Christine Lagarde: The US-China dispute will drive inflation higher

Christine Lagarde warned that geopolitical tensions between the US, China and other countries could cause inflation to rise by 5% and endanger the dominance of the dollar and the euro.

In a Monday speech, the president of the European Central Bank said: “We could see more instability when global supply elasticities decline; and secondly, we might see more multipolarity if geopolitical tensions keep increasing.”

She said that disruptions to global supply chains will affect “critical sectors”, such as the electric car industry. She pointed out that the US relies “completely” on imported materials for 14 key materials, and Europe is dependent on China for 98% of its Rare Earths supplies.

Lagarde said at a Council on Foreign Relations meeting in New York that if global value chains were to fragment according to geopolitical boundaries, global consumer prices would rise by between 5 percent in the short term and 1 percent in the long term.

She said that some countries could reduce their dependence upon the dollar and the euro. She cited “anecdotal” evidence of increased use in cross-border trading of the Chinese Renminbi and the Indian Rupee, as well as greater gold stocks being used to serve as alternative reserves.

Lagarde stated that as developing countries increase their trade with China, the world’s largest exporter, they will be inclined to hold more renminbi in reserve.

Lagarde stated that the data so far does not indicate any substantial changes in the usage of international currencies. But they suggest that the status of international currencies should no longer be assumed.

Janet Yellen was the US Treasury Secretary who called on companies to invest more in countries that they know are reliable. Beijing has sought to reduce its dependence on technology from other countries in response to US restrictions imposed on semiconductors and equipment for chipmaking.

Lagarde stated that a long period “of relative stability” may be giving way to a lasting instability resulting in lowered growth, higher costs and less certain trade partnerships.

Her comments reflect a wider fear among decision-makers who attended the annual meeting of the IMF & World Bank last week that increasing political tensions would weigh on the world economy by disrupting the trade, slackening growth and driving up inflation.

Lagarde, however, said that she would rather be “determined” than “pessimistic”, calling for “greater cohesion in policy” by countries working together to solve problems.

She said that if countries collaborated, for example to diversify their energy supply or secure supply chains, they could create a “virtuous cycle of lower volatility and inflation, increased investment, and greater growth”.

She warned that if fiscal policies are primarily focused on supporting incomes in order to offset costs pressures, rather than temporary and targeted reactions to large and sudden shocks, this will lead to higher inflation and increased borrowing costs as well as a decrease in investment in new supplies.

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