Coronavirus has resulted in an economic meltdown around the world. There are already talks about some countries sliding into a recession, including the U.S., due to the outbreak. To combat the ripple effects of the outbreak, the Federal Reserve has already resorted to a rate cut. However, many believe the coronavirus outbreak may result in a situation much worse than a recession, and that is stagflation.
Stagflation – not a new thing
Stagflation is a term that economists use to describe a situation marked by an economic slowdown and rising prices. Economists will agree that stagflation is a greater evil than a recession as in the former, the authorities need to fight on two fronts – growth and inflation.
Stagflation is not a new thing for the U.S., which witnessed a similar thing in the 1970s. At the time, the oil shock and rising gas prices crippled the economy. The Fed, at the time, decided to fight inflation more aggressively, and increased the interest rate to about 20% by 1981.
Though most don’t expect the coronavirus to lead to stagflation, there are a few who believe the threat is real. The Fed recently resorted to a rate cut as a defense against the economic meltdown due to the outbreak. Moreover, the market is expecting another rate cut announcement from the Fed at its next meeting on March 18.
However, many believe lower interest rates along with coronavirus outbreak could lead to a situation where prices are rising while growth slows.
“Stagflation would be a disaster. People are dismissing it as an old threat from the '70s that won't happen again, but you could see it come back," said portfolio manager of the Quadratic Interest Rate Volatility and Inflation Hedge ETF (IVOL), Nancy Davis, according to CNN.
How coronavirus may lead to stagflation?
Davis notes that supply chain disruptions in China due to the outbreak could result in higher consumer prices. In 2018, China accounted for 28% of the manufacturing output globally, or more than the combined share of its next two rivals – the U.S. at 16.6% and Japan at 7.2%. Moreover, China is much more important to other economies as it specializes in mid to low-cost manufacturing.
This means there isn’t much manufacturing capacity outside of China. Also, a fact that can’t be ignored is that many products that China makes play an important role in the consumer price index. Over the past decade or so, the cost of common electronics goods has come down primarily due to the lower cost of production.
Thus, supply issues, even for the short-term, would lead to shortages and possibly a rise in prices. Eventually, this would lead to inflation as Chinese goods serve as input for many essential commodities.
Hike in wages to make matters worse
On the other hand, despite the sluggish wage growth of just 3% as per the latest jobs report, Davis says the U.S. companies may need to pay higher wages to attract more workers. Offering higher salaries is more of a possibility in retail, food and other services sectors, where employees are more afraid to work due to the risk of coronavirus.
“If you are an employee at Walmart and you decide you're going to stay home due to coronavirus worries, there could be pressure to raise wages," she said.
Things could get worse if the Fed and other central banks globally go for another rate cut. Such actions could further add pressure on the prices as now more money would be chasing limited supply, resulting in inflation.
"During a bond market crisis caused by inflation, global central banks will be completely impotent," said president and founder of Pento Portfolio Strategies, Michael Pento, according to CNN, adding that this could "produce a period of intense stagflation globally such as never before seen.”
Inflation not an issue
There have been signs of stagflation in China, which is the epicenter of the coronavirus. Prices have skyrocketed in the country following the shutdown of factories. However, experts believe the situation would get under control as the virus slows and production returns to normal.
Also, there are those who believe inflation won’t be much of an issue for the U.S. as well. Instead, people should be aware of the risk due to a recession. For instance, the recent drop in oil prices is not just due to the clash between OPEC and Russia, but primarily due to the slowdown in consumer spending (people delaying or canceling their travel plans).
Also, experts believe that companies may postpone their decision or won’t go for a price hike at all as doing so during a health crisis wouldn’t speak good about the company.
"Inflation pressures still seem very limited. There is a lack of pricing power. Firms will be reluctant to raise prices right now,” said Nathan Sheets, who was under secretary of the Treasury for international affairs during the Obama administration and is currently chief economist at PGIM Fixed Income, according to CNN.
Coronavirus seems to be slowing down in China. This would eventually result in more factories re-opening, or those that are already open, to operate at 100% capacity. If this happens, it would take pricing pressure off of the companies which are currently facing supply shortages.