Arun Motianey is director of fixed-income strategy for Roubini Global Economics (RGE). Prior to joining RGE, he worked for two decades at Citigroup in a variety of roles, including head of macro research and strategy for global wealth management, head of investment research and cohead of asset allocation at Citigroup Private Bank Asset Management, and economist in the office of the chairman during the restructuring of Latin American sovereign debt under the Brady Plan, which involved liaising with the IMF. Most recently he has authored SuperCycles: The New Economic Force Transforming Global Markets and Investment Strategy. He received his bachelor’s degree at the University of Bombay and participated in a graduate exchange fellowship at Princeton University. He received his doctorate in mathematics and economics from King’s College, Cambridge.
When, from the perspective provided by your theory of supercycles, you take a global view of growth and the risks to growth, how do you see the interplay of the various regions and what factors are you focusing on currently?
In its essentials the supercycle thesis has two parts: first, the downleg, which we have been experiencing for the last 30 years or so and which is characterized by powerful disinflationary tendencies that take us to the very brink of deflation. This is the result of falling input costs that temporarily widen profit margins in output, but the overcapacity that then follows leads to a crash in the output industry, and so on until the end of the pipeline. The second component is the upleg, where input costs push upward, overcoming the resistance of weak demand until inflation is admitted into the system.
We are now in the earliest stages of the upleg. Keep in mind that these forces play out slowly and are met with significant resistance both in the sluggishness of the economy as well as from central banking ideology, which has intolerance for inflation. We are, however, seeing the ideological resistance breaking down (though for different reasons) in the Bank of England, the US Federal Reserve, and several of the important emerging economy central banks. The European Central Bank, on the other hand, maintains a fortress-like commitment to price stability. But the far more interesting question—and highly relevant to where we find ourselves today in the modern supercycle—is exactly how does inflation seep back into the system?
The sharp rise in commodity prices (due to zero-cost money seeking out “hard” assets) in relative price terms, i.e. against the price of goods and services broadly, implies a reversal of the forces that appear in the downleg. In both legs the cost of inputs drives the movement of prices through the pipeline, but in the downleg the direction is toward deflation, and in the upleg it is toward inflation or possibly stagflation.
Because of the surge in commodity prices, the major developed economies of the world—especially those that suffered most during this supercycle, i.e., the service-dominated economies of the United States and the United Kingdom—will experience a terrible squeeze in margins (in contrast to the widening during the downleg) now that labor costs have been cut to the bone. On the upside, their weakening currencies are giving them some breathing room. However, in order to export their way out of trouble the existing manufacturing points on the pipeline must now become service-led economies. What this means is simply that places need to be swapped in the pipeline.
Nominal exchange-rate appreciation and higher inflation in the emerging markets are already taking us in that direction. Today, the most important thing to watch (far more important, in my opinion, than Federal Reserve policy on interest rates or quantitative easing) is the monetary policy stance of the major emerging economies of the world. If China, India, Brazil, Turkey, and Indonesia (to name just five of the most important) show signs of tolerating higher inflation in their economies and, in fact, allow inflation to slip into wages (which appears to be the case with all of them), the upleg of the supercycle will have begun.
Once inflation comes into these economies you will begin to see signs of inflation in goods everywhere. Rising goods prices globally will give a boost to the tradables sector in the developed world and, provided that this is accompanied by rising wages in these economies, we shall see a return to recovery, though with rapidly rising nominal rates and possibly higher real rates. The risk is that corporations in the developed world may wish to choke off wage increases—so as to rebuild profits—in which case we will get stagflation.
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