Probability of inflationary recession

The Iran war is now on its first month and no one knows when it will end, so the world’s economic wheels will again turn faster. As of the end of March, economic activities in the Gulf States have declined by 70%, in the Asian countries by 30%, and the rest of the world by 15%. The volume and value of global economic transactions have decreased with the blockage of the Hormuz Strait, that provides 20% of the crude oil supply to the whole world. These contractions of economic activities are already the beginning of an economic recession. If it persists for at least six months, it will be considered a full-blown recession, with GDPs of most countries and of the world decreasing by 2% or more.

Together with this recessionary onset, is the sudden and steep rise in the prices of goods and services closely linked to the higher prices of fuel oil and derivatives, then eventually of all goods and services. The prices of fuel oil, including those not from the Middle East, have already risen by 50%, and diesel/gasoline prices in many countries have doubled. This has led to an overall price increase in almost all products and services, which is by definition already higher inflation.

During and under normal economic conditions, inflation and recession don’t go together. Recession happens when there’s inadequate/slow aggregate demand from consumers, investors, and the government. This slows down economic activity, decreasing the volume of transactions, and shrinking of countries’ and/or world GDP. The companion of recession is actually “deflation”, which is the declining of price levels in the economy. In this situation, governments and their central banks would jumpstart their economies by lowering interest rates and pumping liquidity by fiscal and monetary stimulations to increase aggregate demand.

On the other hand, if inflation is a problem due to too strong demand caused by excess liquidity and low interest rates, the governments and their central banks would tighten money supply and raise interest rates to dampen aggregate demand. This reduces demand for goods and services and tames the rising prices or inflation.

The current impending world economic recession with inflation is an unusual situation. The prices are higher not due to excessive demand or “demand pull” but due to a “cost push”, or the higher prices of products. The higher prices of goods and services are caused by the higher prices of crude oil due to the Iran war, which cannot be tempered with monetary and fiscal policies. So, even if economic activities slow down and GDP growth of countries shrink, prices will increase. We have a situation of inflation with recession, of a slower economic activity but with higher prices. This may only be corrected by a political and/or military solution.

The probability of an economic recession with inflation in many countries is a certainty and is already happening. It’s now just a matter of severity and duration, by how much this will lower GDP growth, and how long it will last. The more destructive and the longer the Iran war will last, the longer and greater the suffering of the people. It takes more time to rebuild/reconstruct productive and logistic facilities than to start a war. The economic toll of a recession with inflation on each country will depend its geographic location, level of dependency on Middle East oil, and level of economic development.

Last week, Larry Fink, chairman of Black Rock, the largest private equity company/hedge fund/investor in the world, already cautioned about the coming world economic recession. Black Rock has $12.5 trillion in assets which is 25 times bigger than the Philippine annual GDP, so he is rightfully concerned. Jeffrey Sachs, the eminent Harvard/Columbia political economist, actually warned about the economic consequences of the Iran war months ago.