Economists called it the Great Moderation or Nice (non-inflationary constantly expansionary). It was period of sustained growth, low inflation and very low interest rates, and it described the period from the mid-1990s right up to 2007/2008.

How did it happen? Some say it was down to savvy central banks. But this is surely either wrong, or merely part of the whole story.

The period in question also saw money flow from Japan – where its ageing population was saving in anticipation of retirement – to the West, and from China – where the policy of maintaining a cheap yuan led to money flowing westwards, in particular into US government bonds. By the mid noughties, US corporate profits to GDP steadily rose, hitting the highest level ever recorded in 2006. All these developments led to money sloshing around the global money system, pushing down interest rates. At the same time, global inflationary pressures fell, which may have been partially down to central banks, but the Internet creating unprecedented price competition, globalisation leading to greater productivity, and – in particular – the rise of China and cheap import goods, all helped to push down prices.

Supposing the forces described above reverse. Supposing the Internet effect pushing down prices proves to be a one-off, supposing rising wages in China combined with an appreciating Chinese currency means the cost of manufactured goods rise, supposing the baby boomer generation, once retired, starts to draw down savings and demand for goods and services exceeds production of goods and services?

It is possible that global inflation will rise and interest rates will rise, in part because of inflation. Also because less savings are available to fund investment real interest rates may rise too – that is to say that interest rates relative to inflation will increase.

Such a development may not be wholly negative. One problem with the global economy today is that demand and investment is insufficient to promote growth. A rise in both may lead to more growth, higher wages, but at the same time higher interest rates. Such a development may be good for the economy as a whole but disastrous for those carrying heavy debt, and possibly disastrous for any economic model relying on rising house prices.
Economic historian Russell Napier calls this The Great Reset, while consultancy McKinsey drew similar conclusions back in 2010 in its report ‘Farewell to Cheap Capital’.

For more on inflation, see:
Corporate Profits After Tax (CP)/Gross Domestic Product, 1 Decimal (GDP) 

Russell Napier, The Deflation Times

McKinsey: Farewell to cheap capital? The implications of long-term shifts in global investment and saving 

© Investment & Business News 2013