The Global Inflation Wave: Waiting for Constantine?

Source: The Globalist

Alexander Mirtchev and Norman Bailey,

In the wake of the global economic crisis, the world is trying to chart an economic path to the future and find a "new normal." As Alexander Mirtchev and Norman A. Bailey explain in the first installment in their series "The Search for a New Global Equilibrium," inflation as a factor of global economic security has the innate capacity to upend carefully laid plans and further upset the equilibrium.

“Inflation is always and everywhere a monetary phenomenon.” — Milton Friedman

For as long as there has been the systematic issuance of currency, there have been governments keen to control that currency. Some policies, of course, have been effective, while others decidedly less so.

Exemplary of the latter category is the attempt of the Roman emperor Diocletian (284-305 AD) to find a solution to the socio-economic turbulences besetting his world. Faced with Barbarian incursions, domestic unrest, declining production and rising prices, the emperor imposed price controls and debased the currency, the silver denarius. These measures resulted in shortages, even more rapidly increasing prices, a barter economy with a growing black market and concomitant social hardship and unrest.

Diocletian’s successor, Emperor Constantine (306-337 AD), famous for his conversion to Christianity and for founding the city of Constantinople, was, in his time, probably at least as famous for his monetary reform.

He introduced a series of bold policies and measures, some comparable with the modern understanding of fiscal discipline, epitomized by the replacement of the debased denarius with a gold coin, which he named the solidus, in a brilliant early example of public-relations spin. This currency remained “solid” for 700 years, a span of time unrivalled by any other currency at any time. Notably, hoards of these coins are still found as far away from Rome as China.

History’s lessons have a tendency to repeat themselves. In response to the financial meltdown and in pursuit of recovery, governments around the world have adopted policies reminiscent more of Diocletian than Constantine’s vision.

Confronted by multiple challenges in the wake of the global financial and economic crisis, governments have adopted a series of policies almost as a matter of course, with one of the notable ones being so-called quantitative easing — increasing money supply to ramp up liquidity.

Some central banks, most significantly the U.S. Federal Reserve, are maintaining the policy of directly monetizing the federal debt (also known as quantitative easing) — considering it, if not non-inflationary, then as a preferred remedy for the possibility of deflation.

In November 2010, the Fed introduced a $600 billion program for the direct purchase of Treasury securities over six months in order to drive down long-term rates and thus stimulate recovery from the “great recession” and begin to lower unemployment rates.

The Bank of England also has continued a program of asset purchases to the tune of £200 billion, despite an increasing divergence of opinions within the Monetary Policy Committee. The European Central Bank has been conducting an extensive program of asset purchases that are still ongoing.

However, as noted by Adam Fergusson in his book “When Money Dies,” quantitative easing could be considered a “modern euphemism for surreptitious deficit financing in an electronic age” which “can no less become an assault on monetary discipline” that increases inflationary momentum.

In another important line of post-crisis developments, a number of other countries have also succumbed to the perceived economic advantages of policies that could also contribute to inflationary build-up. Some, like China, are conducting a pegged exchange-rate policy that affects their money supply.

Meanwhile, India and Turkey — although pursuing a floating exchange rate policy — are susceptible to the effects of global quantitative easing. Indeed, several high-growth emerging economies, in particular Brazil, are responding to the massive influx of short-term cash into their economies by putting in place restrictions on foreign investment and other capital controls.

Without trying to divine considerations that were relevant centuries ago, Constantine would have probably questioned such approaches.

The bottom line is that, irrespective of various policies, in the West to the BRICs and elsewhere, inflation concerns are surfacing worldwide. Although U.S. inflation seems to remain within the forecast range, with persistent unemployment keeping labor wage demands at low levels, rising commodity prices and other inflationary pressures are applying opposing pressure.

Inflation in Britain rose to 4% in January 2011, double the government’s target. European Central Bank inflation forecasts, although more optimistic than those in Britain, were still raised to 2.3% from 1.8% on the back of oil price hikes. But in certain countries, inflation has leaped over the EU average, such as the 3.2% registered by Belgium in January 2011.

In the world’s rapidly developing economies, the situation is different — but the bottom line is similar. China’s whirlwind return to growth has been accompanied by rising consumption and wage pressure. When combined with the ongoing weakness of the Chinese currency, it is hardly surprising that, according to government figures, price levels climbed 4.9% year-on-year in January 2011.

