The World Economy Is on the Brink of a Precipice in a Situation Reminiscent of the 1970s.
The energy shocks had rekindled inflation.
The state of the global economy is not unlike that of the 1970s. Except that the current context is in many ways potentially more explosive.
The war in Ukraine and its impact on global supply chains, energy prices, and food prices are dashing hopes of sustainable recovery from the COVID-19 pandemic. The parallel with the stagflation of the 1970s does not give cause for optimism.
At that time, to break the inflation generated by the two oil shocks and the indexation of salaries to inflation, central banks raised interest rates sharply. The result: a global recession accompanied by a debt crisis in developing countries.
History could well repeat itself.
Europe at the test of fragmentation
Since 2010, the world economy has experienced a very significant wave of indebtedness. The increase in public debts is a real danger for countries that are indebted to foreign currencies. This is the case in the Eurozone because the European currency is like a foreign currency for the member countries that are indebted to a currency they do not control. Fragmentation of the eurozone cannot be excluded in the worst-case scenario. Southern European countries have very high levels of public debt (200% of GDP in Greece, 150% in Italy).
Emerging and developing countries are also raising concerns as their foreign currency debt represents 25% of their public debt compared to 15% in 2009.
The looming US monetary tightening could generate a debt crisis, as in 1979, for Latin American countries. Another similarity is the evolution of wages and inflation. As in the late 1960s, the current period is seeing the emergence of strong wage demands.
The purchasing power of the minimum wage increased by 130% between 1968 and 1983. At the same time, the average wage increased by about 50%. Social tensions fed inflation, which in turn led to further wage increases. Until the politicians eliminated this loop, notably by de-indexing wages in the 1980s.
The implicit compromise that had been put in place by then could well be shattered. This compromise was based on moderate wage increases offset by gains in purchasing power linked to the imported disinflation generated by globalization. The current demands for a rebalancing of wages, as revealed by the tensions in the United States since the pandemic in the form of numerous strikes and the phenomenon of the "Great resignation", bear witness to this.
The engine of global growth, China, is running out of steam
Elsewhere, real hourly wage growth is negative in most OECD countries, affecting purchasing power and household consumption. Social tensions are to be feared. Global growth is likely to be affected. All the more so as the Chinese engine, which has accounted for a quarter of global growth over the last twenty years, is seizing up. Not only because of Xi Jinping's disastrous zero-covid policy.
China's working-age population peaked in the early 2010s and is expected to reduce future growth. Productivity growth is slowing.
The effects of the conflict in Ukraine could also be more severe than expected due to the disruption of Russian gas supplies throughout Europe. According to the OECD, output in the manufacturing and market services sectors is expected to fall by almost 3%.
These effects could be underestimated, especially if companies stop production completely. Many industries, especially the most energy-intensive ones such as metallurgy, could go bankrupt. A total halt of Russian gas imports could lead to a drop in German GDP of 3 to 8%.
More than ever, the world economy is at a turning point, on the brink of a precipice, in a situation that is reminiscent of the one the world went through in the 1970s with the two oil shocks.
Some reading
The Great Resignation Could Fix the Decoupling of US Wages From Productivity Growth. Positive change is hoped for the Bottom 90% in a changing labor market.
The Strong Dollar Is a Danger to the World Economy, and It Has Already Taken Its First Victims. The dollar’s rise is probably not over.
The Debt Wall – Huge Public Debts, but Opposite Destinies Between Developed and Emerging Countries. The situation in emerging countries is worrying, but this should not impact the global financial system more than that.
Governments Debt Around the World Is Out of Control — How Long Before a Major Crisis Occurs? 32 countries now have a debt-to-GDP ratio above 100%.
When Hyperinflation Rhymes With Chaos — The Story of Zimbabwe With Inflation of 231,000,000% in 2008. Robert Mugabe’s land reform ruined a country that was once the breadbasket of southern Africa.