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Expert's View
Special> Coping With the Global Financial Crisis> Expert's View
UPDATED: June 17, 2009 NO. 24 JUNE 18, 2009
Stagflation Coming Soon

Normally, in a time of economic recession, inflation is the last thing policymakers worry about. Many tend to believe it is perfectly justified to print more money to keep the economy from sinking further. But Xie Guozhong, former chief economist for Asia at Morgan Stanley and now an independent economist, says this assumption is totally wrong and warns of the rapid development of stagflation that could trigger prolonged stagnation. He made these comments in the Shanghai-based Xinmin Weekly on June 3. Edited excerpts follow:

Inflation is returning much sooner than I thought it would.

It again looms over the United States and China as mirrored in surging commodity prices. The price of crude oil to be delivered in July has soared to $70 a barrel, even though real economic recovery is not yet in sight.

Inflation does not necessarily emerge only when the economy is overheated, with demand exceeding supply. It can also surface when the economy is stuck in low gear. The globally loosened money supply will stir up commodity speculation sooner or later as the ample cash can jack up crude oil, copper, steel and gold prices. The weakening dollar, a major currency for international settlement, adds fuel to the global liquidity problem.

In other words, a new round of inflation in the wake of financial meltdown could be ignited by an aggressive money supply, even though the economy is in stagnation.

Global stagflation is a real risk.

In the 1970s, stagflation haunted the global economy. The central banks were unwilling to hike interest rates too aggressively for fear of dragging the economy further down. As a result, inflation was running at a high level while the economy was in the doldrums. The situation did not improve until the 1980s, when the U.S. Federal Reserve hiked the interest rate to as high as 21.5 percent. The resulting large-scale economic recession finally beat off inflation, after which the economy came back on the right track.

It is without doubt to boost the economy by adopting stimulative policies. But major economic powers are in effect subsidizing speculation. They tend to assume the world economy will run healthily if they pull investors and speculators back into the markets.

An economic rally based on speculation and artificial inflation is unsustainable. It is like injecting hormones to make a patient look glowing without curing the underlying illness. They are technically creating bubbles to hide the necessity of reforming structural problems.

To ease stagflation, the United States should cut its healthcare costs. European countries should raise the retirement age and encourage employment so as to reduce the excessive social burden brought by the aging population. China, on the other hand, must take advantage of this global economic slowdown to reform its growth pattern. It should no longer blindly stimulate the economy without tackling the impending problem of unbalanced economic growth.

If the policymakers of the world fail to understand the aftermath of the co-existence of inflation and stagnation, if they insist on pouring more money into the market, they will ultimately lead the world into a dangerous cul-de-sac.

The world economy is slipping into a decade-long era of stagflation.

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