Can the West also unite against rising inflation?

The leaders of the member countries of the North Atlantic Treaty Organization gathered this week to discuss how to strengthen the military alliance in the face of Vladimir Putin’s aggression. For the sake of the alliance, the next step should be a summit meeting of finance ministers and central bankers to address the economic problems that increasingly threaten to undermine Western cooperation. You should start with inflation.

Two points are relevant. First, although NATO is a military alliance, its members also form, in fact, one of the largest trading blocs in the world, and a complex one at that. The European Union has created a continental free trade area that includes its 27 member states and various neighbors. The US remains by far the EU’s most important external trading partner.

Added to this is the economic involvement of the USA with Great Britain and Turkey as well as the special trade relations which connect the USA and Canada together with Mexico. And don’t forget the relationships between these countries and non-NATO partners like Japan and Australia.

Second, many of these countries are in economic distress, largely due to inflation. Americans have seen prices rise 7.9% over the past 12 months, while Brits expect similar inflation to wash their banks this spring. Inflation is 5.9% in the euro zone, including 5.5% in Germany, 5.1% in Italy and 7.3% in the Netherlands. In Japan, the yen’s runaway slide below the lows last seen in 2016 has raised fresh concerns about price instability.

Inflation is usually understood as a domestic problem. Look at President Biden’s cratered approval rating, UK Prime Minister Boris Johnson’s weak hold on power and cracks in the German governing coalition on consumer fuel price relief. Inflation is also often assumed to have a domestic solution as the Federal Reserve, Bank of England, European Central Bank and others go their own way.

But there is also a global dimension. When the West last experienced inflation of today’s proportions in the 1970s, the problems did not remain ‘local’. There’s no reason to think this time will be any different.

Then came the inflationary threat to the Western alliance from Washington’s refusal to maintain the post-war monetary order. Fiscal profligacy in the 1960s, leading to the closing of the Bretton Woods gold window in 1971, forced America and its allies to find, or at least learn to do without, a new price and exchange rate arrangement to mediate trade and investment Life.

mayhem ensued. Trade policy was an early casualty. As much as some politicians suspected that freer trade could ease price pressures, it proved difficult to argue with voters in dire economic straits.

The Tokyo round of world trade negotiations dragged on for six years, the longest series of such talks up to that point. Most countries experienced agitation over one partner’s trade deficits or surpluses, leading to economic irritations in key strategic relationships such as US-Japan or US-West Germany.

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Added to this were the consequences for investments. Fluctuations in relative price levels caused by differential inflation rates, combined with exchange rate instability, wreak havoc on international business investment. It becomes impossible to make any educated guess as to how the value of a foreign asset or its expected rate of return might vary over time.

In this regard, it suggests that a long boom in foreign direct investment in the US only began in earnest in the mid-1980s, after the Plaza and Louvre Accords of 1985 and 1987, respectively, finally introduced policy coordination to cure the exchange-rate hangover the inflation of the 1970s and its suppression in the early 1980s.

Such investments are an engine for job creation, economic growth and strategic partnerships. The spirit of monetary cooperation that makes this possible is in short supply today. Instead, the growing divergence between the leading central banks is causing exchange rates to rumble, mainly through a sustained and not fully explained appreciation of the dollar.

The world economy today is very different from the 1970s, but in ways that make the problems of that era even more acute today. Trade has exploded, multiplying and complicating the channels through which today’s monetary instability can spread around the world. The same is true of investment, whose flows dwarf the movement of tradable goods. Large central banks have become dominant participants in their local asset markets. The national debt has exploded.

So, based on historical experience, without a dramatic change in course in economic relations between the Western allies, things are likely to go wrong. But it’s more or less impossible to guess what or how.

Mr Putin has tested the credibility of Western security institutions like NATO. For the most part, at least in Europe, they try to rise to the challenge. The West’s next credibility test could come in the form of worsening economic problems and whether leaders can respond with a commitment akin to their belated awakening on defense.

Journal Editorial Report: Democrats face major policy challenge of high energy bills. Image: Michael Nagle/Bloomberg News

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