If I prove to be right, you read it here first, and not for the first time before and during this global crisis
The chief global economic characteristic of 2011 will be the return of inflation, within a stagflationary environment to boot. This inflation, however, is quite unlike the stagflationary 1970s: that inflation was driven in the UK by the Unions ensuring the cost push-wages pull symptom and was mainly a domestic matter, although the US decision to abandon Bretton Woods in 1971 and the OPEC embargo on Rotterdam in 1974 and its fourfold hike in oil prices were the initial inflationary triggers of that lost decade. Then Thatcher handbagged the Unions in the early 1980s and their extreme militancy was exorcised by precise laws.
Inflation in the second decade of the third millennium is quite different: it is global. That means that individual central bankers’ actions will have a lesser effect – unless they all act together, that is. Government statistics across the globe seriously and deliberately under-estimate inflation: China reports 5.1% but it’s over 10%; the UK’s CPI (which is based on the eurozone and omits the cost of housing!) is 4.2%, whereas the domestic RPI is over 6% and reality is over 8%; and America is saying 2%, but don’t try telling that on Main Street.
Inflation is being caused by a number of global factors: demand for raw materials, and then energy, caused in turn by the harshness of the winter across the Northern hemisphere; food prices by drought; cotton prices by flooding; and expanding monetary policy or QE and bail-outs in the West and similar unrestrained monetary expansion in the east, especially China and Japan.
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Given the fact of globalisation with its international supply lines – I was struck by an article in the Daily Mail showing how our average UK Christmas relied on supplies from across all five continents – the power of individual central banks is very much reduced compared with the 1970s and 1980s. There’s not much point in the BoE raising UK interest rates to counter the floods in Pakistan that have sent clothing prices up by 8% already, or the droughts in Siberia and the US and Northern China that have sent wheat and rice prices soaring. Hence there must be a global stance against inflation, but the world’s biggest economy is out of step.
Obama’s America made a bad economic miscalculation from its election: it thought that the normal recovery from recession would lift the economy out of the doldrums, so there was no point in cutting back on its $1.3 trillion fiscal deficit. This error now means that with the stalemate on Capitol Hill that The Fed has no option but to resort to QE 2, 3 and 4 etc. as, in the light of continuing doldrums in the US housing and employment markets, it must also print money to fund the expanding deficit.
And QE can only work in an ultra-low interest rate environment or it will bust the economy on its own. And this seems to suit Bernanke’s discrete policy of inflating away America’s federal, municipal, city, bailout and private debts. America’s interest rates are stuck near zero until the next presidency. We shall all see then what the true cost of Bernanke’s Friedmanite monetary policies really were, and more interestingly, who paid for them.
No one wants to see interest rates rise, but the timing is slipping beyond King’s control
Cameron’s Britain is in exactly the reverse position, with the priority to reduce the deficit, restrict any more QE and with the necessity of raising interest rates not far off now. It has not got the luxury of size on its side. Similarly, China has already raised rates twice since the Autumn to curb its overblown property sectors and must act soon in the light of the emerging 1970s’ style wages pull; and there’s no doubt that another item on the discrete economic US agenda is to force the dollar lower so that the Chinese peg to the dollar begins to loosen, a position that China may realise actually suits it too. Today’s currency wars are 1930s’ Trade Protectionism by another name: foreign exchange rates the new global inflation-fighter, which will in turn set domestic interest rates for the UK.
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Where does all this leave Mervyn King’s BoE? In an increasingly shrinking space for further policy-wonk initiatives and running out of road called ‘Further Delay’. The MPC will try to look across the inflationary valley, but the other side is now moving beyond their control, as foreign mists cover the landscape. No one wants to see interest rates rise, other than Britain’s 38 million savers who have paid the cost of this crisis so far, but the timing is slipping beyond King’s control.
The massive 25% Sterling devaluation in 2009 and the stabilisation of the banks and housing markets are looking at their last few months of easy living, before everyone has to stand or fall on their own two feet again, just as all those early fixed low interest rate mortgages are due to convert to Base Rate. My guess is that rates will have to rise around May, and will then keep on rising to around 5% or more during 2012, and even higher in 2013 when global recovery really could get going again. But then again, I could be wrong! But if I prove to be right, you read it here first, and not for the first time before and during this global crisis.
