Published June 4, 2008

It's not a repeat of the '30s or '70s

Globalisation will reduce the chances of sustained inflation


IT WOULD be handy for investors if Wall Street could agree on which decade the US economy is about to relive. But increasingly, no period from the last century seems to fit the bill. Three months ago, there was plenty of talk about repeating the 1930s - maybe not quite so horrific, but with many of the same destructive trends: rocketing unemployment, collapsing consumption and widespread asset devaluations.

It's still early in our housing-centred mess, but it's clear that the economy thus far has shown remarkable resilience given the ravaged state of our financial system. US first-quarter growth was revised to a 0.9 per cent annualised rate in a government report last Thursday, up from a previously estimated 0.6 per cent rate.

No question, many consumers and businesses are struggling. But the first-quarter data and many of the economic reports since just aren't accommodating the depression mongers. Credit goes partly to globalisation, as foreign demand for US exports has mushroomed.

Extraordinary rise

If the '30s aren't the right template, how about the 1970s? Now, as then, commodity prices are surging, led by oil. That has stoked fear of inflation leaping into double digits - the most enduring painful memory of the '70s other than leisure suits. Last week, two major companies announced price increases that had that ugly '70s feel to them. Dow Chemical Co - which annually sells more than US$50 billion worth of chemicals, plastics and other stuff worldwide - said that it would boost prices as much as 20 per cent effective from last Sunday. Dow cited the 'extraordinary rise in energy and related raw material costs'.

And Eastman Kodak last Friday said that it would do the same with prices of film and other products on July 1. Just how many of those increases will stick remains to be seen, though. Because one of the cold realities of a slower economy is that pricing power is harder to come by, unless you've got something that the world just can't do without.

Joe LaVorgna, an economist at Deutsche Bank Securities in New York, notes that weak or no growth historically has had a way of 'eventually wringing inflation pressures out of the economy'. Since World War II, the inflation rate on average fell by two-thirds in every recession, he said.

But there's a bigger reason to doubt that a '70s-style inflation spiral could take hold this time around: It takes two to spiral - meaning you need rising wages to give consumers the wherewithal to pay higher prices and create the vicious cycle of one feeding the other.

Unlike in the '70s, when cost of living increases for workers were routine, they now are 'more the exception than the rule', says Paul Kasriel, an economist at Northern Trust in Chicago. What's more, labour unions are far less powerful now than they were then, he notes, which limits the effect on wages in general from union-negotiated pay contracts.

Of course, real incomes weren't growing much in the early part of this decade, either. But consumption got a big assist in that period from the housing boom, as people cashed out some or all of their home equity. We know what happened to that trend. Overlaying all of the above is the downward pressure on the wages of many US workers from the effects of globalisation (that is, more competition all around the globe).

Bitter pill

So this is good news? My pay isn't going up, and that will eventually help bring down inflation? It is, no doubt, a bitter pill. And at least in the near term, globalisation could well make inflation worse. America's status as a debtor nation means that we have, in effect, transferred a huge amount of our wealth to the rest of the world. The slide in the US dollar's value, one by-product of that wealth transfer, means that other peoples' purchasing power has risen while ours has fallen.

So even as we cut back on petrol use, much of the rest of the world is willing to pay up for oil. That will help keep the price elevated until either global demand eases or supplies increase, or both. And higher energy costs will continue to make it difficult for formerly low-cost exporters (such as China) to keep a lid on prices of manufactured goods. Still, in the long run, globalisation should reduce the chances of sustained, '70s-style inflation by favouring innovators worldwide. The best way to keep prices in check is to make sure the best goods and services - including ours - can quickly find their way into the marketplace.

The flip side is that, by keeping our doors open to cash-rich foreign investors, we may help keep the value of our assets from deflating as much as they otherwise might have, given our own financial struggles at the moment. So it's not the '70s all over again, nor the '30s. It's a very different world, and we're making it up as we go along. -- LAT-WP