The world is bracing itself for a stagflationary shock

The world is heading for “the biggest commodity shock since 1973, and one of the worst disruptions to wheat supplies since World War I”, says The Economist. “Savage” rises across “energy, metals and food markets” have taken commodity-price indexes up by more than a quarter since the start of the year. “A world facing a physical shortage of raw materials dug up from the ground seems like a throwback to an earlier age. Yet that is exactly the predicament that lies ahead.”  

“Recession is here, or will be soon,” says John Mauldin of Mauldin Economics. Most recessions are deflationary – they are driven by a slump in economic demand – but they can also be inflationary when caused by higher prices, as during the 1970s Middle East oil embargo. “Then you get falling growth and rising prices at the same time – an especially miserable combination.” Such “stagflation” operates in a similar way to a tax increase, eating into disposable incomes and sapping demand. “Energy spikes preceded almost every recession for the last 80 years. We now have another one.”

A different kind of inflation

Soaring inflation last year wasn’t all bad, says Noah Smith on Substack. Though stretched supply chains played a role, 2021’s price hikes were “mostly demand-driven – people had more money to spend due to Covid-19 relief spending and pent-up savings from 2020”. That at least brought the upside of “booming employment” and higher wages for the lowest paid along with higher prices. By contrast, impending stagflation looks set to “be more painful”. 

A recession in advanced economies is not yet nailed on, but Goldman Sachs analysts puts the odds of a US recession over the next year at about 35%, says Julia Horowitz for CNN. The bank also thinks that American growth will be flat over the first three months of the year. The risks of a recession are even more elevated in Europe, which is more exposed to soaring energy prices.   

A new oil shock

Oil prices offered a moment of respite from surging inflationary pressure this week. Brent crude prices had risen to $128 a barrel earlier this month, but this week dipped back below $100 a barrel. Covid-19 lockdowns in parts of China have left investors anticipating weaker global demand for fuel. Nevertheless, even after the recent pullback, crude is still up about 30% since the start of the year.

The 1973 oil shock sent inflation-adjusted oil prices up 500% in a matter of months, says Arthur Sants in Investors’ Chronicle. That took UK consumer price inflation up to an eye-watering 16% in 1974. Stagflation is also bad news for equities: “in 1974, corporate profits fell 13% and the stockmarket recorded its worst annual performance since 1900”. 

Still, there are reasons to hope that a similar tightening of Russian oil supply will not have such a dramatic effect this time, at least in Britain. Note, for example, that a shift to less energy-intensive service industries means that “national output per barrel of oil is around four times higher today than during the Yom Kippur war”.