The Great Stagflationary Debt Crisis may have begun already
By Nouriel Roubini, emeritus professor of economics.*
New York – A variety of megathreats is imperilling our future – not just our jobs, incomes, wealth, and the global economy, but also the relative peace, prosperity, and progress achieved over the past 75 years. For four decades after World War II, climate change and job-displacing artificial intelligence was not on anyone’s mind, and terms like “deglobalization” and “trade war” were on nobody’s lips. Global pandemics weren’t even an afterthought – the last major one was in 1918. After the 1970s détente between the United States and the Soviet Union and the opening of the US to China, the already low risk of a conventional or nuclear war between great powers fizzled out.
Growth was robust, economic cycles were contained, and recessions were short and shallow, except for during the stagflationary 1970s; and even then, there were no debt crises in advanced economies, because private and public debt ratios were low. There was no implicit debt from pensions and health-care systems as the supply of young workers was growing while aging was moderate. Sound regulation and capital controls subdued boom-bust cycles and kept major financial crises at bay. The major economies were strong liberal democracies that were free of extreme partisan polarization. Populism and authoritarianism were confined to a benighted cohort of poorer countries.
Fast-forward to late 2022, and you will immediately notice that we are awash in new, extreme megathreats that were not previously on anyone’s radar. The world has entered what I call a geopolitical depression, with (at least) four dangerous revisionist powers – China, Russia, Iran, and North Korea – challenging the economic, financial, security, and geopolitical order that the US and its allies created after WWII.
There is a sharply rising risk not only of war among great powers but of a nuclear conflict. In the coming year, Russia’s war of aggression in Ukraine could escalate into an unconventional conflict that directly involves NATO. And Israel – and perhaps the US – may decide to launch strikes against Iran, which is on its way to building a nuclear bomb.
With Chinese President Xi Jinping further consolidating his authoritarian rule, and with the US tightening its trade restrictions against China, the new Sino-American cold war is becoming colder by the day. Worse, it could all too easily turn hot over the status of Taiwan, which Xi is committed to reuniting with the mainland, and which US President Joe Biden is apparently committed to defending. Meanwhile, nuclear-armed North Korea has once again been seeking attention by firing rockets over Japan and South Korea.
Even discounting the threat of a nuclear conflict, the risk of an environmental apocalypse in the future is becoming increasingly serious, especially given that most of the talk about net-zero and ESG (environment, social, and governance) investing is just greenwashing – or greenwishing. The new greenflation is already in full swing, because it turns out that amassing the metals needed for the energy transition requires a lot of expensive energy.
There is also a growing risk of new pandemics that would be even worse than biblical plagues, owing to the link between environmental destruction and zoonotic diseases. Wildlife that carry dangerous pathogens are coming into closer and more frequent contact with humans and livestock. That is why we have already experienced more frequent and virulent pandemics and epidemics (HIV, SARS, MERS, swine flu, bird flu, Zika, Ebola, COVID-19) since the early 1980s. All the evidence suggests that this problem will become even worse in the future.
The economic situation is no better. For the first time since the 1970s, we are facing high inflation and the prospect of a recession – stagflation. And when it comes, the recession will not be short and shallow but long and severe, because we may also be facing the mother of all debt crises, owing to soaring private and public debt ratios over the last few decades. Low debt ratios spared us from that outcome in the 1970s. And though we certainly had debt crises following the 2008 crash – the result of excessive household, bank, and government debt – we also had deflation. It was a demand shock and a credit crunch that could be met with massive monetary, fiscal, and credit easing.
Today, we are experiencing the worst elements of both the 1970s and 2008. Multiple, persistent negative supply shocks have coincided with debt ratios that are even higher than they were during the global financial crisis. As inflationary pressures force central banks to tighten monetary policy even though a recession looms, the costs of debt service will skyrocket. And aging also implies massive unfunded public-sector liabilities – for pensions and health-care benefits – that are as large as the explicit public debt. Everyone should be preparing for what may come to be remembered as the Great Stagflationary Debt Crisis.
Then again, while central banks have been at pains to sound more hawkish, we should be skeptical of their professed willingness to fight inflation at any cost. Once they find themselves in a debt trap, they will have to blink. With debt ratios so high, fighting inflation will cause an economic and financial crash that will be deemed politically unacceptable. Major central banks will feel as though they have no choice but to backpedal, and inflation, the debasement of fiat currencies, boom-bust cycles, and financial crises will become even more severe and frequent, leading to monetary and financial chaos.
At the same time, geopolitical conflicts and national-security concerns will continue to fuel trade, financial, and technology wars, accelerating the deglobalization process. The return of protectionism, and the Sino-American decoupling, will leave the global economy, supply chains, and markets more fragmented, making a wide range of goods and services more expensive. “Friend-shoring” and “secure and fair trade” have replaced offshoring and free trade, respectively.
Over time, advances in AI, robotics, and automation will destroy more and more jobs, even if policymakers build higher protectionist walls in an effort to fight the last war. By restricting immigration and demanding more domestic production, aging advanced economies will create a stronger incentive for companies to adopt labor-saving technologies, which can increasingly perform not just routine but also cognitive and creative work. Even Homo sapiens may eventually become obsolete.
These megathreats will contribute further to rising income and wealth inequality, which has already been putting severe pressure on liberal democracies (as those left behind revolt against elites), and fueling the rise of radical and aggressive populist regimes around the world.
Part of the reason we have come to this dangerous point is that we have long kept our heads stuck in the sand. Now, we need to make up for lost time. Without decisive government and private-sector action both domestically and globally, the period ahead will be less like the four decades after WWII than like the three decades between 1914 and 1945. What started with World War I and the influenza pandemic gave way to the 1929 Wall Street crash and the Great Depression, to massive trade and currency wars, to inflation, hyperinflation, and deflation, and to financial and debt crises that led to massive meltdowns and defaults. Ultimately, authoritarian militarist regimes emerged in Italy, Germany, Japan, Spain, and elsewhere, culminating in WWII and the Holocaust.
If we are not poised for a similar sequence of disasters, it may be because it has already begun.
* Nouriel Roubini, Professor Emeritus of Economics at New York University’s Stern School of Business, is Chief Economist at Atlas Capital Team and the author of MegaThreats: Ten Dangerous Trends That Imperil Our Future, and How to Survive Them (Little, Brown and Company, 2022).
Copyright: Project Syndicate, 2022.