Will the world go back to the pre-Covid deflation era?

China’s deflation could spill over into a global concern.

>> How could Vietnam respond to China's deflation?

There is a view that the world is moving from what might be called an age of plenty into an age of scarcity. We have a good deal of sympathy for this view. What does it mean for financial assets?

The so-called age of plenty basically covers the period from the 1990s. We have made reference to this period before. It encompasses things such as an excess supply of labor caused by helpful demographics, particularly in Asia. At the same time, there was an excess supply of global trade reform that allowed newly industrializing countries, such as China, to export more goods. This excess of goods drove down prices, and the resultant deflationary pressure helped central banks supply an excess amount of money.

All in all, this age of plenty basically contributed to low wages, low prices, and low rates. The question now is whether there’s been a reversal of this period of excess supply and, if so, if it means permanently higher inflation and rates.

The transition to an alleged age of scarcity runs on many different levels. Firstly, demographic pressures have built up, notably in China, and with labor markets tight in developed countries as a hangover from the pandemic, a return to cheap labor and hence cheap goods appears distant.

Of course, there are countries and regions where the demographics of sharply higher dependency ratios have not kicked in yet and won’t do so for some time. This might be part of the reason why global investors currently departing China seem to be looking at India. But even if other countries or regions fill some of this space to maintain excess global goods supplies, there’s still the headwind of deglobalization to contend with.

In addition, we might also note that many such countries and regions could be adversely impacted by another supply-sapping headwind, which is climate change. On top of this, there is the possibility that deglobalization in terms of goods markets is also found in financial markets. Here we are not just talking about the position many developed country governments are taking with respect to inward investment by allegedly hostile foreign companies, but also the free-market decisions by investors to "reshore" their capital for fear of retaliatory actions by foreign governments. And even where no such sanctions are feared, there is still the argument that if insufficient global supply increases the need for domestic investment over foreign investment, this too may sap global financing.

>> How does global inflation impact the FX market?

Clearly, we have not even scratched the surface of what is a huge issue here. One question that arises from all this is as follows: if we accept that the age of scarcity is upon us and will mean higher inflation and higher real rates, where do we stand right now? For instance, are current inflation rates in G10 countries more like those we will see over the long haul, or will there be a return to target or near-target levels (usually 2%)? And a corollary of this is whether the rise in real rates that’s been happening recently, as nominal policy rates rise and inflation falls, represents a new normal or whether real rates will have to rise even more.

The Standard Bank suspects it might still take some years for developed nations to settle down into their "new normal,"  where deficient supply rather than excess supply is prevalent. During this time, cyclical forces will be pulling inflation down and very possibly giving the false impression that the world can go back to the pre-Covid lowflation/deflation era. Similarly, central banks will bail on policy tightening well before inflation hits target, and this too may give the false impression that real rates can go back down to levels more consistent with the age of plenty.