Reliving the history of global economies

Many political economists, these days, have begun to think that the world's economic arrangement resembles the multipolar power-sharing arrangements that European and North America had in the late 1800s.

It is, as the wit reminds us, déjà vu. Today's world in which US, China, the European Union, India, Japan and Brazil play pivotal roles is no different, so goes the thesis, than the late 19th century when the UK, the US, Germany, France and Russia shared power, created ententes and détentes, traded off one other and collectively improved their fortunes.

Irrespective of whether this comparison is accurate or not in its entirety, the economic tensions and strengths that dominated then purportedly informs today's world. Many luminaries have thought about this question of multipolarity — Zbigniew Brezezinski, Fareed Zakaria, Robert Kaplan et al — but, these have largely been explorations into the nature of the political realignment and power; and not strictly how the economic world may evolve or unravel.

One notable exception, and insightful one at that, is Adam Posen who is a member of the UK's Monetary Policy Committee at the Bank of England. His principal thesis is that as US dominance declines, we will have a period of interregnum. This period of ‘inbetweeness' will result in other reserve currencies, deflationary pressures and a rise of unfettered markets much as in the late 1800s.

In contrast to this prognosis of global strength, we ought to ask if there is one dominant mechanism and institution by which this daisy-chain of global power and stability can be undone?

Worldwide inflation?

Central banks are the key. They will be the singular most important player who can overwhelmingly destabilise, or contribute positively to, economic growth. Moreso than the legislative and executive branches. In the emerging markets, the central bank will be the first among equals, even if they are the quietest of all.

For the past couple of years, many market observers have openly speculated whether we will have a worldwide inflation in the coming decades, thanks to extensive monetary intervention by various global banking authorities. One powerful argument against the possibility of runaway inflation is that the size of the global retired class living off fixed income has increased, particularly in the western world. They form a powerful voting bloc in most democratic countries. Since inflation would eat into their fixed income, they are likely to exert extensive pressure on policymakers to rein in inflationary expectations.

Key factors

Thanks to demographic structures, this view of retirees affecting banking policy is largely unlikely to hold in the non-western emergent powers. Instead, there are key factors affecting inflation in countries such as China or India: As the reach of communication and transportation increases, supply side disruptions, which usually cause transient inflationary pressures, will disseminate faster, real and financial volatility are likely to transmit ripple effects faster than ever before, and as the economy of these emergent powerhouses increase in size, the Central Banks will increasingly demonstrate policy dissonance.

Who are they creating their policies for? Is it for the exporters, for a domestic agenda of full employment, as measures to ameliorate extant commodity crises or are they motivated by an old fashioned goal of price stability or inflation targeting.

Astute but, alas, a minority of observers such as Ila Patnaik in India, Michael Pettis in China have voiced against this policy. The reality remains, the more heterogeneous is a society's income and wealth distribution, the more compromised is a central bank's independence. It takes extraordinary strength to resist political and social pressures. So, while Europe and the US may escape inflationary pressures, the odds that China, India, Brazil will escape are unlikely.

The consequences deviations will manifest in the rising cost of capital that is employed in investments and through foreign exchange volatility. As capital costs become unpredictable, the economic growth (spurred by investments and consumption) is likely to be volatile as well.

The columnist works for a major European investment bank in New York City. All opinions are personal and don't reflect any institutional perspectives.