As persistent inflation drives economic decisions in the wealthiest economies, we are seeing more-pronounced threats of a global economic slowdown and new crises related to debt and balance of payments. High inflation in a context of high levels of government, corporate, and individual debt makes the current situation very different from other historical moments of high inflation. Because of the tools involved, controlling rising prices and containing the risks of financial crisis appear as partly contradictory objectives for economic policy. The indebted dependent countries are especially weak links at a time when the risks of debt crisis are deepening.

The Return of Inflation

The OECD recently reported that in May its 38 member countries had an average annual inflation of 9.6 percent — the highest figure since 1988. These are levels that could make Argentina jealous; the figure in Argentina during that period reached 60 percent annually and continues to grow. These days, the processes of class struggle unfolding in Europe and the United States are driven by the efforts of the working class to overcome a decline in its purchasing power.

It has been decades since the wealthy countries experienced a sustained period of general price increases like the one we’ve seen since the post-pandemic recovery. The most traumatic cycle in the United States was during the 1970s, when rising prices were accompanied by weak economic growth and recessionary slumps. It was a rather unprecedented situation, given that conventional economic theory typically associates inflation with economic “overheating” that produces “excess demand”¹Although in dependent countries that were subjected to recurring balance-of-payments crises, the phenomenon of inflation in a recessionary context had already been widely documented. — and it gave rise to “stagflation.” In the early 1980s, the so-called Volcker Shock — named for Paul Volcker, chair of the U.S. Federal Reserve from 1979 to 1987 — dealt the final blow to the inflationary scourge. Thanks to harsh defeats imposed on the working class, inflation gradually disappeared as a concern in the years that followed, beyond some episodic and pronounced rises. After the post–Great Recession recovery of 2008–10, for example, we saw the Fed consistently fall behind its 2 percent annual inflation target.

The continuous monetary discipline imposed by the Volcker Shock, though, does not on its own explain the eradication of inflation, despite the tendency of the more conventional interpretations to do so. Among other things, there’s the fact that from then on there was no continuous restriction of monetary policy, but rather the opposite. Economist Paul Krugman, in a recent New York Times column, explained why the very difficulties that were unseen for decades are occurring now:

It was following conservative policies (in the nonpolitical sense) that kept the economy running below its potential. This slack in the economy meant that there was little risk of a major inflationary outbreak, hence little need for major policy changes. All the Fed had to do was gently step on the brakes if the economy seemed to be getting closer to potential or give the economy a bit more gas if it was starting to slide; not much drama was involved.

Beyond the relevance of the debate on just how much the economy has been “treading” below its potential, there were more fundamental transformations in how the world economy is configured that unleashed powerful forces and led prices to be largely contained (with, of course, the routine ups and downs). Most notable is the formation of global production chains that allowed multinational corporations from imperialist countries to tap into the labor force of poor and developing countries — at wages that are a small fraction of those paid in wealthy economies — for the most labor-intensive production processes. In the context of intensified international competition due to increasing trade openness, and in the framework of continuous corporate restructuring (through mergers and acquisitions), firms could reduce their costs. There was a sharp decline in production prices, at least for manufacturing products (commodities have gone through their own cycles of ups and downs for long periods but with less clear trends, despite the increases in yields produced in sectors such as agriculture by the large-scale application of biotechnology).

It is important to keep this issue in mind in order to get to the roots of the current sustained price increases, which cannot be explained simply as a result of issuing money. Since 2020 some have been warning that large-scale monetary issuance will cause inflation; they may now feel vindicated, but the same warning about the measures taken after 2008 were wrong. Despite the nonsense repeated by libertarians based on poorly digested readings of economists Friedrich Hayek or Milton Friedman, the growth of money issuance (which increased qualitatively during the pandemic) and the laxity of interest rates driven by monetary authorities cannot explain the rise in prices. Contrary to the conventional orthodox explanations, there is no mechanical relationship between prices and the variation of monetary aggregates²Translator’s note: A money aggregate is a formal way to account for money, such as cash or money market funds, and is used to measure a national economy’s money supply. — but it is necessary to pay attention to what happens in the entire circuit of capital valorization.

Nor is it simply a matter of “excess demand” pushing up prices. As Marxist economist Michael Roberts observes, “The recovery after the Covid slump in the major economies has been faltering — every major international agency and analytical research consultancy has been lowering its forecast of economic growth and industrial production for 2022.”

