Stephen S. Roach: I view stagflation as a protracted period of high inflation, below-potential economic growth, and rising unemployment. In the stagflation of the late 1970s, the Fed was, indeed, a key actor. Convinced that idiosyncratic supply-side disruptions like energy and food shocks should not be addressed by monetary policy, Burns erred on the side of excessive accommodation, allowing the real federal funds rate to fall deeply into negative territory from late 1974 to early 1978, setting the stage for the Great Inflation that was to come.
As expected, Chinese President Xi Jinping has been given an unprecedented third five-year term. More surprising was the absence of any sign that Xi intends to revise the policies that have done so much economic damage in recent years.
The Fed’s current chair, Jerome Powell, seems determined to avoid that mistake. But in reacting to pandemic- and war-related shocks, the Powell Fed initially succumbed to the Burns-era mindset and viewed sharply higher inflation as transitory. In fact, from November 2019 through October 2022, the Fed has held the real federal funds rate at -3.7% – fully two percentage points below the Burns Fed’s average of -1.7% in 1974-78.
Today, the real fed funds rate stands at around -5% (based on the three-month average of the headline consumer price index – my preferred measure). Excessive monetary accommodation is quicksand; a painless exit is exceedingly difficult to achieve. And Powell’s Fed remains mired in it. We thus need to take seriously his warning that pain – i.e., a recession – is unavoidable, as the Fed attempts to bring inflation under control by continuing to raise US interest rates.
SR: In conventional macroeconomics, an economy’s longer-term growth potential is determined by the sum of labor-force and productivity growth. If one of those factors slows, the other must accelerate. Otherwise, long-term growth suffers.
China is in serious trouble on both fronts. An unsustainable one-child family-planning policy –subsequently changed to a two- and now three-child policy – means that the working-age population is already declining. Moreover, Xi’s report to the just-concluded 20th Party Congress underscores that already-strong productivity headwinds are likely to intensify.
China’s productivity problems don’t stem only from its unsustainable zero-COVID policy and continued property-sector deleveraging. They also reflect a confluence of more fundamental pressures, arising from the shift toward a less market-driven and more state-directed economy. Lacking in indigenous innovation, China will also suffer from new regulatory constraints encumbering the “animal spirits” that typically drive entrepreneurialism and underpin vibrant consumer societies.
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Moreover, as I discuss in my latest PS commentary, Xi’s more muscular foreign policy, with its fixation on national security, stands in stark contrast to the “hide and bide” approach that enabled the reform-driven dynamism of the Deng Xiaoping era. In short, China’s considerable growth sacrifice of the past few years is likely to persist.
PS: As you note in your new book Accidental Conflict: America, China, and the Clash of False Narratives, China seeks to match the US in terms of “geostrategic clout.” After Russia invaded Ukraine, China had an opportunity to make progress on this front by leveraging its partnership with Russia to help restore peace and stability. You suggest that Xi should abandon his “unlimited partnership” with Russia. But hasn’t that already de facto happened, with Xi issuing not-so-veiled criticism of the war and refusing to provide Russia with weapons and technology? What would he gain from a more formal break with Putin?
SR: Xi is talking out of both sides of his mouth. Any criticism of Russia’s unconscionable actions has been oblique at best, and although China has not provided direct military assistance, it has helped to fund Putin’s brutal campaign through its purchases of Russian energy products.
If Xi abrogated his new partnership with Russia, he would obviously risk a venomous response from Russian President Vladimir Putin. But he would gain considerable clout as a global statesman at a treacherous point in world history. Not only would that advance China’s great-power aspirations; it would be consistent with China’s long-standing “Five Principles of Peaceful Coexistence.”
As the greatest beneficiary of globalization, China stands to lose the most from deglobalization – a trend that its partnership with Russia only intensifies. If China clings to its alliance with a pariah state, it may be judged guilty by association and end up even more deeply isolated from the rest of the world. Xi is the only world leader who could put a stop to Putin’s madness – and he would probably win a Nobel Peace Prize in the process!
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