Stephen King: As the global economy pivots, we face years of looming austerity

Debt-driven attempts at expansion by Western nations have unravelled

A s economies begin to expand again, policymakers are doubtless expressing a collective sigh of relief. They can now go off to the beach, with bucket, spade, sun tan lotion and dodgy economic model in hand, happy in the knowledge that their worst fears – a return to a 1930s-style Depression – have proved unfounded. When they return to their post-holiday desks and computer screens, they will perhaps find themselves having to deal with an unexpected threat. Inflation will be on the rise. Until now, inflation has been quiescent, helped by a decline in global commodity prices, particularly for oil. Yet, over the past months, oil prices have been heading up.

As the credit crunch took hold, oil prices collapsed. It seems a long time ago but, in the middle of 2008, oil prices had threatened to top $150 per barrel. They then dropped, three times bouncing below $40 per barrel. Now, they are $70 per barrel. Is this a sign that the global economy is returning to renewed health and vigour as earlier worries over depression and deflation begin to fade? Or are these renewed oil price rises a threat to lasting economic prosperity?

The answer depends mostly on where you live. In the US, Europe and the UK, signs of economic stabilisation are encouraging but, at present, the level of demand in these economies remains depressed. To understand why oil prices have risen so much, you have to look at other parts, most obviously Asia. China has given a shot in the arm to global economic activity via the stimulus package pushed through over the past few months. Its renewed strength has been a key reason behind the return to much higher oil prices.

Other Asian economies are also beginning to contribute. Indeed, Asia may be retuning to the buoyant economic conditions last seen in the early parts of this decade. To understand why, it's worth thinking about how policymakers in these countries tend to conduct monetary policy. As with many other emerging nations, countries in Asia tend to link their currencies, formally or otherwise, to the dollar. So when the Federal Reserve decides on interest rates suitable for the US economy, it is also, inadvertently, setting interest rates for many other countries. Of course, those countries could detach their currencies from the US dollar and plough their own monetary furrows, but there is a considerable reluctance to do so.

If you're an American Congressman, this reluctance stems from the blind pursuit of mercantilist trade policies by the Chinese and others. If you're Chinese, the tie to the dollar creates a useful external anchor for monetary policy given the lack of a properly developed domestic financial system. In these circumstances, a currency target is often preferred to a domestic inflation target.

The US sets interest rates for a big chunk of the world economy. If the US has a nasty credit crunch, but other countries do not, those other countries are likely to end up with interest rates which are too low. As a result, their economies expand, their credit systems go into overdrive and their financial markets boom, a point made forcibly by Fred Neumann, my colleague in Hong Kong, in a recent paper, Blowing Bubbles.

Rising oil and other raw materials prices are not good news for commodity-importing nations. So-called "headline" inflation – which includes the volatile bits and pieces such as food and energy – is likely to be moving up again later in the year, seemingly putting paid to earlier worries about deflation. Stronger Asian demand will boost US and European exports to that part of the world but, despite Asia's immense regional power, its economies have yet to replicate successfully the US consumer's role on the world stage: Asian countries are full of savers, not borrowers. My guess is that the impact of higher commodity prices will swamp the effect of stronger Asian demand for developed-world exports, creating a new set of questions about economic recovery in the developed world.

The picture I've painted is one in which the developed world will increasingly have to make room for the strength of demand from Asia and other parts of the emerging world. Rising oil prices are part do not threaten 1970s-style inflation, where prices and wages went up in leaps and bounds. Instead, they make people in the developed world worse off.

Janet Henry, another colleague at HSBC, has just written a paper, Delving Beneath the Surface, examining the likely dynamics of inflation in Europe in response to higher commodity prices. Her conclusions make for uncomfortable reading. In the UK, for example, inflation will be back above 2 per cent in months. Yet, with huge amounts of spare capacity, even allowing for a permanent drop in productive potential associated with the lasting effects of the credit crunch, the chances are that wage growth will be, at best, desultory. Real spending power will be under tremendous downward pressure.

In the good old days, we'd have borrowed our way out of these difficulties. If incomes were being squeezed, we could have relied upon credit markets to allow consumption and investment to continue rising. But the credit crunch has put paid to this. The only borrower left is the government, and few governments will be either willing or able to keep borrowing at the pace seen over the past year.

The credit crunch has created a pivot in the world economy. The debt-driven attempts at continued expansion in the developed world have unravelled uncomfortably quickly. Lower interest rates will provide part of the solution, but they are working more to stimulate demand in Asia than in the developed world. Asia is a lot bigger economically than it used to be, at a resource-dependent stage of its development and is helping driving energy prices back up again. Those increases, in turn, threaten to constrain the pace of economic recovery in the west by eating away at our real disposable incomes.