Just as the shaping of global value chains provides structural determinants of why inflation was disregarded for a long period in the imperialist countries, today the disruption of these global value chains is a fundamental cause of the price hikes we have been seeing since 2021. In this respect, the war in Ukraine dealt a new devastating blow. First the war disrupted critical markets that were already under stress, such as wheat and oil — of which the two belligerent countries are important suppliers. Then the economic sanctions, aimed at freezing Russia’s trade with the rest of the world (or at least with the countries that agreed to go along with this application of the “economic weapon”), did the rest by hitting energy and fuels.

The End of an Era in Monetary Policy

The return of inflation took central bankers by surprise. They at first treated it as a transitory phenomenon and were slow to adjust their policies. Over decades, those at the helm of monetary policy had gotten used to moving interest rates and monetary expansion according to the needs of the economic cycle and the concerns of banks and investment funds, without worrying about the impact of these decisions on prices. Since the years of Alan Greenspan (who succeeded Volcker as the Fed chair in 1987), keeping interest rates low became a privileged tool to stimulate the economy, abandoned only for brief periods when central bankers were seeing signs of “overheating” in the economy and some indication — never coming to fruition — that inflation levels might rise. Increasingly, decisions about interest decisions were made according to levels of what Greenspan dubbed “irrational exuberance” that might generate systemic risks. The “art” (with apologies for the term) of putting some brake on the most threatening manifestations of this financial valorization, in order — ultimately — to preserve its perpetual motion, ended up dominating economic policy from Greenspan to Jerome Powell, the current Fed chair.

In the wealthy countries and, above all, in the United States, monetary policy — oblivious for a long period to the risks of significant inflation — ended up being subordinated to the preservation of value of an increasingly gigantic mass of fictitious capital (stocks, bonds, and other debt obligations, along with increasingly sophisticated derivatives) that thrived under the lure of cheap money and became the systemic risk.

One might think that the bursting of the U.S. housing bubble in the 2007–8 crisis, which bankrupted Bear Stearns, Lehman Brothers, AIG, Fannie Mae, and Freddie Mac, and nearly took down other large investment banks and financial institutions around the world, would have served as a warning to attack deeper risk factors. But changes pushed in the years after the crisis to limit the intertwining of investment banking and commercial banking, along with other restrictions on intervention in risky assets, have been revised or eliminated since Donald Trump took office. This, however, is almost anecdotal; what is central is that among the policies implemented to revive the U.S. economy was the large-scale infusion of money into the economy through the Fed’s purchase of long-term financial assets, which helped to boost once again the value of assets that were deflated in the heat of the crisis. These policies, also imitated by the European Union and Japan, were the basis of the fairly long-lasting recovery — albeit quite uneven in social terms — that these economies experienced from 2010 to the pandemic (an economic cycle that is explained not only by internal factors in these economies but also by the role of China as an increasingly important market and investor).

As it turns out, the recipes to get out of the Great Recession only multiplied the underlying problem of fictitious capital. In particular, we’ve seen debt (public and private, corporate and personal) grow to exorbitant levels. And while the financial system was cleansed of some particularly toxic types of derivatives associated with hedging mortgage debt, the overall fragilities were not reduced.

With prices on the rise since the post-pandemic recovery, central banks could no longer continue to be guided by the same coordinates that guided economic policy over the last decades. They were forced to confront, at the same time, the inflationary rise and the problems flowing from indebtedness, which point to policies that take contradictory directions. The traditional arsenal for fighting inflation — again, based on very partial diagnoses of the causes of the phenomenon — includes interest rate increases and a reduction in the amount of money in circulation. This is what the U.S. Federal Reserve, the EU Central Bank (ECB), and many others around the world have been doing for more than a year now, in an increasingly harsh manner. In mid-June, the Fed raised the rate by 75 basis points (0.75 annual percentage increase), when in general the increases it announces are 25 or at most 50 basis points; this was the highest increase since 1994. The minutes of the most recent Fed and ECB meetings anticipate more drastic rate hikes in the coming months unless price rises slow sharply.

It is in the light of this change in economic policy that we must assess the roller coaster ride that stock markets have been on since the beginning of the year, and that at the end of June saw them entering a period of great turbulence in response to the latest interest rate hikes. The Dow Jones index has already lost 13 percent of its share value, and all signs point to that being far from the floor. The most inflated bubbles, such as cryptocurrencies, burst violently, and also hit the sovereign debt of some countries — including Sri Lanka. The “collateral damage” that a tightening monetary policy can have becomes increasingly risky as fictitious capital grows in volume, and as the leverage of financial institutions and imbalances in countries’ accounts become higher. The current situation, thus, has nothing to do with other inflationary situations experienced in wealthy economies. The combination of a gigantic mass of debt and other forms of fictitious capital and high inflation makes the current scenario an explosive combination of factors that pushes contradictory responses to each other.

