February 14, 2008 | posted by Michael Baxter in UK economy |

Fascinating fact number one: cash was the best performing asset last year.Fascinating comparison number one;  the way economic growth has been leveraged on low inflation.

Question to make you feel a little queasy: “Whether high levels of leverage can persist in a more-volatile and inflation-prone economic environment?”

Conclusion to make you want rush for the sickbowl, but perhaps pop open the champagne all at the same time: “The credit crisis of 2007–08 is not just another permutation of the leveraged boom and bust cycles that have been so familiar over the past two decades. Rather, the current credit crunch represents the death throes of a rather inefficient economic arrangement that was only sustainable under disinflationary conditions.

“Resource scarcity,” begins the Barclays Capital Equity Gilt Study 2008,  “is the single most important social, political and economic factor of our era and will remain so for the foreseeable future.” It goes on to warn that we are depleting the stock of natural resources at an accelerating rate and says, ”The rise in per capita consumption of natural resources has been vastly accelerated by rising prosperity in the developing economies. The scale of the potential increase in aggregate demand is large enough to warrant doubts that it can be satisfied.”

Turning aside from the Barclays report for a moment – it does seem to be human nature to dismiss warnings that our consumption of natural resources is unsustainable, because these warnings have not come true before – but this is dangerous. You must bear in mind that the experiences of the last hundred years or so are actually not statistically significant. The industrial age – which is now gathering new momentum with the development of India and China, has, in the scheme of things, occurred in a blink of a eye.

We all know bubbles don’t tend to look like bubbles until they burst. They often surge in the last throes before they end – but the forces that lie behind our exploitation of natural resource, are deeper and slower to react. If we are sitting in the midst of a raw material bubble, then the trajectory of this bubble will necessarily be much more drawn out than any we have witnessed before – the experiences to date are totally consistent with this.

Meanwhile, back with Barclays Capital, it said, “In many, if not most, instances, the more accessible stocks of resources have already been exploited. Increasingly, future demand will only be met by utilising the less productive and more marginal stocks. Given the pace of economic growth in the developing world, the supply/demand balance in most resources becomes critical within a one to two decade timetable. For some resource sectors, the prospect of complete exhaustion within this timeframe is a realistic scenario if hypothesised deposits and technological advances disappoint. Resource scarcity is likely to wreak significant changes to the global economy, ending the long trend of decreasing volatility in growth and inflation.”

“The net result of intensifying natural resource scarcities is an increase in structural upward pressures on inflation and a worsening trade-off between inflation and growth. ”

And then comes the damning conclusion “To prevent the inception of an inflationary spiral in the future, monetary policy-makers will have to become somewhat tougher than has been the case over the past two decades. In particular, central banks will be more constrained in dealing with the aftermath of speculative bubbles and phases of excess leverage. Macroeconomic volatility is therefore likely to rise as policy-makers find their ability to smooth the cycle constrained by inflation. In time, this development will break the familiar cycle of the past two decades, under which the seeds of each new speculative bubble germinate in the ashes of the previous bubble. Leverage levels, notably in the household sectors of developed economies, will most likely start a long drift lower. In this context, the credit crisis of 2007–08 is not just another permutation of the leveraged boom and bust cycles that have been so familiar over the past two decades. Rather, the current credit crunch represents the death throes of a rather inefficient economic arrangement that was only sustainable under disinflationary conditions.”

Barclays went on to talk about what it calls “the four demons of illusion.”

Back in the mid 1990s, Roger Bootle, head man at Capital Economics wrote a book called the Death of Inflation. In it, he said that technological change, and the surge in supply created by globalisation, would lead to an era of low inflation.

He was right. But, low inflation may have led to low interest rates and allowed the UK to enjoy its longest-ever run of economic growth – but it has also led to apparently unsustainable high asset prices.

It has led to a boom funded by debt – and to an extent, creditors have not really considered the cost of repaying the debt – rather they have merely factored-in interest rate payments.

If the Barclays report is right, and we are about to enter an age in which inflation rises, and interest rates tend to be much higher – and by the way Alan Greenspan has made similar predictions, then all of a sudden all that debt will seem like a terrible curse.

Recently, some analysts have dismissed some forecasts of doom as being little more than Cassandra-like ranting. They forget that, according to Homer, Cassandra’s prophecies were always true, it’s just that no one believed them.

As one of our readers once said to us, it’s as if the world’s markets are slowly suddenly realising, the emperor that is a boom based on debt has no clothes.

Does this mean things are all simply awful? Not at all, there are good reasons for believing we can move to a scenario in which we are less-reliant on the earths scarce and highly valuable natural resources. But the first stage in grappling with a problem is in recognising the problem exists – and that is what we are witnessing at the moment.