High Inflation, Slowing Growth Raise Risk Of Global Downturn
Yellen cites ‘stagflationary effects’ in a warning ahead of a meeting of leaders of seven wealthy nations.
Yellen cites ‘stagflationary effects’ in a warning ahead of a meeting of leaders of seven wealthy nations.
The global economy is in danger of entering a period of so-called stagflation, or high inflation and weak growth, policy makers and corporate leaders say, which could erode living standards around the world.
United States Treasury Secretary Janet Yellen on Wednesday became the latest leader to warn of turbulence for the global economy. “Certainly the economic outlook globally is challenging and uncertain,” Ms. Yellen said in Bonn, Germany, ahead of a meeting of leaders of seven wealthy nations. “Higher food and energy prices are having stagflationary effects, namely, depressing output and spending and raising inflation all around the world.”
Growing fears of high inflation rippled through financial markets Wednesday after large retailers reported disappointing earnings due in part to their own higher costs. The Dow Jones Industrial Average fell more than 1,164 points, or 3.6%, as of 4 p.m. ET in its worst day since 2020. The tech-heavy Nasdaq fell more than 4%. Target Corp. shares sank 25%, putting the company on track for its largest single-day percentage decline since 1987.
Ms. Yellen—a former Federal Reserve chairwoman—indicated that inflation, particularly the rising cost of food and energy, is becoming a greater longer-term concern and will be a dominant theme among global leaders in the weeks and months ahead. She added that the strong U.S. economy could help buffer it from the threat.
“The United States in many ways is best positioned, I think, to meet this challenge, given the strength of our labour market and the economy,” Ms. Yellen said.
A day earlier, Fed Chairman Jerome Powell warned that “there could be some pain involved” in the U.S. as the central bank moves to raise interest rates further to tamp down high inflation.
Meanwhile, Wells Fargo & Co. CEO Charlie Scharf said this week there was no question that the U.S. is headed for an economic downturn. “It’s going to be hard to avoid some kind of recession,” Mr. Scharf said Tuesday at The Wall Street Journal’s Future of Everything Festival.
Earlier this week, Ben Bernanke, also a former Fed leader, raised the possibility of stagflation in an interview published in the New York Times. “Even under the benign scenario, we should have a slowing economy,” he said. “And inflation’s still too high but coming down. So there should be a period in the next year or two where growth is low, unemployment is at least up a little bit and inflation is still high.”
Mr. Bernanke wasn’t available to comment, a spokeswoman said.
Inflation fears have risen in recent days because of new pressures that could further push up prices for oil and food from already-high levels. The European Union this week released a plan aimed at ending its dependence on Russian energy within five years. Rising food prices—also linked to Russia’s invasion of Ukraine, a major global producer of crops—are triggering shortages across the developing world. The U.K. government reported this week that inflation hit a 40-year high of 9% in April. That eclipsed inflation in the U.S., which hit 8.3% in April.
Meanwhile, economists have cut their forecasts for global economic growth this year as China and Europe show signs of a slowdown. China reported this week that consumer spending and output fell sharply in April as the government imposed new lockdowns to stem a wave of Covid-19 infections.
Last month, the International Monetary Fund said it sees the world’s economy expanding 3.6% this year, down from 6.1% last year. The most recent forecast was 0.8 percentage point lower than its projection in January and a 1.3 point cut from its October 2021 outlook.
The Bank of England earlier this month warned that the U.K. was likely to enter a recession.
One big factor behind the darkening outlook is signs from the Fed and the European Central Bank of a more hawkish stance to aggressively tackle inflation. The Fed last month raised interest rates by a half-percentage point—the biggest increase since 2000—and is planning additional increases this year.
ECB President Christine Lagarde indicated this month that she would support raising the central bank’s main interest rate in July, which would mark the first such increase in more than a decade. Higher interest rates mean that the cost of borrowing—for homes, cars, business expansions and other items—would go up, and could ultimately force consumers and firms to cut back, slowing inflation but also economic growth.
