Stagflation

One after the other, every country sees itself going back into stagflation. Growth slows dangerously, inflation rises. Authorities, governments and central banks get anxious. Commentators tear each other apart to know if it is better to fight against inflation or the slowdown. But what is happening? Why does everything everywhere seem to go wrong? The fashion of the new economy was in full swing, its ardent supporters even talked of a ‘new paradigm’, a sort of new golden age propelled by the information technology revolution. Astounded by the ever increasing power of computers, seduced by unlimited Internet space, we were ready to believe anything possible. Never mind the fact that start-ups made no money while their shares reached heights that nobody knew how to justify. Never mind that no reliable study found any real increases in productivity outside the computer sector. Only a few malcontents could set off immediately ignored warnings. And then, a wave came to wash away these sandcastles.Today’s difficulties have two sources. Firstly, the end of the dream: no, there was no new paradigm. Computers have of course changed the way we work, or the way some of us work, but they are expensive, in time and money. Software companies are determined to create new versions of their old products (What is new for Microsoft since Word and Excel, more than 10 years back?) ever greedier for calculating power, thus causing accelerated obsolescence for equipment, without much fundamental change.Certainly, they run faster, but each change of version and equipment wastes time, which largely absorbs what will subsequently be gained. And who uses more than a tiny fraction of the functions of these amazing toys? The wonders that are the ‘Web’ or the mobile phone are above all social gadgets whose effect on productivity is negligeable. Fun, certainly, a productivity accelerator, hardly. Besides, those experts who, yesterday, were promising a new world, today shamelessly mock those who listened to them. For it is true that prophecies of gurus only involve those who believe them. The second source of our current problems is the oil shock. Obsessed by the end of the new economy, governments, central banks and experts never see this aspect clearly. However, every time the price of oil has significantly risen, economic growth (measured by the index of industrial production) reacted about a year later. That oil becomes more expensive, and growth slows down, whilst it strengthens when the prices drop, as was the case in 1996 and 1999. The increase in the price of oil in 2000 therefore heralds a decrease in growth, and this is exactly what is now happening.Is this fated or are there ways of facing oil shocks ? In fact, these shocks characteristically create an uncomfortable situation. On the one hand, rise in the costs of production cause inflation to rise. On the other hand, growth slows, in part because businesses try to cut back their other production costs, and therefore employment, salaries and their profits fall. Moreover, a rise in oil prices acts as a tax deducted for importing countries, thus reducing revenues, and therefore consumption.Authorities find themselves faced with a dilemma : should they fight inflation which implies reining in growth, or should they revive economic activity at the risk of seeing inflation rise ? Central banks can clearly be seen to get in troubles faced with this enigma where all action is immediately up for criticism. The Federal Reserve has chosen sides: it fights against recession, trying, it seems, to avert a new fall in stocks and shares. The Central European Bank ums and ahs. The Swiss National Bank made a symbolic gesture in slightly decreasing its interest rate, but not much more than this.It is surprising that we do not know an oil shock when we see one. It must be expected that, even once the diagnosis is correctly made, the attitude to adopt is still being debated. However, previous shocks have showed what is the best strategy. Thus we can compare the French and German reactions after the first shock, which happened in 1973 (in part caused by the Israeli-Arab conflict in that year). Germany undertook to prevent all inflation rises. It accepted a lowering of its GDP in 1975, but closed the decade with a lower rate of inflation rate than that which prevailed in 1973. France, on the contrary, tried to sustain the growth, and ended up with a double digit inflation rate. It devoted the next 15 years to effacing the consequences of this choice, at the price of mediocre growth. This example is not the only one, and the lesson drawn at the time is still valid today: the priority must be to control inflation. This is not good news, especially at a time when the financial bubble is deflating following a hard decade. Why does fate always dog our economies ? This is no random effect. Oil shocks always occur at the same time, when there is generalized growth in the world. A first reason for this is the law of supply and demand. An acceleration in economic activity entails more energy consumption, and therefore oil and gas prices go up. But there is another reason: the role played by the cartel of producer countries, OPEC. Oil production capacities are not saturated, so it is unnecessary that the prices rises so sharply. What happens is that the cartel tends to brake up in periods of low demand, hence the collapse of 1996, for example. But it comes together once demand rises. It takes hold and does what all cartels do: imposes extortionate prices. The cost for consumer countries is considerable. But the heaviest price for the whole world is the fall in growth, a fabulous waste of human and economic resources, which represents several times the GDP of a country such as Switzerland. In principle, cartels are prohibited, and OPEC constitutes by far the most harmful cartel which has ever existed. So, how is it that OPEC is allowed to function officially? There are two reasons for this. The first is a geopolitical matter. The second is cynical: some sparcely populated countries in the Middle East hold half the global oil reserves. If they decide to stop all production, they can strangle the whole world’s economic activity. Given their low needs and their wealth, nothing is to stop them doing it if they wanted to. The weapon of oil is so formidable that no-one dares to attack the cartel. And this is why, as soon as the global economy is going well, OPEC is reborn from its ashes and takes pains to extract its exorbitant rent, suddenly provoking a slowdown of the type that we see today.