Vijay Kumar Gaba

A key learning from the past 150 years of economic history is that every major economic cycle has been a function of a different set of factors like war; decolonization; politics triumphing over economics; major demographic shifts; major technological evolution (industrial or technical revolution); etc. The policy responses to various economic cycles have depended upon the mix of factor that were responsible for the cycle.

Industrial revolution, destruction due to world wars and then reconstruction effort; emergence of Communism (command economies) and cold war; decolonization of European colonies; population boom (baby boomers); conflict in middle east and emergence of American hegemony (end of Bretton Wood, beginning of petro dollar, invasions in Vietnam, Afghanistan etc.); end of cold war, falling of Berlin Wall, dissolution of USSR, induction of China into WTO and relocation of American and European manufacturing to Asia; democratization of internet & advent of digital commerce, dematerialization of money, commodities & trade; and pandemic, etc. have been some of the events which catalyzed major economic cycles (up and down) in the world.

In the post war period, until the mid-1990s, the role of the major central bankers was limited to regulation of monetary policy. They regulated the money policy, not necessarily in tandem with the fiscal policies, to manage the economic cycles. The monetary policy responses were marked in most periods of economic imbalances, averting major economic disruptions. Up-cycles (economy overheating) were also treated with due alacrity as were the down-cycles (recessions). However, since late 1990s, the central bankers have been assigned the additional duty to support economic growth also.

This additional (and often contradictory) assignment perhaps distorted the function of monetary policy in the past two decades. The central bankers were expected to not only support the economic growth but also ignore the instances of economic overheating. They were expected to stimulate demand during periods of low growth and sit on the fringes (or even keep fueling the furnace) during the growth phase. This has made the global financial system fragile and susceptible to frequent disruptions.

This tendency of the central bankers during past two decades is now a source of concern for markets. The massive monetary and fiscal stimulus, palpably to mitigate the impact of Covid pandemic; prolonged phase of widespread inclement weather conditions; intensified Sino-US cold war and invasion of Ukraine by Russian forces triggering a global energy & food crisis, has unleashed a massive global inflation crisis.

The governments and markets continue to expect the central bankers to control prices and stimulate growth. In the past 9-10 months the central bankers have however focused more on price control, mostly at the expense of economic growth; conscious of the fact that most of the factors causing inflation may be beyond their realm. Juxtaposing this central bankers’ predicament to the fact that most of the government may have already run out of the fiscal ammunition to stimulate growth, it is not too difficult to assess the depth of the quagmire global market are sinking in.

This entire narrative of India escaping the global turmoil (decoupling); market bottoming; a shallow recession etc. seems rather optimistic to me. I believe that the global policy reset will be a protracted and painful effort for almost everyone across the globe. Of course this reset journey will be dotted with phases of relief and false hopes, when it would appear that all is well and we are back to business as usual.

But the recent instance like fiscal policy fiasco in UK; BoJ’s and PoBC’s reluctance to join the global monetary tightening bandwagon; and fissure in RBI’s MPC over effectiveness of monetary tightening have shown that policymakers are mostly clueless and they shall be using trial and error method to control the situation. Each new trial would trigger a wave of hope; and each error would trigger a wave of despair. Legends like Russell Napier are expecting a major shift in political paradigm in this phase. He expects a major shift to 'command economy', de-globalization and an end to era of free markets that we have seen in the past three decades. (read here)

We can argue that the domestic investors in India may not be impacted materially by this global reset as we have a stable financial system; strong domestic economy; manageable debt at government; corporate and household level; and favorable demographics, among other positives.

My view is that all this is true. But all this was also largely true in 2000 (dotcom bubble); 2008 (global financial crisis) and 2020 (pandemic); nonetheless our economic growth slowed down; corporate and financial stress increased; stock markets corrected 50%; risk premiums on our bonds rose sharply; and investors panicked and incurred huge losses, in each of these instance. A similar pattern repeating this time cannot be completely ruled out. So it is better to stay in the bunker and shun adventurism, at least till the sirens are blowing full force.

It is true that these periods of turbulence usually throw brilliant opportunities. But to avail these opportunities you need to survive till the peace is fully restored. A few brave men will take their chances; but I am a normal person with very ordinary resources. I will avoid adventure of any kind and try to survive this period of reset.

…to continue tomorrow