As Australia attempts to tip-toe out of the chilling waters of Covid and into the warmth of recovery, the United States threatens to send cold winds our way. But fortunately fears of stagflation inherited from America are more often predicted than realised.
Despite the growth of China, one would have to be a fool to deny the hold America still has on the global economy. Its economy remains around a third bigger than China’s and is more than four times the size of the third largest economy in the world of Japan.
Just under half of all daily foreign exchange transactions involve the US dollar either being bought or sold, and US$5.8tn worth of currency is being traded each day, which is well over double the US$2.1tn worth of Euros traded.
So, when the American Congress starts to go down a process which may see the US government default on its debt, that tends to create a chilling effect outside its borders as well.
The current fight over the US debt ceiling is very much a movie we have seen before.
In 2013, I did a live blog/ask me anything about the US going close to defaulting on its debt because the Republican party refused to raise the debt ceiling.
Back then the crisis was averted; and the general belief is that surely it will again. But given that since 2013 the Republican party has changed significantly, you can never be sure.
Should the US effectively run out of money around 15 to 18 October (the date is a bit movable based on daily taxation receipts and payments) the impact to Australia will be greatly dependent on just how catastrophic the impact is in the US and the rest of the world.
It may send a calamitous tsunami through the global financial system that sets off GFC 2.0, or investors might all take a deep breath and in effect ignore it as best they can because actually thinking that the US dollar is no longer safe is too scary to contemplate.
At the very least our stock exchange would have a fall – if only because everyone would expect it to.
It would also likely increase interest rates because US government loans would be viewed as less safe and thus investors would demand a higher interest rate.
We already see this now as the yield (or interest rate) for US treasury one month bonds is higher than for one year bonds.
In effect investors believe it is riskier to borrow from the US government for one month than for one year:
And this is also where we come to the other concern coming from America – high inflation and thus also higher interest rates, which would stifle our recovery and create a repeat of the 1970s stagflation (high inflation, stagnant growth).
As with the debt ceiling fight there is nothing new in this.
Numerous economists and politicians – especially those of a more conservative bent – always worry about rising inflation. Many predicted it during the GFC, only to be found utterly wrong.
The fears of inflation have been around most of this year. In April I noted that we should calm ourselves over such fears, and to be honest I see little to change my mind.
You can understand why some are fearful of rising inflation hitting Australia because the US’s consumer price index rose by 5.3% in the past 12 months.
This is relevant because Australia’s inflation does largely move in line with the US’s:
And indeed we have seen a spike here with Australia’s CPI increasing 3.8% the 12 months to June.
But as with our own figures, America remains very much within the churn of the pandemic.
When you compare the US’s consumer price index with the Federal Reserve’s “trimmed mean” (a measure akin to the RBA’s own such “core inflation” measure) you see that what is happening now looks more transitory than a real change:
And the US government’s median-term bond yields remain very much below previous levels and are not following the recent spike in inflation:
The problem is unreal and uncertain for now. Interest rates are at record lows and the government continues to spend massive amounts on stimulus. Trying to discern the underlying state of Australia’s economy – let alone the US’s which is also facing default – becomes rather like tea-leaf reading.
Of course, all calming words about our economic wellbeing go out the window should we decide to see what happens when a global reserve currency defaults.
But until that occurs, we should hold off on predicting rising inflation let alone stagnation when so much of the global economy remains in the weird and somewhat artificial state of the pandemic.