Summary

Manoj began by highlighting the structural influence of demography on inflation. He believes we are at a tipping point for the structural sources that drive inflation as the balance of dependents and workers is changing. Workers, by definition, get paid less than their marginal product. And if they are also saving for retirement, then workers are deflationary. As dependents (who consume but don’t work and are inflationary) start growing in size, inflation will start rising too. During the last 30 – 35 years the influx of the Chinese and Eastern European workers into the global supply chain and the coming of age of baby boomers has led to this dramatic decline in dependency ratios. Advanced economies since 1990 saw a 120% increase in labour force, a massive deflationary shock. Now in advanced economies the dependency ratios are moving up adversely and the number of workers to support these dependents is becoming smaller which is inflationary. Central banks, therefore, do not deserve all the credit for inflation targeting over the last 30-35 years as this structural story shows – that means they may not be able to control inflation going forward either. Cyclically, we are in the age of a liberal central banker where average inflation targeting and an invitation for more fiscal policy is the mantra led by the Fed. At the time of the GFC, monetary injections went to banks to restore their balance sheets. This time, households and firms have received injections and will spend on big ticket items. This is the first recession where the entire private sector has been in surplus – a ‘socialist’ recession. Manoj sees demand outstripping supply much earlier than consensus. A housing cycle will result which central banks will love as it will mop up excess labour from the retail sector. He expects significant divergence in the EM complex where many did not have the means to take the policy measures seen in the west. Manoj points out the European crisis did not emerge until 4 or 5 years after the GFC. To be long or short the dollar in the medium-term depends on the behaviour of the US consumer. If they mirror the parsimonious German consumer then the exceptionalism in the US economy gets transferred to investment rather than consumption. On the other hand if the US consumer continues to use the exceptionalism of its corporate sector to finance consumption, the dollar continues to use its exorbitant privilege and will see periods of strength and weakness depending on the cycle. We are in an early-cycle ‘currency war’ because every economy has a negative output gap. As a global rising tide lifts all boats there are three questions to answer - Which CB are ok with currency appreciation, which are not ok with it and what can they do with a negative output gap to stop the currency rising. Russia might not stand in the way of currency appreciation. Where inflation is very low, advanced economies and North Asian do not want currency appreciation. Also EM that has not seem much export growth, so FX strength seen thus far cannot be deemed to be ‘endogenous’. What options to EM central banks have? Russia and Mexico can cut by a lot, Korea can use QE or use FX intervention (like India), while the like of Brazil can keep policy rates low for much longer than markets think.

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