Don’t say you weren’t warned.
Back in August 2006 we headlined: “No more Mr NICE economy?” and warned that inflation was coming back. It wasn’t our first warning. Governments and consumers were borrowing, spending was on the up, money supply was growing – every economic text says that when this happens inflation is the result. Yet inflation remained stubbornly low. It seemed a puzzle. Was it really that central bankers had got so clever that, finally, inflation had been slain, for good?
In November 2005 this is what we said: “The last few years have witnessed a phenomenon that economic theory suggested was impossible. Consumers and governments went out and spent – and then spent some more, and yet inflation stayed firmly in check. This created the golden scenario of a low rate of interest at a time of high expenditure and borrowing.
“Economists had explained this quantum shift by saying: “Ah, yes, it’s a new paradigm now.” They argued that the combination of ever-fiercer competition and low cost of goods from China had changed the rules.
“But if the history books tell us anything, it’s this: when experts say it’s a new paradigm, beware. They said that before the dot com crash, they said that about the high level of corporate valuation before shares crashed across the board, they are saying that now about house prices and they are saying that now about inflation.”
And now, inflation is well and truly back, and not just here.
As Ambrose Evans-Pritchard pointed out in the Telegraph: “Inflation rates have reached: Venezuela (22 per cent), Vietnam (21 per cent), Latvia (18 per cent), Qatar (17 per cent), Pakistan (17 per cent), Egypt (16 per cent) Bulgaria (15 per cent), The Emirates (11 per cent), Estonia (11 per cent), Turkey (9.7 per cent), Indonesia (9 per cent) Saudi Arabia (9.6 per cent), Argentina (8.9 per cent), Romania (8.6 per cent), China (8.5 per cent), Philippines (8.3 per cent), India (7.6 per cent).”
Yesterday, a reader’s comment on our blog referring to yesterday’s piece on food inflation, which blamed trade subsidies, said: “No mention of monetary inflation? M3 growing at 20 per cent surely must be THE cause!”
Is he right? Are we now paying the price for years of loose monetary policy? Have central bankers let us down?
This morning, many media accounts seized on the warning contained in the latest Bank of England inflationary report that there would be no more rate cuts for two years. Others think the Bank’s prediction will not be adhered to. Capital Economics, for example, still believes interest rates will be cut. Yesterday, Jonathan Loynes, Chief European Economist there, said, “We still think interest rates will eventually fall considerably further as the economy continues to weaken and inflation concerns finally fade.”
But is this all really down to our excessive spending in the past? Surely, food, oil and other commodities are going up in price because of China and India, not because of loose monetary policy.
Sometimes it is argued that inflation is a symptom of a bigger problem. Inflation occurs when we spend too much. But on this occasion, our excess spending led instead to rising house prices and too much debt.
Maybe there’s a choice: debt or inflation? After all, don’t forget, high government borrowing of the 1970s was reduced in real terms because of inflation. Back then, if you like, we chose inflation.
Maybe today we are choosing the course of repaying debt. Then again, loose monetary policy in the UK and US certainly led to massive trade deficits, which are now unravelling in the form of a falling dollar and pound, which in turn is creating inflationary pressure – oil is, after all, measured in dollars, so as the dollar falls, oil goes up.
But it was US spending in particular that helped fuel the Chinese growth story. So maybe loose monetary conditions in the West fuelled Chinese growth, which led to the escalating price of oil and food.
It does seem, however, that while there is a good chance food and oil will rise even further in the short-term, they will fall back in price eventually. Demand relative to price is just not that inelastic. This, will in turn will cause prices to fall back.
The potential fly in the ointment is wages. If wages go up in response to the higher prices of food and oil, then the inflationary pressure will stay in place.
And that’s the dilemma for the Bank. Thanks to the credit crunch, money is tight. The latest data, out yesterday from the Office for National Statistics, recorded a 7,000 rise in unemployment in April. Furthermore, after revising the figures for the previous month, it is now recording three months of rises in unemployment.
Right now, the hope for recovery rests with wages not rising. It rests with us having to pay the real cost of rising food and oil. That spells trouble. But, if we get out of jail, if interest rates move lower, if relaxed monetary conditions allow wage rises, the trouble will be so much worse.
An economic slowdown now, is the price we pay for greater stability in the long-run.
If everyone is complaining about inflation, shouldn’t inflation numbers been in the teens?report this comment
This is an important point. This argument, was also ventured by Gordon Brown this morning.
The point is we have built up debt on the naive assumption interest rates will stay low. But even sustained inflation of 3 or so will prompt interest rates that will make that debt too expensive for some, - although in the longer-term inflation helps those in debt.
There is another point. Once it sets in inflation is difficult to stop, it has been likened to squeezing tooth paste back into its tube.
In the early 1970s we had cost push inflation, which led to higher wages, which led to an upward spiral.
It is important we don’t repeat those mistakesreport this comment