The new year is sure of more uncertainty as it begins

While pharmaceutical companies have a clear interest in perpetuating virus fears and calling for more frequent and endless doses of vaccination, some financial interests would also prefer to prolong the fear and uncertainty as it would put central banks in easing mode. Monetary authorities will be reluctant to reduce their provisions of liquidity for economies, even though these flows mostly fund speculative activities. If fear and uncertainty persist, European economies will most likely be vulnerable and the euro a sitting duck. The continent is in the midst of a political transition in several major countries and their policies are yet to be tested. The European Central Bank has gone for unprecedented monetary accommodations, which pushed the inflation rate in Germany to more than 5%, the highest since 1992.

In another time and era, the German Bundesbank would have erupted in anger and raised interest rates, even if it brought the economy to its knees. Now, the chairman of the Bundesbank could only retire from his position five years ago. Time, they are different now.

Amid this pandemic of fear, the re-appointed chairman of the US Federal Reserve is determined to reduce bond purchases, which have kept government bond yields low despite record borrowing by the US government. Inflation as measured by its official consumer price index is 6.88%, the highest in nearly four decades. This has brought down the real short rate (the real 90-day T-bill secondary market rate) to a level slightly higher than the level last seen in June 1980. It was -7.2% then and is -6.83% now. However, the actual federal funds rate has not been so low in the 67 years of data available in the FRED database.

It is fitting for a debt-heavy US economy to have such a negative real short rate. It is part of a US toolkit for keeping debt serviceable and reducing the debt burden relative to gross domestic product (GDP). So many developed countries dissolved their mountain of debt after World War II. But even then the growth was enormous. This time development will be missing from the equation.

This sets up a possible generation-to-generation conflict between capital and labour. High growth then kept both capital and labor in balance. Now, higher inflation will squeeze real wages. Given the constraints of structural development in many parts of the developed world to prevent this, the squeeze would be of benefit. This should set up the conditions for a stock-price crash. It is overdue. As a result, the federal funds rate will be around 1.0% or less this cycle, as in a recent article in Barron’s argument (bit.ly/3DPcIZt).

In a normal world, this would be very bad news for the US dollar, as it would lack interest rate support. But the euro, its closest rival, is in greater trouble. This brings us to China.

Most commentators who blame the US for what appears to be broken in the world of capitalism somehow blame China’s policy makers for the mess their economy is in. China, in his view, is more willing to face its economic challenges head-on. The facts do not support such positivity. An investigation into alleged links between the People’s Bank of China (PBOC) and the country’s financial sector set the stage for coercion by the Communist Party to reduce reserve requirements for banks. According to Lingling Wei, party observers have lectured officials of China’s central bank that “any macro-policy discipline the central bank tries to maintain will be secondary to the need to meet the demands of the party leadership.” ” (on.wsj.com/3DRZJpM The US is not going to have sleepless nights that the dollar will soon lose its reserve currency status.

India looks to be in relatively better shape, but with elections to several major states approaching, economic policy is still a knife move. While the Reserve Bank of India has left its monetary policy in accommodative mode, memories of 2013 will be fresh in the minds of policymakers, as the rupee fell as the monetary and fiscal stimulus actions lost their welcome. Now the situation is different. Fiscal policy is not lax and the current account deficit is low but could reach close to 3% of GDP. But asset markets are more expensive now. Therefore, a meaningful global asset price correction, coupled with a fall in Indian stocks, should not go unwelcome in Indian policy circles.

As we move towards 2022, both nurturing each other, there are a lot of geopolitical and geo-economic risks. There will be light at the end of the tunnel, but we have to cross it first.

V. Ananth Nageswaran is visiting Distinguished Professor of Economics at Kriya University. These are personal views of the author.