Central Banks in the Crossfire

If we look at the U.S. debate, we find economists — notably former U.S. Treasury secretary Larry Summers — reproaching the Fed for having done too little, too late to fight inflation. Without more decisiveness, these economists warn, a long period of stagflation like that of the 1970s could be repeated. Summers bluntly argues that more unemployment is needed to curb inflationary pressure by disciplining the workforce at a time when struggles for better working conditions and the right to unionize are multiplying in the United States. Contrary to Summers’s claims, Roberts reminds us that wages have been running behind in the race, while capitalist profits have risen more than prices.

There are other economists who are more skeptical about the effectiveness of a tougher monetary tourniquet than the current one. The aforementioned Paul Krugman warns against “sado-monetarism,” which could overemphasize restrictive measures in the face of inflationary phenomena far beyond what is necessary. In his opinion, the current response is controlling the underlying factors of inflationary inertia, and once the more conjunctural or “seasonal” phenomena cease to act, the rise in prices will decrease to levels more in line with the Fed’s goal of 2 percent per year. Further tightening of monetary policy will bring more recession but will not alter inflationary dynamics.

Taking a view between these two poles, UC Berkeley economics professor Brad DeLong points out that there are risks of overreacting in monetary policy if inflation is determined by factors of short duration, unnecessarily aggravating the economic slowdown that almost everyone considers ruled out. He also recognizes, however, that there is a risk of acting too timidly in the face of an inflationary process such as that of the 1970s, for which he believes it is appropriate to act quickly and drastically. Others, like Nouriel Roubini, directly question the firmness of the current Fed chief, Jerome Powell, to maintain the current line of monetary restriction when recession forecasts are confirmed. As he observed in late June,

Most market analysts seem to think that central banks will remain hawkish, but I am not so sure. I have argued that they will wimp out and accept higher inflation — followed by stagflation — once a hard landing becomes imminent, because they will be worried about the damage of a recession and a debt trap, owing to an excessive build-up of private and public liabilities after years of low interest rates.

Roubini’s assessment is that if central banks discontinue the current spin once a hard landing becomes feasible,

We can expect a persistent rise in inflation and either economic overheating (above-target inflation and above-potential growth) or stagflation (above-target inflation and a recession), depending on whether demand shocks or supply shocks are dominant.

In this context, he argues against those who until recently claimed that the Fed could avoid a recessionary tightening, and now accept that the economic slowdown is more likely but will be shallow and brief. In Roubini’s assessment, “This view is dangerously naive.” At current debt levels, “a rapid normalization of monetary policy and rising interest rates will drive highly leveraged zombie households, companies, financial institutions, and governments into bankruptcy and default.”³Translator’s note: “Zombie” in this context refers to being so indebted as to be able to repay only the interest on debts, but not the principal, or needing some sort of bailout to continue to function.

This is the basis for Roubini’s assertion that “we are heading for a combination of 1970s-style stagflation and 2008-style debt crises — that is, a stagflationary debt crisis” in which “the space for fiscal expansion will also be more limited this time. Most of the fiscal ammunition has been used, and public debts are becoming unsustainable.”

On the monetary side and in terms of public spending, the potential tools to employ are much more limited today than they were after 2008.

The Weak Links

This is not a very reassuring panorama. It reveals once again that, as is often the case, it is the dependent countries — as weak links — that have resorted to more indebtedness in recent times. The much milder monetary tightening of 2018, when inflation was not as persistent as it is today, already dragged countries such as Argentina and Turkey into debt crises. Now we have the case of Sri Lanka, which has already defaulted. But the list of threatened countries is much longer, although some have managed to mitigate the risks in recent months thanks to high commodity prices. There, too, alarm bells have been ringing of late, as prices fall sharply because of rising interest rates and fears of a recession in the United States. Wheat, corn, soybeans, and other commodities are now at prices reminiscent of where they were in February, before the war broke out and sent them through the roof. It would not be surprising if they continue to fall. For months now, the “emerging markets” — to use the financial jargon — have been suffering from capital outflows, in addition to facing higher interest rates to finance public debt.

The global situation today is marked by instability and disruptive shocks.

First published in Spanish on July 10 in Ideas de Izquierda.
Translation by Scott Cooper