the latter is true, with supply chains becoming more efficient and bottlenecks being resolved, the expectation is for inflation to sustain its recent moderation. This could lay the groundwork for a more enduring economic recovery. Personally, I remain cautious and don't believe that we have completely overcome the challenges yet.

Mitigation Strategies

To avert a stagflationary scenario, policymakers need to address the underlying causes of inflation and support economic growth:

• Resolving supply chain disruptions: Governments and businesses must collaborate to improve supply chain efficiency and alleviate bottlenecks. This could involve investing in infrastructure, streamlining regulations, and adopting new technologies.
• Targeted monetary policy: Central banks should carefully consider the impact of their policy decisions on both inflation and economic growth. A more targeted approach could involve focusing on specific sectors that are driving inflation without unduly tightening overall monetary conditions.
• Political stability: In the face of these challenges, achieving political stability in Ukraine and the Middle East is crucial for alleviating supply chain disruptions and promoting a more sustainable economic recovery. Resolving the conflict in Ukraine would restore the flow of exports from the country, helping to moderate food and energy prices. Similarly, addressing the underlying tensions in the Middle East, including the Israel-Hamas conflict, would improve stability in the region, reducing disruptions to transportation and logistics networks.

Conclusion

The current economic environment presents a significant challenge for policymakers, as they navigate the delicate balance between addressing inflation and supporting economic growth. While the potential for a repeat of the stagflation of the 1970s cannot be ignored. Addressing supply chain disruptions, achieving political stability, and implementing targeted monetary and supply chain resilience measures are crucial steps towards navigating these challenges and promoting a more stable and prosperous global economy.