This time, China can only follow Japan’s example

In recent months, almost all of the world’s major economies have been running an inflation fever.

Take this past July:

America’s 8.5%, Germany’s 8.5% and France’s 6.1% are all high values of the past few decades;

In Britain, it is 10.1%, the highest in decades.

With inflation fevered, if you look at real GDP growth, after inflation, in the United States, the euro area, Japan and the United Kingdom, it is either close to or below zero — meaning that their economies are either close to or in recession.

In short, the world’s major economies are teetering on the brink of stagflation.

Stagflation is nothing new. As early as 50 years ago, major western economies such as the US, Japan, Germany and the UK all experienced stagflation.

In the United States, for example, the CPI inflation rate began to rise rapidly to more than 5% in 1973, while the real GDP growth rate continued to decline and entered a negative phase in early 1974, followed by a rise in unemployment…

Inflation of more than 5% plus negative economic growth plus rising unemployment combined to form the picture of stagflation in the 1970s.

In the case of the United States, the economy first fell into stagflation in early 1974 until China was relieved in mid-1975. However, from the end of 1979, the western economy fell back into stagflation and did not emerge from stagflation completely until mid-1982.


Comparing the stagflation that began in 1973 with what is happening in the global economy today, we can find a lot in common.

The first common denominator is that geopolitical conflicts lead to energy supply crises and soaring oil prices.

In 1973, the “Yom Kippur War” broke out and the powder keg in the Middle East was lit. Optec countries in the Middle East imposed an oil “embargo” on the United States and Western Europe, resulting in the skyrocketing price of crude oil.

In 2022, it was Russia’s invasion of Ukraine that caused major problems in global oil supply and transportation and skyrocketed oil prices.

The second common denominator is the extreme mismatch between economic demand and production in western countries, fuelling inflation.

From the 1960s, the United States began to implement a series of social welfare programs, such as the Great Society Program, the War on Poverty, the protection of civil rights and the promotion of medical insurance. Ordinary people in the United States “has money in hand” to buy things and the social demand became extremely strong. Meanwhile, the production activities of Western countries did not keep up. This leads to a general increase in the price of the means of production in the whole society;

After the outbreak of the pandemic in 2020, European and American countries handed out massive fiscal subsidies in an attempt to get the economy back on track through demand-side stimulus. However, under the high welfare policy, the social demand is constantly hot. However, so far, the labor force in Europe and the United States is not strong in employment, and there is a serious shortage of labor force. However, the long-term epidemic of COVID-19 has caused a gap in the domestic production end, and the mismatch between supply and demand has led to the continuous upward inflation.

The third common denominator is that the production of goods abroad is blocked, which exacerbates inflation in western countries.

Since the late 1960s, when many developing countries saw Japan and Germany leap into the ranks of the developed countries through industrial development, they have sought to replicate that success. To be specific, it is to promote industrial building and implement “import substitution”. In order to protect the fragile industrial base, trade protection policies were implemented one after another, such as Argentina, Venezuela, Iran and other countries at that time, which greatly reduced the production efficiency and circulation efficiency of commodities in resource exporting countries, making it easy for commodities and industrial products to rise and fall.

Since the outbreak of the pandemic in 2020, the global commodity supply chain, including China’s, has been continuously disrupted, and combined with the labor supply gap caused by the pandemic, the prices of commodities and most industrial products have continued to rise amid strong demand from developed countries.

A fourth common thread is the emergence of alternate wage-inflation spirals in western countries.

In the 1970s, when labor unions were powerful in the welfare society, the high bargaining power of labor was the core reason for the “wage-inflation” spiral during the “Great Inflation” of the 1970s. Labor shortages and demands for higher wages pushed up inflation with higher incomes.

Since the outbreak of the epidemic, because of the implementation of the “money policy” in Europe and the United States, the labor gap cannot be closed for a long time, labor tension, labor compensation continues to rise, producing a positive feedback to inflation, and forming a new round of “wage-inflation” spiral.

The fifth and most important common denominator is that stagflation was preceded by a debt explosion and a monetary overshoot.

The painful memories of the Great Depression led to the prevalence of Keynesianism in all countries after the Second World War. Since the 1960s, the idea of emphasizing government intervention in the economy and creating effective demand has been deeply rooted. Especially since the mid-1960s, the Western economies led by the United States experienced increasing government debt and Nixon abandoned the gold standard. The collapse of the Bretton Woods system provided the best excuse for a debt explosion and currency overshoot;

Since the outbreak of the global financial crisis in 2008, Western countries, led by the United States, have been in a spiral structure of excessive debt and excessive currency issuance for a long time until the outbreak of this epidemic, and the arrival of the epidemic has provided the best excuse for the excessive currency issuance and excessive debt of Western countries. Unprecedented debt burdens and unlimited QE money printing mean that Western governments are bound to inflate their way down.

Having discussed the similarities between the western stagflation of 1973-1975 and the current economy, let’s look at how the Western countries responded to that stagflation and what the consequences were.

In the first round of stagflation in 1973-75, Western central banks and governments responded, arguably badly, to inflation and recovery without unemployment, leading to indecision in monetary and fiscal policy. Once the rich world had recovered slightly, we are back into the more severe stagflation of 1978-1982.

Take the Federal Reserve as an example. In September 1973, the inflation rate in the United States was still rising rapidly, but due to the rising unemployment rate, the Federal Reserve immediately thought of lowering the interest rate. Not surprisingly, the inflation rate continued to soar, and the Federal Reserve had to raise the interest rate again. By July 1974, the Federal Reserve saw signs that inflation was falling and immediately began cutting interest rates. In fact, the CPI inflation rate in the United States, from the beginning of 1973 to the end of 1982, never fell below 4%.

The reluctance of the Federal Reserve to tighten monetary policy and to “save the economy” was one reason why America’s great inflation in the 1970s was so stubborn.

In contrast to what the U.S. government and the Federal Reserve did, Japan, also suffering from the Great inflation of 1973-1974, explored a different path.

First of all, Japan controlled the growth of M2 money by reducing expenditure and managed the main gate of money.

Second, the government tolerates a rise in unemployment and a fall in overall economic growth.

Last but not least, Japan actively promoted industrial upgrading in the 1970s, gradually transforming its export structure from fiber textiles to mechanical and electronic products through industrial upgrading. This transformation greatly reduced energy consumption, and then controlled the inflation caused by the skyrocketing oil price within a relatively moderate range.

The practice of “planning for a rainy day” made Japan perform relatively well in inflation control and economic growth among developed countries during the stagflation in the 1970s

Starting in mid-1977, inflation, which had receded slightly over the past two years, returned, but this time Japan took it in its stride. Although the economy as a whole is growing at a lower rate than it was before 1973, it has never suffered from inflation as high as America’s, nor has it had to raise interest rates to the dreaded 20%. In the absence of “stagflation” pressures, Japan became the first developed country to start a cycle of interest rate cuts.



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