This is why a debate over fiscal consolidation is ultimately so important. Keynes wasn't wrong. The fiscal pump-priming we've seen over the past 12 months prevented a far worse economic meltdown. But, by increasing government debts, we have increased the tax burden on future generations. That's fine if we can look forward to strong and sustained growth. But, as the global economy pivots, that becomes less likely for the developed world. At some point, we will have to accept a string of years in which the key word will be "austerity".

stephen.king@hsbcib.com

Start your day with The Independent, sign up for daily news emails
News
Lois Pryce... Life Without a Postcode. Lois lives on a boat with her husband.. Registering to vote in the election has prooved to be very difficult without a fixed residential post code. (David Sandison)
newsHow living on a houseboat meant I didn't officially 'exist'
Arts and Entertainment
Cassetteboy's latest video is called Emperor's New Clothes rap
videoThe political parody genius duo strike again with new video
Sport
Steven Fletcher scores the second goal for Scotland
cricketBut they have to bounce back to beat Gibraltar in Euro 2016 qualifier
News
news
ebooks
ebooksA special investigation by Andy McSmith
  • Get to the point
Latest stories from i100
Have you tried new the Independent Digital Edition apps?
Independent Dating
and  

By clicking 'Search' you
are agreeing to our
Terms of Use.

iJobs Job Widget
iJobs Money & Business

Recruitment Genius: Retirement Coordinator - Financial Services

Negotiable: Recruitment Genius: To provide a prompt, friendly and efficient se...

Recruitment Genius: Annuities / Pensions Administrator

Negotiable: Recruitment Genius: You will be the first point of contact for all...

Ashdown Group: HR, Payroll & Benefits Officer - Altrincham - up to £24,000.

£18000 - £24000 per annum + benefits: Ashdown Group: HR, Payroll & Benefits Of...

Ashdown Group: Learning and Development Programme Manager

£35000 - £38000 per annum + benefits : Ashdown Group: A highly successful, int...

Day In a Page

Election 2015: How many of the Government's coalition agreement promises have been kept?

Promises, promises

But how many coalition agreement pledges have been kept?
The Gaza fisherman who built his own reef - and was shot dead there by an Israeli gunboat

The death of a Gaza fisherman

He built his own reef, and was fatally shot there by an Israeli gunboat
Saudi Arabia's airstrikes in Yemen are fuelling the Gulf's fire

Saudi airstrikes are fuelling the Gulf's fire

Arab intervention in Yemen risks entrenching Sunni-Shia divide and handing a victory to Isis, says Patrick Cockburn
Zayn Malik's departure from One Direction shows the perils of fame in the age of social media

The only direction Zayn could go

We wince at the anguish of One Direction's fans, but Malik's departure shows the perils of fame in the age of social media
Young Magician of the Year 2015: Meet the schoolgirl from Newcastle who has her heart set on being the competition's first female winner

Spells like teen spirit

A 16-year-old from Newcastle has set her heart on being the first female to win Young Magician of the Year. Jonathan Owen meets her
Jonathan Anderson: If fashion is a cycle, this young man knows just how to ride it

If fashion is a cycle, this young man knows just how to ride it

British designer Jonathan Anderson is putting his stamp on venerable house Loewe
Number plates scheme could provide a licence to offend in the land of the free

Licence to offend in the land of the free

Cash-strapped states have hit on a way of making money out of drivers that may be in collision with the First Amendment, says Rupert Cornwell
From farm to fork: Meet the Cornish fishermen, vegetable-growers and butchers causing a stir in London's top restaurants

From farm to fork in Cornwall

One man is bringing together Cornwall's most accomplished growers, fishermen and butchers with London's best chefs to put the finest, freshest produce on the plates of some of the country’s best restaurants
Robert Parker interview: The world's top wine critic on tasting 10,000 bottles a year, absurd drinking notes and New World wannabes

Robert Parker interview

The world's top wine critic on tasting 10,000 bottles a year, absurd drinking notes and New World wannabes
Don't believe the stereotype - or should you?

Don't believe the stereotype - or should you?

We exaggerate regional traits and turn them into jokes - and those on the receiving end are in on it too, says DJ Taylor
How to make your own Easter egg: Willie Harcourt-Cooze shares his chocolate recipes

How to make your own Easter egg

Willie Harcourt-Cooze talks about his love affair with 'cacao' - and creates an Easter egg especially for The Independent on Sunday
Bill Granger recipes: Our chef declares barbecue season open with his twist on a tradtional Easter Sunday lamb lunch

Bill Granger's twist on Easter Sunday lunch

Next weekend, our chef plans to return to his Aussie roots by firing up the barbecue
Joe Marler: 'It's the way I think the game should be played'

Joe Marler: 'It's the way I think the game should be played'

The England prop relives the highs and lows of last Saturday's remarkable afternoon of Six Nations rugby
Cricket World Cup 2015: Has the success of the tournament spelt the end for Test matches?

Cricket World Cup 2015

Has the success of the tournament spelt the end for Test matches?
The Last Word: Justin Gatlin knows the price of everything, the value of nothing

Michael Calvin's Last Word

Justin Gatlin knows the price of everything, the value of nothing