How to Handle Stagflation

Includes: EWJ, FXI, PGJ
by: Enzio von Pfeil

Excerpts from Dr. Enzio von Pfeil's July 25, 2008, appearance on CNBC Asia:

  1. Dr. Enzio, while inflation was previously contained to food and energy, some economists say that is now spilling over to wages, triggering a wage-price spiral. They say broader inflation trends are now becoming more apparent. Do you share their view?
    • Yes: it is only understandable that “the little guy” will feel the terrible effects of this “tax” of higher food and energy prices: it reduces his disposable income, so naturally he will seek to get more money.
    • However, I doubt whether he will be able to do this. It all depends on how strong the unions in each country are.
  2. What are some of emerging patterns that is cause for concern?
    • My guess is that you will not find a wage-price spiral evolving; instead, the “valve” will be rising social unrest. Indeed, we see this clearly in China.
  3. The Asian Development Bank said many Asian central banks have been behind the curve in tightening monetary policy to deal with inflation. With inflation threatening to become more serious now, what options do central bankers have?
    • NO central bank can fight stagflation, i.e. cost push inflation. No central bank can:
      • Force it to rain more (agricultural commodities)
      • Force OPEC’s hand (oil)
      • Force miners to resume work (South Africa’s gold miners)
      • Tell China and India to stop growing/creating millions of jobs each year.
    • I for one find it disgraceful that highly paid economists at places like the ADB and IMF are asleep at the wheel and then, once the market has screamed loudly enough, they trot in with their usual precociousness, acting as if they have been saying this all along.
    • Indeed, even more disgraceful are some chief economists and chief strategists of major investment banks: even a blind person saw recession coming a year ago (we ”called” stagflation in Spring 2006). My cynical hunch is that the props desks of these investment banks told their chief PR guys (economists, strategists) to talk the market up so that they, the props boys, could unload the banks’ “long” positions: if the PR guys do not play ball, their bonuses would be cut, and their employment threatened.  Now that this largely has been done, no doubt the props boys have put on huge short positions. So now they will threaten the PR guys with bonus or indeed job cuts if they don’t talk markets down. I just wonder when huge institutional investors are going to sue such houses for having cost them and their retail investors trillions of investment dollars for their deliberate shenanigans with investors’ money.
      • Now that the props boys want the economists etc. to bray about recession or stagflation, that will keep the markets down longer than they should.
  4. Some are calling for a united response among central banks to deal with inflation. How feasible is that?
    • For the aforesaid reasons: central banks cannot do anything about commodity inflation.
  5. What else can they do to manage inflation?
    • They cannot manage inflation.
    • But they can manage social unrest by providing more fiscal “band aids”, e.g. tax cuts for the little guys.
  6. Aside from tighter monetary policy, countries have to cope with slower economic growth by raising fiscal spending. What's your view?
    • We have stridently beaten the drum of “stagflation” to our clients since Spring 2006. We have had four stagflations since 1970.
    • So, in order to stem social unrest, expect more fiscal measures. Monetary ones cannot work.