For the second year in three, 2022 was characterised by a one-off event that completely changed the economic landscape. Whilst 2020, and to a large extent 2021, was derailed by pestilence, this year was dominated by war. Those of a religious persuasion might recognise these as the first two Horsemen of the Apocalypse. Most of our predictions were derailed by the Russian invasion of Ukraine which resulted in a bigger surge in inflation than anticipated and forced central banks to raise interest rates to their highest since the GFC. However, this year was not just about monetary policy: governments were forced into using an active fiscal policy to offset the worst effects of the cost-of-living crisis on households. However, it will not be enough to prevent recession in large parts of the industrialised world in 2023 and the continued rise in government liabilities may yet turn out to be a big problem in future.
Covid slipped down the list of things to worry about in 2022. In my year-ahead piece almost a year ago, one of the options I laid out was that the Omicron variant would prove to be the last hurrah for Covid, which would regress to become an endemic problem. That is indeed how things panned out in 2022 although as China opens up following its zero-Covid measures there is every prospect that global cases will start to pick up once more. We cannot yet be sure that we are out of the woods. However, I did expect that as Covid related supply shortages began to ease, inflation would slow towards the end of 2022. It has not worked out like that.
Newspaper headlines have been full of suggestions that recent events herald a return to the conditions of the 1970s, with a commodity price shock triggering a surge in inflation accompanied by increasing industrial unrest as unions push for higher wage claims. Whilst the parallels are attractive on the surface, a closer look at the evidence suggests the comparison does not quite hold up. One of the key differences so far is that real wage growth has been crushed by the recent surge in inflation whereas in the 1970s it remained positive (although we have been compensated with lower real interest rates). Here in Britain, the strikes that have hit train, postal and health services are a response to the fact that many workers are being squeezed very hard, two years after they were lauded as key workers who kept the country going during the initial Covid lockdown. Labour relations are going to be a problem for governments in 2023, particularly in France and the UK.
One way to think about the inflation problem in the short-term is that it is the outcome of a distributional conflict between firms, workers and taxpayers which will only be resolved when the various actors accept the outcome. Indeed all players have to accept that they will be made worse off: At issue is the extent of the losses they are prepared to bear. The fact that central banks have raised interest rates to combat inflation has complicated matters by raising the burden on households. My issue has long been that higher interest rates will do nothing to offset a supply-side inflation shock, although central banks have to be wary of second round effects, particularly where labour markets remain tight as is currently the case in the US and UK. But as pointed out by the journalist Sarah O’Connor, author of this article on why worker power has not strengthened in 2022, while central banks fret about a wage-price spiral, the current situation looks more like a living standards bloodbath.
On the basis that inflation slows in 2023, as base-year effects drop out of the annual calculations, and as European economies – and maybe the US – fall into recession, the calls for interest rate cuts will build. Central banks are unlikely to heed these calls, and maintain policy tighter than might be justified by economic conditions, which would be a contrast to the post-GFC period when they held policy looser than justified by economic conditions. Central bankers are paranoid about repeating the mistakes of the 1970s when they eased policy too early only for inflation to take off again.
A bad year in the markets
On the basis of data back to 1928, 2022 was one of the worst years for total asset returns with the S&P500 losing around 17% whilst returns on Baa corporate bonds were the second worst in history (beaten only by the collapse of 1931). It was not supposed to be this way. Indeed I expected equities to perform relatively well, largely because of an absence of alternatives. But the surge in interest rates and fears of recession well and truly did for markets. It is not usual for a year of losses to be followed by a second consecutive decline but it has happened before – most notably for equities over the period 2000-2002. I would like to say that things can only get better but we cannot be sure that they will.
2022 was also the year in which crypto assets were reassessed. Long-term readers will be aware of my scepticism regarding cryptocurrencies but I was not prepared to write them off at the start of the year on the basis that there seemed to be genuine retail interest in their adoption. But as the energy costs associated with mining Bitcoin continued to rise, they became an increasingly unattractive prospect. Matters were not helped by the bankruptcy of the FTX exchange amid allegations of fraud. As a result Bitcoin lost two-thirds of its value against the USD, to currently trade at 16558 – still almost triple my back-of-the envelope estimate of fair value.
Politics: Some right calls, some wrong
If I got anything right about 2022 it was that geopolitics would be at the forefront of the agenda after two years in which governments were preoccupied with Covid. I did point out there was a risk that Russia would invade Ukraine and that western relations with China would continue to fray. I also tipped Emmanuel Macron to get a second term as French President. However, the one call that went badly wrong was that Boris Johnson would end the year as UK prime minister. As I wrote at the time: “Ditching a third Tory leader in six years, before their term is up, will not play well with an electorate that appears increasingly restive, particularly when there is no obvious candidate to replace Johnson.” I stand by the logic – Johnson’s departure will do the Tories no favours at the ballot box. But I could not have foreseen that Johnson’s replacement would themselves be replaced after a spectacularly incompetent fiscal plan was rushed through.
Last word
Tough times are now the order of the day. We survived the GFC, coped during the pandemic and are having to tighten our belts to deal with the most significant war on European territory since 1945. I look back fondly to the days of the Great Moderation when we had to invent things to worry about (who now remembers the Millennium Bug?). We can be thankful we got through 2022 relatively unscathed but as we look ahead to 2023, there will be bigger challenges ahead. Happy New Year to you all.
