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It's Best to be Wary of Stagflation

By David McEwen

Friday 13th October 2000

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Reserve Bank Governor Don Brash made few friends when the warned that stagflation - that wealth destroying combination of low economic growth and high inflation - could hit New Zealand again if we don't watch out.

Despite the flak he attracted, he was right to warn of such an eventuality. Let's hope those with their hands on the levers of the economy keep an eye out for it.

Dr Brash is not the only person to use this term lately. Another who worries about stagflation and worse is Fred Bergsten, Director of the US-based Institute for International Economics.

In a recent speech he noted that globalisation was on the decline and that the effects of this could be greater than the awful period of stagflation of the 1970s.

He believes demonstrations against world trade and financial bodies around the world this year are only superficial signs of the real issue.

He cites a number of worrying trends. First, the international monetary system is crisis prone as can be seen from Europe in the early 1990s; Latin America in the mid 1990s and East Asia, Russia and Brazil in the last two or three years.

Second, the trading system has gone nowhere for several years and recent attempts to launch new trade talks have failed. "There are no new multilateral negotiations of any serious nature being conducted anywhere. The situation is very serious if, like me, believe in the bicycle theory, which says you either move forward or you fall over," he said.

His point is that there is a big backlash against globalisation. It can be seen in global finance trading trends.

Curiously, dissatisfaction with globalisation comes after a long period of prosperity and growth in many countries, especially in the US.

"It seems to me that all these things make the backlash all that more worrisome. If we have the manifestations I've indicated in a period of economic progress and success, what could be the outcome when the US economy inevitably slows down, unemployment begins to rise and a US$400 billion trade deficit becomes a huge target of attack and criticism? What if a similar downturn and more difficult economic times occur in the rest of the world?," he asked.

Economic woe is not inevitable and Mr Bergsten believes problems can be averted with:

Education "Much of the criticism of globalisation either reflects ignorance of the facts; or is sheer nonsense"

Recognition. "There are costs and losers. For too long, those of us on the proglobalisation side tried to ignore and deny this fact but it clearly must be accepted and admitted."

Reform. "We need much more openness and transparency of the financial system. We need much more effective means to coordinate exchange rates among the big countries."

Openness. "We need to restart true multilateral liberalisation of the global trading system, partly for momentum and bicycle reasons but partly to head off potentially destabilising regional steps."

These factors could all apply equally to New Zealand. Our weak dollar could lead to higher inflation and lower economic growth. If conditions worsen, interest rates may have to go up to attract international funds and support the dollar. However, higher rates could further depress the economy.

The result would be stagflation. Thank you Dr Brash, forewarned is forearmed.

David McEwen is an investment adviser and author of weekly share market newsletter McEwen's Investment Report. He is commissioned by the New Zealand Stock Exchange to write an independent personal investment column. He can be reached by email at

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