'Influence Of The US Is Diminishing'

'It was diminishing even before Trump came to power.'
'The US was at the centre of the global economy. That position is going to become less and less important and less central.'

After more than a month, there is a temporary, uneasy ceasefire in the war the US and Israel launched against Iran. Nobody is sure how long it will last.

Will the Strait of Hormuz through which 20% of the world's oil tankers pass remain open?

How much will the global economy be affected by the oil crisis?

Will there be stagflation like many experts fear?

Dr Anil B Deolalikar is the Professor of Economics and founding dean of the School of Public Policy at University of California, Riverside.

"Oil prices really have a ripple effect on the entire economy. We saw that in the 1970s. So, both the tariffs and the war have made things worse," Professor Deolalikar tells Rediff's Shobha Warrier in the first of a two-part interview.

The IMF chief and many other experts have been talking about stagflation. Are we going to see stagflation or have we already started seeing the effects?

Stagflation is a situation where you have high inflation, no growth, and high unemployment.

We had that situation in the 1970s largely because of the oil price shock in 1973, and then again in 1979.

The truth is, you cannot definitively say you are in stagflation until you are in it for a couple of years.

Right now, it is too early to tell whether we are experiencing stagflation.

It is in the last few months that job losses have been mounting in the US and unemployment has been rising. So has inflation.

The trends are very recent for anyone to conclusively say that we are definitely entering into a period of stagflation, and that we will be in the same boat as in the 1970s.

The 'experts' who say that are just speculating; they don't know for sure what is going to happen.

That said, I am not saying stagflation is not going to happen. We may be in it, but the trends are too recent to say conclusively.

Stagflation is bad because we don't have many tools to fight it. The central banks are limited in what they can do. Normally unemployment and inflation move in opposite directions. When you have high inflation, central banks raise interest rates to lower growth.

But if you are in a situation where you already have very low growth and high unemployment, raising interest rates will increase unemployment even more.

It is a very tricky situation, and we don't have easy ammunition to fight stagflation.

Have you started seeing the signals of an impending recession?

No, I don't think anybody has seen signs of a recession.

By historic standards, unemployment is still low in the United States -- about 4%. During the pandemic, it had gone up to 15% and in 2007-2008, it had gone to 10%. Today, we are not in that situation at all.

But we are seeing worrying signs that unemployment is stubborn. We are also seeing worrying signs that inflation is creeping up slowly.

Another problem is, there is a lot of policy uncertainty because we have erratic policy-making in the US. One day there is a new announcement, the next day it is rescinded.

Tariff rates have been all over the place. There is no policy certainty, so we just don't know what will happen tomorrow.

If there are worrying signals, is it due to the war on Iran or due to the tariff war because of which the global economy is in terrible strain?

Both. Inflation has crept up because the tariffs are eventually passed on to consumers in the form of higher prices. Also, if you have tariffs on many intermediate goods that are imported, such as car parts or steel, the price of cars will go up.

And then, as consumers were getting used to the tariff shock, the Iran war started and oil prices went up sharply.

Oil prices are also bad from the point of view of stoking inflation because petroleum is used in so many goods, such as fertilisers and transport. If fertiliser prices go up, so will food prices.

And, of course, increased transport costs mean the price of all products that are transported will go up.

So, oil prices really have a ripple effect on the entire economy. We saw that in the 1970s.

So, both the tariffs and the war have made things worse.

Why is everybody comparing the present situation to the energy crisis of the 1970s?

No, not yet. People often like to compare things with the past, but we haven't reached that situation yet. We might though; no way of knowing right now, although I hope not.

Markets react not to what is happening now but to what traders think will happen in the future. That's why the oil prices go up sharply to $110, $120 one day, and then fall to $90 the next day. It is not because oil has suddenly become short; it is because the market is afraid that the oil shortage is going to be worse and worse.

You saw the stock market in the US going up sharply as soon as the ceasefire was announced. Oil prices also fell because of the ceasefire.

And when the talks between Iran and the US failed, you saw oil prices increase sharply and the stock market down.

That's why I said there is a lot of uncertainty now. It's like a ping pong ball, up one day, down the next.

Which is very bad for the economy...

Yes, it is horrible for the economy. Nobody can make long-term investments because nobody knows what exactly will happen tomorrow.

The tariffs also changed dramatically, from 25% to 50% to over 100%...

The US supreme court then declared that the tariffs were unconstitutional. That's another complication.

Now, they will have to stop collecting the tariffs. We don't know whether they will refund those who paid tariffs last year. The refunds are going to be another big mess.

Again, a lot of policy uncertainty.

Do you see a realignment of the world order happening after this? For example, France pulled out 129 tonnes of gold from New York and moved it to Paris. Do you see America's supremacy is going to be questioned by other nations?

Definitely. I think the influence of the US is diminishing. In fact, it was diminishing even before Trump came to power.

What has happened now after all the sharp policy changes is that the rest of the world has realised they cannot afford to depend on the US so much.

For example, the European countries, Japan and Korea are dependent entirely on the US for their security guarantees. Now they are not so sure of the US guarantees; there is even fear that the US may pull out of NATO.

Trump has been saying that South Korea and Japan should pay more for their defence, and that the US cannot continue to take care of them always.

All of this is producing a lot of anxiety among the US allies.

So, from a very practical point of view, I think the rest of the world, especially the American allies, have realised that they cannot depend on the US, and they have to be a bit more independent.

Economically, what kind of realignment do you see?

Because of the trade tariffs, and because the US pulled out of the Trans-Pacific Partnership, new trade agreements are being signed: between Europe and Asian countries, between Europe and India, between Canada and China.

So, there is a danger that the US might find itself a bit more isolated in the world than before.

Has it already happened?

Yes, it has already happened. And it is going to continue happening.

There will be a major shift, obviously not immediately, but in the next 20-30 years.

Of course, being the largest economy in the world, the rest of the world will still be inextricably tied to the US, whether they like it or not. That can't change in the short or medium term.

If you take India, it has signed bilateral trade agreements with the EU, the UK, Canada, Australia, etc. ..

Yes. India signed one of the biggest trade agreements they ever had with the EU.

These kinds of trade agreements among what Canada's PM Carney called the 'middle powers' will continue to increase because of the rise of isolationism in the US.

China is also building very strong networks with the rest of Asia and Africa.

• THE MIDDLE EAST CONFLICT

The US was at the centre of the global economy. That position is going to become less and less important and less central.

It doesn't mean that the US is going to suddenly become irrelevant in the next 5 or 10 years. Because the US has such a big lead and has such deep capital markets, it will continue to be relevant in the foreseeable future, but its relative dominance will continue to decline.

The US treasuries (bonds) are still one of the most liquid and safest financial instruments in the world. That's why most countries still want to keep their foreign exchange surplus in the form of US treasuries although not to the same extent as in the past.

IMAGE: Dr Anil Deolalikar.

So, France taking its gold from New York is just the beginning?

Yes, it will be the beginning. The big advantage and dominance of the US will slowly erode in the next 20-30 years.

I repeat, it doesn't mean the US will become irrelevant.

It is just that the US will not be as dominant in world trade and in international matters as it was during the last 70 years.

Part 2 of the Interview: 'Very Bad For Global Economy If War Continues'

Feature Presentation: Aslam Hunani/Rediff