Even if the global economy avoids recession, many people could feel like they are in one, economists say. With the cost of living rising faster than most workers’ paychecks, consumers are getting less and less for each dollar they spend. Five dollars spent at the local cafe might get them a medium coffee instead of a large, for instance. Three hundred dollars spent on airfare might get someone from San Francisco to Denver, but not to Chicago.
Americans accumulated savings during the pandemic, as many reduced expenses and received government stimulus. That is now reversing. The saving rate fell in March to the lowest in nine years, according to the Commerce Department. Households are increasingly pulling out their credit cards and spending down their savings to keep up. Americans’ debt loads rose quickly in the year through March after stalling earlier in the pandemic, the latest Fed data show. As interest rates rise, monthly payments on that debt would further eat into household finances, economists say.
For now, the fundamentals of the U.S. economy are solid, with households still in a strong position financially as more people get jobs and return to old habits like travelling, dining out and going to concerts. Sales at American retailers—a big chunk of consumer spending, the biggest source of economic activity in the U.S.—rose in April for the fourth straight month, the Commerce Department said this week.
April’s unemployment rate of 3.6% remained just a shade above the 50-year low set just before the pandemic. Job openings across the U.S. reached a record high of 11.5 million in March.
But the risk of a recession has risen in recent weeks, and certain problems—such as supply chains disrupted by Covid-19 lockdowns in China and the Ukraine war—could be largely beyond the ability of central banks to address.
Diane Swonk, chief economist at the consulting firm Grant Thornton LLP, said one risk is that persistently high inflation would ultimately cause consumers to cut spending and businesses to slow hiring to maintain profit margins. If that happens, there would, for a period at least, be high inflation and rising unemployment—a combination generally known as stagflation that defined the 1970s, when oil shocks, high federal spending and loose monetary policy caused inflation to soar.
Unemployment could rise, as could homelessness, Ms. Swonk said. People could be forced to move in with parents and relatives and do away with healthcare, not to mention vacations and dinner outings.
“Inflation erodes living standards, and especially the kind of inflation we’re talking about—of basic needs—food and shelter and energy, the three pillars of existence,” Ms. Swonk said. “That kind of inflation is an incredible threat to the economy. We’re talking about a humanitarian crisis on top of what’s already been a pandemic and a war in continental Europe.”
Reprinted by permission of The Wall Street Journal, Copyright 2021 Dow Jones & Company. Inc. All Rights Reserved Worldwide. Original date of publication: May 18, 2022.
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Crypto’s lack of connections with traditional finance means its problems haven’t spilled over to the economy
This year’s crypto collapse has all the hallmarks of a classic banking crisis: runs, fire sales, contagion.
What it doesn’t have are banks.
Check out the bankruptcy filings of crypto platforms Voyager Digital Holdings Inc., Celsius Network LLC and FTX Trading Ltd. and hedge fund Three Arrows Capital, and you won’t find any banks listed among their largest creditors.
While bankruptcy filings aren’t entirely clear, they describe many of the largest creditors as customers or other crypto-related companies. Crypto companies, in other words, operate in a closed loop, deeply interconnected within that loop but with few apparent connections of significance to traditional finance. This explains how an asset class once worth roughly $3 trillion could lose 72% of its value, and prominent intermediaries could go bust, with no discernible spillovers to the financial system.
“Crypto space…is largely circular,” Yale University economist Gary Gorton and University of Michigan law professor Jeffery Zhang write in a forthcoming paper. “Once crypto banks obtain deposits from investors, these firms borrow, lend, and trade with themselves. They do not interact with firms connected to the real economy.”
A few years from now, things might have been different, given the intensifying pressure on regulators and bankers to embrace crypto. The crypto meltdown may have prevented that—and a much wider crisis.
