We get daily updates on the pandemic - but how well understood is the economic impact? Investor confidence may be misplaced; history tells us that share prices can be a poor indicator of the global economy. Officially, the Bank of England and other central banks agree on stimulus and seem to welcome a little inflation. Governments are providing high levels of business and social support. All looks like the right response, but is uncharted territory. An inflation shock may still lie ahead.
While the pandemic has closed some borders, the impact of distant economies can still be felt in Scotland. China and the US have unfortunately become less predictable. Differing responses to the pandemic around the world are beginning to create political tensions. Maybe not yet a new world order, but regional power has shifted. China has gained influence and is more in control of its own destiny: the US less so.
The last year has seen the Chinese economy grow despite the challenges to global supply chains. Now the second biggest world economy, it is taking steps to reduce dependence on the US Dollar and to build more resilient supply chains. China’s foreign exchange reserves are the largest in the world and Beijing has recently created a digital version of its own currency, not linked to the Dollar-dominated global financial system. The next phase of China’s development may not be export-led but instead focus on boosting domestic demand. A rise in global food prices may be the result, exporting inflation that will feed into wages in the West.
In contrast, the stimulus programme in the US is truly exceptional. Financing this is now heavily dependent on the confidence of international investors; in terms of US ability to re-pay borrowings, to finance higher interest rates, or maintain the value of its currency. Printing money began as a fix for the financial crisis, but is now over-used around the world by most central banks.
For a UK economy with low growth, a little overheating may be welcomed. And the Pound still appears to be rebounding gradually from its Brexit sell-off. But a stronger Pound coupled with supply chain challenges and travel restrictions, is not the best background for Scottish exporters. And, actions taken by most governments to give some temporary relief from tax and rents may be essential now, but could reduce flexibility in the economy in an upturn. There is a danger that intervention in the economy continues for too long, discouraging business investment and entrepreneurship. Western economies are rebalancing from one version of a mixed economy towards a new model - with bigger public investment and planning replacing market prices in areas of strategic national importance. Businesses must position themselves for this change, and renew their strategy with a clear sense of purpose at the top.
US economic strategy is experimental, not only in terms of the level of stimulus but the degree of control on bond prices that is being attempted. The US Federal Reserve may no longer have the authority to dictate to global investors in this way. Buyers of US debt could decide to impose more financial discipline, triggering a shock in financial markets and currencies. Huge global stimulus should boost company profits over the next two years, but it could bring more volatility in currencies and interest rates.
After decades of low inflation, widespread faith in the power of central banks is understandable. Even after the financial crisis, inflation only briefly popped up and it seemed that an even greater stimulation might have been merited. Businesses should not delay in preparing for inflation and higher borrowing costs. More signs of overheating will emerge, causing supply disruption. Many businesses have never faced these challenges and may need to adapt their strategies. Inflation will be a real test of pricing power.
A version of this article was published on The Herald on 13/04/2021.