What a year. Who would have thought it? 2007 began with such promise and ended with such trepidation. This is the last issue of Investment and Business News from Defaqto this year, so we thought we would leave you with a reminder of how the economic prospects turned, and look at what 2008 may have in store.
In yesterday’s Independent, it was stated that no one had predicted the crisis of 2007. Well, that depends on what you think the crisis is. If you think the credit crunch is all a big misunderstanding, and it’s down to trust leaving the market, then they are right: it was not predicted. But if you think the problem is deeper than that, and that the fundamental cause of today’s economic crisis is the level of debt we have built up, the writing was on the wall, or at least it was in your email newsletter from us.
In our first issue of this year, we wrote, “We have noticed an abundance of books being published that predict doom for the economy in a few years’ time, from the Great Debt Crisis, Boom and Bust, to even the esteemed Roger Bootle (top honcho at Capital Economics and a man often quoted here) with his book Money for Nothing. If the number of books out there on the subject is any guide, then there’s trouble ahead.”
We then added, “The truth is, consumers and governments across the developed world are spending. The Anglo Saxons in particular seem to spare no thought for the present as spending becomes the fashion.”
We went on: “In the past, overspending and borrowing led to inflation. This time around, it has stayed relatively in check. But does that mean that thanks to the Internet and China we can have our cake and eat it? Spending without inflation taking hold, creating prosperity for all. It may do, but on the other hand… ”
But perhaps the headline that proved the best sign of things to come was this one. “Stuck between rock and hard place.” (4 January) Weren’t we clever? Surely we were the first to run the most popular business news headline of the year. Mind you, in getting there first we were a tad lucky. Our story had nothing to do with Northern Rock. Rather it referred to the dilemma faced by the Fed of facing inflationary pressure at a time of declining economic sentiment. Yet in a way this story did relate to Northern Rock. It was the first sign of the problem that was just beginning to hit the economy.
For 2007 was the year when inflation reared its ugly head. And when the economy turned, when it became obvious that economic growth both in the US and then in the UK was set to slow, what did inflation do? Did it obligingly go away? No, instead it appeared to make itself comfortable and prepared to stay. Then on April 16 it happened. The official Consumer Price Index hit 3.1 per cent, more than a whole percentage point above target, and Mervyn King got his pen out and wrote his infamous letter to Gordon Brown, then chancellor, explaining what had happened.
And turning to today, it really does seem that there are two schools of thought. Last night, Capital Economics released a press release in which it said, “The pick-up in headline inflation has been driven largely by temporary supply-side pressures on food and energy prices. It is hard to see underlying inflation picking up in 2008, given the prospect of weaker economic growth.” In any case, it added, “There is still relatively little evidence of “second-round” effects whereby a jump in inflation (whatever the cause) might become embedded in the economy via higher inflation expectations and in wage and price-setting behaviour.”
Capital Economists may well be right, but we want to make you aware of an alternative point of view that many economists seem to be oblivious to.
Those who say inflationary pressures are temporary, point to historical trends. They say oil always goes up, and then goes down. They point to the high price of food, and say it is just down to one-offs. In his book, the Age of Turbulence, Alan Greenspan ridiculed the idea of peak of oil as a short term problem; when demand rises, supply rises to meet it, he said.
The problem with this is that economists, when they map out their trends, look at an incredibly short period of time. They look at oil, and think that just by tracking its pattern over the last 100 years, they can predict the future. They look at economic cycles, and think it will always be like that. We found some of Mr Greenspan’s views articulated towards the end of his book on future productivity, almost naive.
The fact is that change is occurring at an accelerating rate; not only that, the rate of acceleration is accelerating. We really are entering a new era, we really are stepping into new territory.
Whether we run out of oil is almost irrelevant. The fact is that the planet needs us to find an alternative. If producers had to bear the true cost of environmental damage in their production, prices would be soaring.
And yet, new technology is coming fast. There are many reasons to be hopeful, and no reason to believe economic growth has to be dramatically curtailed in order to avoid ecological crisis.
But it does seem inevitable that soaring demand from China and India will exact a toll on the earth’s resources. The world has never seen anything like it. Literally billions of people are about to join the consumer society. Can you really say with certainty that inflation will stay down?
At the beginning of this year it was thought oil had peaked, and inevitable that 2007 would see the black stuff decline in price. Instead it soared, from around $52 in mid-January to almost $100 a few weeks ago.
Economic theory says high consumer and government spending leads to inflation. But, of late, it hasn’t been like that. Inflation stayed down despite high spending because of other factors: the end of the Cold War, central banks becoming more savvy, rises in productivity caused by technological advances, the Internet promoting competition, and China.
But this year, that fortuitous combination seemed to shrink. The word stagflation crept back into the lexicon. Whether inflation will ease next year or not, we are yet to see, but if you really want to know the story of 2007, it is not subprime, or credit crunch, it is rising inflation at a time of falling economic prospects. And whether we see a repeat of this story next year, or whether Capital Economics is right, and inflation falls, will determine whether the US and UK can avoid recession.
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