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Mazars: deflation is dependent on multiple global economies

Author: ICAEW Insights

Published: 12 Jul 2022

From ending war to kickstarting manufacturing, George Lagarias, Chief Economist at Mazars, examines how global markets have dealt with inflation during the 20th century, adding what we can learn from their experience.

Inflation was a feature of economic life for most of the 20th century, but it wasn’t always thus. From the period of the Napoleonic wars almost to the First World War, British prices remained stable. But, the more the economy was democratised, the more prices would become deregulated and more volatile.

The ebbs and flows of inflation went hand in hand with elections and wars. There were times when prices fell and others when prices rose, but at the end of the day, 20th-century consumers knew inflation was always around the corner. 

Then, as we celebrated the Millennium, inflation almost disappeared. No matter what we did – higher or lower interest rates, economic booms and busts, wars, populism and unfettered money printing – price levels remained stable. So much so that central bankers were unsettled. After all, with low inflation, interest rates remain low, and thus money lenders became disincentivised. Pension funds suffered and their deficits grew.

Inflation’s disappearance was mostly due to globalisation, the optimisation of supply chains, online shopping and the ascent of China. Simply put, most companies could offer their product at very competitive prices. This was because it was manufactured in low-cost locations and shipped efficiently; inventories were kept low; and costly physical shops gave way to cheaper online facilities.

In 2015, the new Chinese leadership became convinced that China would need to transition from the secondary sector (manufacturing) to the tertiary (services and consumption). Thus, the world’s most important manufacturer, at the heart of all supply chains and the force behind lower prices, took a different direction.

Then COVID-19 struck

In early 2020, the global pandemic led to widespread lockdowns. As these were lifted, demand surged. Companies struggled to meet that demand as their factories were still underutilised and supply chains were shattered. The more difficult it became to procure items, the more wholesalers and manufacturers ordered.

As capacity finally ramped up, logistics managers decided they needed to increase inventories to meet any future fluctuations in demand. All these factors pushed prices higher for at least nine months into 2021. As a result, workers, emboldened by labour shortages and frustrated at persisting inflation, asked for higher wages. Before the situation had time to normalise, the war in Ukraine added significant pressure on raw material prices worldwide.

It wasn’t one or even two things that brought about inflation. Rather, it was the persistent and long unravelling of the prior deflationary factors: cheap China, cheap inventories and efficient supply chains. Online sales continue to rise, and at least in and by itself, this is disinflationary, but even that trend has its limitations. When most of the consumers who can possibly use online retail do so, then the marginal disinflationary effect of more online stores will not be significant.

The Office for National Statistics (ONS) has made a peak inflation prediction of 10%, but that’s only part of the picture. The larger question is for how long will high prices persist. Brexit certainly adds to longer-term inflationary pressures. Thus far these are mostly external. However, the UK jobs market is incredibly tight, much more so than its counterparts in the US and Europe. This means that when eventually inflation recedes elsewhere, it could persist for longer in the UK.

Every bout of inflation is different. In the 1920s, it was due to significant failures in the global economy. Post-war inflation in the 1950s was due to high demand for manufactured goods. In the 1970s inflation was the result of the US dropping the gold standard and flooding money markets with fiat currencies. In the 1990s, UK inflation was a result of prior economic mistakes. This inflation is not so much about one policy, but rather many deflationary elements coinciding.

Globally, how do we trigger deflation?

For inflation to come down, we would need to see a number of things:

  • the definitive end of the pandemic and disruptions to logistics, eg, China ending lockdowns and resuming some sort of normal operation;
  • India preparing to take over as the world’s next manufacturing hub;
  • inventory restocking finishing;
  • the war in Ukraine and concomitant sanctions ending swiftly; and
  • developed market wage growth slowing.

At this point, UK inflation is mostly driven by external factors. Companies have been passing price rises along to clients and have started cutting costs, even as employee expenditure is rising.

Inflation is a systemic event, affecting all aspects of the economy. It is, also, by nature, transient. At some point, demand meets supply and price rises slow down. The larger question is whether we have seen the end of the deflation we experienced for the two decades prior to the pandemic. We believe this is not necessarily the case.

On the one hand, China’s transition towards the services sector and rising energy costs as a result of environmental awareness may well keep price pressures higher than pre-pandemic.

On the other hand, however, consumers who have suffered crisis after crisis in the last 15 years are still wary of big spending decisions. Companies have got used to keeping personal expenses low, and focusing on tech-driven growth, which means that low wage growth trends might not necessarily be disrupted.

The global economy is in uncharted waters, suffering from high inflation, high debt and the weakening of the post-WWII global order. Making predictions can be a tricky process. Accountants and business professionals need to keep their clients up to date with all developments and assume that the status quo will be changing much more rapidly than in the past.

George Lagarias, Chief Economist, Mazars

Click here to watch the ICAEW graphic, Inflation: 75 years of ups and downs.

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