Norms and Values
The Return of Inflation

Suddenly inflation is back, forcing investors to wake up from a dream they thought would last much longer. In the near future, this awakening risks leading to the bursting of speculative bubbles. Bubbles in real estate, money and finance, produced by speculation on commodities can explode when the ample liquidity runs out drastically, writes Valdai Club expert Dario Velo.

After a long period of stable prices, interest rates fell to nearly zero or even below zero, which was a relatively satisfactory development; the belief had spread in most Western countries that there was no limit to debt, both for private individuals and for states.

The prospect of being able to rely on an interest rate lower than the growth rate for a long-term cycle detracted from the importance of the growth in debt. Those who had accumulated a high level of debt saw no reason to reduce their debt load.

The Quantitative Easing guaranteed by the major Central Banks served only to affirm that a new economic policy had emerged which was capable of sustaining stable development, while overcoming the ancient economic theories, which were judged to be deflationary and conservative.

In this way, economists believed that traditional cyclical policies could assume the role of structural policies. Liberal Keynesianism has led many economists to focus attention short-term consequences, while underestimating the importance of the causes of the processes.

Suddenly inflation is back, forcing investors to wake up from a dream they thought would last much longer. The increase in debt leads to an increase in financial vulnerability. No state can infinitely increase the circulation of money without respecting the structural limits of money creation; firms must respect a balanced relationship between debt and risk capital. Inflation creates inequality among citizens who have a different ability to protect their purchasing power; differences between these abilities to protect themselves that distinguish freelancers and retirees, to cite two profoundly different social groups. This can generate extremist opposition and at the very least bring about the resurgence of terrorism that was thought to have been eradicated.

The inflation that has grown in the United States and, to a lesser extent, in Europe generates imbalances in the international financial order, setting the more developed countries against the rest of the world, and fosters inequality between states corresponding to the inequalities that are generated within states between citizens who have a different ability to protect their purchasing power.

Inflation also creates disparities between companies with different abilities to align the prices of products sold with inflation. This can generate instability in the market and specific problems among the industrial areas where companies with different abilities to deal with the effects of inflation are concentrated. The social impact can be significant, aggravating the inequalities that are generated at the individual level.

Forecasts become more difficult and confidence both on the part of producers and consumers and in general among all economic players decreases, with long-term negative effects.

In the near future, this awakening risks leading to the bursting of speculative bubbles. Bubbles in real estate, money and finance, produced by speculation on commodities can explode when the ample liquidity runs out drastically.

The effects of bursting bubbles fuelled by the illusion of infinite debt can be slowed, but not eliminated. The possibility of this scenario leading to a recession is real. The first signs raise fears of this possibility.

Understanding this shift requires identifying the structural causes.

This shift, if not addressed, can lead to inflation giving way to hyperinflation, fuelling an increasingly uncontrollable world disorder.

The signs that we can glimpse a possible serious crisis on the horizon can prompt us to reflect and understand the structural causes that fuel the disorder, as in reality we have recorded similar signals on the occasion of the crisis of the monetary order founded in Bretton Woods, the Gold Exchange Standard. This analogy has a reason to be.

The monetary crisis that began in 1968, which resulted in the inconvertibility of the dollar into gold, decided by President Nixon, was followed by:

  • the oil crisis;

  • the spread of speculation in commodities markets;

  • opposing trends in exchange rate parity, in particular among European currencies;

  • the fragmentation of commercial integration, primarily in Europe, as an integrated market is possible only in the presence of stable exchange rates;

  • the return of protectionism.

These phenomena have had several concurrent causes; the end of the order founded in Bretton Woods can be considered the trigger.

Today the signs of a possible increasingly serious crisis are substantially the same, where the monetary aspects are integrated with the financial aspects.

The monetary crisis of 1968 corresponds to the financial crisis of 2007, and the end of the gold standard corresponds to the growing difficulties of US finance in playing the role of pivot of the global financial order.

The most indebted country in the world is the United States. The US legislature had to increase the federal government’s ability to increase the constitutionally permitted budget deficit. If exceeding this limit had not been authorized, the spectre of a US debt default would have spread. But no authorization granted as an emergency measure can boost the international confidence of private finance and financial authorities. The risk at an international level is the insolvency of the most indebted economic actors, whether states or individuals. It should not be forgotten that Italy is the second-most indebted country, after the United States: financial crises can generate contagion, increasing disorder.

The belief that borrowing could be expanded was fuelled, in the United States, by the mechanisms that ensured the international absorption of US Treasury securities.

The United States was able to increase the issuance of government bonds as these were largely placed in countries that used the dollar as a reserve and payment currency; dollar assets were invested by these countries in US public debt to receive compensation without giving up the liquidity of their assets.

The use of the dollar as a reserve and payment currency has decreased, while US debt has increased. The imbalance was temporarily reduced as a direct result of the on-going conflict; conflicts always strengthen the leading currency, which takes on the characteristics of a safe haven.

The crucial problem that must be addressed is the construction of a new world order; within it there are several issues, first and foremost a new international monetary and financial order, the definition of rules supported by the broadest international consensus, and the re-establishment of international institutions.

One episode is illuminating. The UN voted on a motion on the conflict in Ukraine, supporting the reasons of the Western front. The motion was approved by about 150 countries and rejected by 50, an overwhelming majority. Few have noticed that this minority represents more than 50% of the world’s population and is made up of the fastest growing countries. Many African, Asian and Latin American countries, despite having solid and traditional ties with the West, have refused to follow suit in sanctioning Russia. It is evidently the manifestation of profound dissent: these countries do not recognize the Western leadership of the current world order. The rules of the UN, therefore, are obsolete. The same is true, mutatis mutandis, for other international institutions.

A new world order is on the agenda. As has been noted, the world order following the fall of the USSR has been defined by many analysts as unipolar. The USA has decided to be able to impose a specific political and economic model, while also resorting to military force.

But a world order can only take root if it is supported by a global consensus and part of a long-term plan. This is the realistic condition for affirming a new multipolar world order.

We must avoid making the mistake of thinking of a model of world order based on the proposals of a single country. If a new world order emerges, this can only be the result of a choice shared by all world players or at least by the main ones. This is the prerequisite for the establishment of a stable monetary-financial order. Today, faced with the worsening financial crisis, the answer can only be a financial order anchored to certain shared rules, aimed at allowing the financing of balanced development and green investments. International institutions will need to be updated to match this multipolar world order.

Views expressed are of individual Members and Contributors, rather than the Club's, unless explicitly stated otherwise.