Meanwhile, Russia’s consumer price index reached 8.8% in 2010, exceeding the 5.5% the government had deemed feasible at the end of the summer, and has now gone above 10%. And Brazil is facing a rate of growth that is the envy of a number of economies, but with an inflation rate that has been projected to reach 5.8%, well above the central bank’s inflation target of 4.5% for the year.

While the “Great Recession” is far from over, and another downturn is not inconceivable, commodity prices are soaring, helped by drought (China), floods (Australia), civil unrest (throughout the Middle East) and a number of other factors.

In the year from February 2010 to February 2011, all commodity prices were up 50% in U.S. dollar terms. Companies from snack food producers to steel mills are suffering from exponentially increasing raw-material costs. Such a build-up threatens to take on a life of its own and acquire a dynamic beyond the scope of existing contingency plans.

Governments everywhere are responding by devaluing currencies, applying price restrictions, raising interest rates or imposing currency controls — in a way, true to the legacy of Diocletian. In some cases, they are attempting to obfuscate price increases — by changing definitions, altering the composition of indices or applying creative statistics. Few are fooled, however. Citizens know in real terms how much they pay for food, fuel, household goods … the list goes on and on.

The response to these challenges is predictable — growing uncertainty, discontent and rising tension. Indeed, achieving the right policy balances faces a number of practical impediments. Foremost among them are the political and economic pressures that converge from the tectonics of modern history.

The simultaneous pressures of both fragmentation and integration that emerge in a post-Cold War world driven by globalization and wracked by recession have not only created befuddled governments — but also hampered the ability of those governments to coordinate for the mutual benefit of each other.

Instead, Diocletian-like solutions are sought which are bound to produce economic externalities, increasing political pressure. Notably, as “First World” countries fare better than Second and Third, the finger-pointing begins, on the background of disparate impacts being felt in particular in less-developed countries.

Admittedly, the Federal Reserve’s position on the current comparative weakness of inflationary threats as a result of U.S. quantitative easing is a legitimate view, which, however, represents one end of the spectrum.

Another view that could turn out to have even greater mid and long-term relevance is exemplified by comments like those made by historian H. J. Haskell who noted, when comparing the Rome of Diocletian to the United States of Franklin Roosevelt, that the impact of inflation induced by quantitative easing are far-reaching and structurally significant.

“The decay of character that attended the sudden rush of great wealth undermined the Republic,” he said in his book “The New Deal in Old Rome.” “Later, in a society unstable through social bitterness, extravagant public spending proved fatal. … The spending for unproductive public works, for the bureaucracy, and for the army, led to excessive taxation, inflation, and the ruin of the essential middle class and its leaders.”

Similar considerations emerge with regard to the other vectors of dealing with the post-crisis turbulence. Although far from being comparable with the situation in the 1920s Weimar Republic, the inflationary trajectory can be seen as moving toward a tipping point.

It is worthwhile noting that inflation as a factor of global economic security has the innate capacity to upend carefully laid plans and further upset the equilibrium, in particular being a source of economic hardship that only a limited number of state actors can affect via their national policies. Witness the underlying catalysts behind the unrest in North Africa and the Middle East.

With the persistence of strained growth prospects, the specter of inflation becomes all the more worrying. In the present circumstances, the current wisdom simply will not do.

Should we be looking for the new Constantine? So far, one has not stepped forward.

Dr. Alexander Mirtchev is president of the Royal United Services Institute for Defence and Security Studies (RUSI) International (Washington D.C.) and vice president of RUSI (London).  He is a founding member of the Council of the Woodrow Wilson International Center for Scholars’ Kissinger Institute on China and the United States and a Board Director of the Atlantic Council of the United States. He is president of Krull Corp. USA, serves and has served as chairman and director of multi-billion dollar international industrial enterprises, and has had a distinguished public office and academic career, and is the author of four monographs and numerous articles.

Dr. Norman A. Bailey is an economic consultant, adjunct professor of Economic Statecraft at the Institute of World Politics — and president of The Institute for Global Economic Growth. He is professor emeritus of The City University of New York — and served on the staff of the National Security Council during the Reagan Administration and the Office of the Director of National Intelligence during the George W. Bush Administration.  Mr. Bailey's degrees are from Oberlin College and Columbia University. He is the author, co-author or editor of several books and many articles.