Crypto has long been marketed as an unregulated, anonymous, frictionless, more accessible alternative to traditional banks and currencies. Yet its mushrooming ecosystem looks a lot like the banking system, accepting deposits and making loans. Messrs. Gorton and Zhang write, “Crypto lending platforms recreated banking all over again… if an entity engages in borrowing and lending, it is economically equivalent to a bank even if it’s not labeled as one.”
And just like the banking system, crypto is leveraged and interconnected, and thus vulnerable to debilitating runs and contagion. This year’s crisis began in May when TerraUSD, a purported stablecoin—i.e., a cryptocurrency that aimed to sustain a constant value against the dollar—collapsed as investors lost faith in its backing asset, a token called Luna. Rumours that Celsius had lost money on Terra and Luna led to a run on its deposits and in July Celsius filed for bankruptcy protection.
Three Arrows, a crypto hedge fund that had invested in Luna, had to liquidate. Losses on a loan to Three Arrows and contagion from Celsius forced Voyager into bankruptcy protection.
Meanwhile FTX’s trading affiliate Alameda Research and Voyager had lent to each other, and Alameda and Celsius also had exposure to each other. But it was the linkages between FTX and Alameda that were the two companies’ undoing. Like many platforms, FTX issued its own cryptocurrency, FTT. After this was revealed to be Alameda’s main asset, Binance, another major platform, said it would dump its own FTT holdings, setting off the run that triggered FTX’s collapse.
Genesis Global Capital, another crypto lender, had exposure to both Three Arrows and Alameda. It has suspended withdrawals and sought outside cash in the wake of FTX’s demise. BlockFi, another crypto lender with exposure to FTX and Alameda, is preparing a bankruptcy filing, the Journal has reported.
The density of connections between these players is nicely illustrated with a sprawling diagram in an October report by the Financial Stability Oversight Council, which brings together federal financial regulators.
To historians, this litany of contagion and collapse is reminiscent of the free banking era from 1837 to 1863 when banks issued their own bank notes, fraud proliferated, and runs, suspensions of withdrawals, and panics occurred regularly. Yet while those crises routinely walloped business activity, crypto’s has largely passed the economy by.
Some investors, from unsophisticated individuals to big venture-capital and pension funds, have sustained losses, some life-changing. But these are qualitatively different from the sorts of losses that threaten the solvency of major lending institutions and the broader financial system’s stability.
To be sure, some loan or investment losses by banks can’t be ruled out. Banks also supply crypto companies with custodial and payment services and hold their cash, such as to back stablecoins. Some small banks that cater to crypto companies have been buffeted by large outflows of deposits.
Traditional finance had little incentive to build connections to crypto because, unlike government bonds or mortgages or commercial loans or even derivatives, crypto played no role in the real economy. It’s largely been shunned as a means of payment except where untraceability is paramount, such as money laundering and ransomware. Much-hyped crypto innovations such as stablecoins and DeFi, a sort of automated exchange, mostly facilitate speculation in crypto rather than useful economic activity.
Crypto’s grubby reputation repelled mainstream financiers like Warren Buffett and JPMorgan Chase & Co. Chief Executive Jamie Dimon, and made regulators deeply skittish about bank involvement. In time this was bound to change, not because crypto was becoming useful but because it was generating so much profit for speculators and their supporting ecosystem.
Several banks have made private-equity investments in crypto companies and many including J.P. Morgan are investing in blockchain, the distributed ledger technology underlying cryptocurrencies. A flood of crypto lobbying money was prodding Congress to create a regulatory framework under which crypto, having failed as an alternative to the dollar, could become a riskier, less regulated alternative to equities.
Now, stained by bankruptcy and scandal, cryptocurrency will have to wait longer—perhaps forever—to be fully embraced by traditional banking. An end to banking crises required the replacement of private currencies with a single national dollar, the creation of the Federal Reserve as lender of last resort, deposit insurance and comprehensive regulation.
It isn’t clear, though, that the same recipe should be applied to crypto: Effective regulation would eliminate much of the efficiency and anonymity that explain its appeal. And while the U.S. economy clearly needed a stable banking system and currency, it will do just fine without crypto.
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