Governments “don’t seem interested in raising taxes or reining in spending”, which is “going to cause problems at some point in the future”, James Bullard has warned, noting that the world could be “inching” towards the sour policy mix experienced in the 1970s.
The ex-president of the Federal Reserve Bank of St Louis and former member of the rate-setting Federal Open Market Committee cited “undisciplined governments” and central banks that do not have a “good, coherent plan” for dampening inflation as reasons why the world could be returning to the unpleasant conditions of five decades ago.
Back then, high inflation, oil shocks and interest rate policy mistakes provided a potent cocktail for the global economy. There was also exchange-rate manipulation, Bullard noted, following US president Richard Nixon’s decision to cut the link between the dollar and gold, leaving most major currencies unanchored.
Speaking at the Amundi World Investment Forum, he said: “There were no inflation targets in the 1970s and lots of exchange rate manipulation. That led to a lot of volatility. It led to a lot of recessions in many different countries over time.
“You're inching closer to that poor policy mix that we have seen in the past — one that was in place in the global order in the 1970s. I'm not saying we're seeing the 1970s yet, but we're inching in that direction.
“We need to remember now that fiscal discipline actually pays off in the medium and long term, and central bank independence also pays off in the medium and long term.”
One way Bullard fears we could return to the past is if central banks abandon their 2% inflation targets. The Federal Reserve has used the 2% target since 2012 and in August 2020 adopted a ‘flexible average inflation targeting’ framework, which states if inflation runs below 2% the central bank will tolerate a higher figure to balance this out over the long term.
But there are “forces in the US and elsewhere” that want to go to higher inflation targets, said Bullard. These “prominent voices” can be compelling but the result would be “an absolute disaster” for major currencies and would be a surefire way to ensure a return to the 1970s.
“You'd get other countries saying inflation didn't need to be kept low and stable. You'd have higher and more variable inflation around the world, volatile exchange rates around the world and a lot of volatility that we simply do not need,” he said.
Regardless of whether the global economy returns to the same conditions as the 1970s, he warned that there will be more volatility ahead than there has been in the recent past as the world embarks on an increasing competition for power.
“The good news is we've seen this in the past. The bad news is it's going to be more volatile than what we're used to,” he said.
He pointed to several countries around the world that are at odds with one another, including China, Europe, the US, Japan and India, which he noted is the fastest-growing country in the world and the largest by population.
“[You have] many countries competing,” said Bullard, making the world “much more fractured than it was after the end of the Cold War in 1989”.
“This is the reality. We have to get used to it and price everything accordingly. I think that means building more resilience into our systems – including our regulatory systems – than we would otherwise.
“If you felt all your partners were super trustworthy, you might go with just-in-time inventory and similar ideas. But if relations are a little more tentative, you want to build something more resilient. I think that will be a theme going forward.”
It’s not all doom and gloom
While there are dark clouds surrounding the world right now, particularly when it comes to central bank policy, there are also signs of positivity in the world.
For one, the AI boom is “very real”, said Bullard, with the amount of money being spent in the US dwarfing what was spent on railroads, the automobile highway build-out and the space programme.
“The only thing bigger in history is the Louisiana Purchase of territory west of the Mississippi from Napoleon, so it's quite the spectacle,” he said.
There will be winners and losers in this next wave of technology and investors need to be wary, particularly of companies pretending to have AI in their business models. But the technology is real and it is going to improve productivity going forward, said Bullard.
“The positive hope is that we would get something like the second half of the 1990s in the US – rapid productivity growth and rapid economic growth – which would also help with the fiscal problem,” he said.
“You want to do as much as you can to encourage technological improvement and rising standards of living – and not allow political drift to send us back into a situation that did not work in the past.”