So, British gas announced its intention to raise gas prices by 35 per cent and electricity by 9 per cent. That will hurt. Meanwhile, the collapse in the price of oil seemed to come to a halt yesterday, and go back into an unfortunate reverse – as news that US stockpiles of oil had fallen led to a sharp $5 a barrel jump.
So that is it then, inflation is just taking off.
Yet, news from Incomes Data Services this morning revealed a fall in pay rises in the three months to June. The period saw average pay increases of 3.5 per cent, from 3.6 per cent during the three months to May.
We keep hearing about strikes making a comeback in the public sector, and how a wage inflation spiral could have its origin in the government controlled arena, at a time when the Gordon Brown regime dare not risk a confrontation. Yet the Incomes Data Services report revealed that the public sector received pay deals worth just 2.7 per cent during the period.
According to a report from KPMG, the number of firms planning to make job cuts has almost doubled in the last three months.
KPMG’s survey of senior executives in both public and private sector organisations indicates that more than half (53 per cent) now plan to reduce their staff headcount over the coming months, with a similar number (52 per cent) planning to implement recruitment freezes. Back in March 2008 when the same organisations were questioned for KPMG by Opinion Leader Research, only 29 per cent were looking at job cuts as a cost-saving measure.
It seems highly unlikely that in this environment of job uncertainty, wage inflation will take off. In fact, as the credit crunch deepens, wage deflation seems more likely to go negative. In fact, there has already been some anecdotal evidence to suggest some workers are being put under pressure to accept pay cuts. They are having to choose between pay cuts or losing their job altogether.
Yet, in yesterday’s FT, Kenneth Rogoff, a respected economist if ever there was one, for Mr Rogoff is a former chief economist at the IMF and now Professor of Economics at Harvard, banged the anti inflation drums.
He argued that the current idea of bailing out banks, and slashing interest rates to stimulate the economy, is flawed. “The world can not grow its way out of this slowdown” went the headline to his piece, and he said: “governments in every corner of the world showed themselves perfectly capable of achieving very high rates of inflation long before they had the assistance of modern unions.”
So what we have then is quite a dichotomy.
On the one hand, the forces of inflation are self-evident. On the other hand, there are good reasons to fear deflation, once the recent rises in oil and commodity prices have worked their way out of the system.
So we have economists such Mr Rogoff, and last week the National Institute of Economic and Social Research, arguing for an increase in the rate of interest to choke off inflation.
On the other hand, with asset prices in such freefall, there has to be a serious risk of anti inflationary measures backfiring and creating years of deflation – in a recession that could mirror the Japanese lost decade.
How do you reconcile these two views?
Well, actually, there is a reason for this divergence, and the reason is quite simple.
Not only is the economic world split down the middle, so is the real world too.
The UK and US, and countries such as Spain, and Australia – which by the way has joined us in seeing big falls in house prices, face the danger of deflation by the end of 2009 and beyond. In the BRIC countries – Brazil, Russia, India and China, inflation is still public enemy number one.
Well, maybe not in Russia; the official public enemy number one seems to be anything Western.
But in a way, Russian antipathy to Western corporate giants is a symptom of inflation. Public spending rose before the election which saw Dmitry Medvedev become the nation’s new President. This has helped stoke Russian inflation, but evil and greedy capitalists made a convenient scapegoat.
As the BRIC nations expand, yet more pressure is put on commodity prices – but the true cost of this in terms of inflation is being glossed over. In China you have the Olympics overriding all other concerns. You have the subsidy on oil, disguising the true cost. But you can’t hide problems for ever. They will always come back and bite you in the end.
If the likes of the US and UK do hit recession – then the result will surely be a big slowdown in international trade, which will hit China et al, the price of oil will fall – maybe even go into freefall. This will hit the Russian economy hard.
Economic theory would suggest the recovery will have its roots in this downturn – as cheaper commodity prices make us feel better off.
But, the danger is that the resulting recession could be self-reinforcing. As Keynes showed, economic depressions don’t fix themselves, or not for quite a long time, anyway. The last depression only really came to an end with the end of World War II.
So, while is true to say this economic crisis was caused initially by too much borrowing in the West, and can not be solved through borrowing more, it is also true that to let market forces take their natural course could be very dangerous – very dangerous indeed.
Which is why the ultimate solution to this crisis lies in some kind of middle ground. A slowdown, but not too much of a slowdown. A gradual move in the West from being greater spenders to being great savers – but only a gradual move.
Ultimately, the solution to this crisis lies in growing productivity enabling higher income – but without a corresponding rise in borrowing. Somehow, economic policy makers need to engineer that path. It does not lie in the policies advocated by Mr Rogoff.
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