Mervyn King has apparently admitted in the introduction to the Bank of England's annual report that the Monetary Policy Committee
can have little impact on the path of inflation in the short term.
He's guilty of one thing: he understates the sheer impossibility of the Bank having any control on inflation right now when the only weapon in their armoury is the interest rate.
The reality of current inflation is that it is cost push, but the cost is not wage driven, as is the experience of most who have been around long enough to remember what inflation is about, as I am. In that case using interest rates to try to diffuse the cost pressure is entirely pointless, unless the objective is serious recessionary pressure through the creation of significant unemployment and massive social disruption. A side product will be the destruction of the financial system on this occasion, rather like Thatcher destroyed the manufacturing base in her own misguided effort to destroy inflation more than tenet years ago.
Why? The logic is fairly simple. Our banks are failing. Bradford & Bingley cannot survive, even with a £400 million injection. That's enough to cover a 1% right down in its mortgage loan book, and that is obviously insufficient to cover its risk. Alliance & Leicester has gone in acknowledgement that it cannot face that risk. And this trend will continue so long as interest rates in the UK stay at 5% base rate. That rate will mean many people have no hope of paying their increasing mortgage costs as low price deals are withdrawn and risk based interest rates increase way above the rates available only a year ago. This is no fault of those borrowers but it will lead to default, banking failure, rapidly falling house prices and disguised deflation. The latter, by the way is the simple reverse of the disguised inflation we've had for many years, which has been suppressed by ensuring house prices and housing costs stayed out of the RPI. The result is inevitable: it will be social turmoil, unemployment, the loss of many well known enterprises, the destruction of the some significant skill sets and further undermining of the core viability of the UK economy.
Now I agree that might at some time provide domestic compensation for external price pressure, but is that a price we are willing to pay for low inflation? I assure you, this is what will happen. It won't yet: Mervyn King knows it hasn't, which is why he says in the short term that inflation cannot be controlled. The pain, disruption and turmoil has to be imposed before that can happen. But is this a price worth paying to seek to stabilise an artificial measure of inflation? And is all this social disruption worth unleashing on our economy just to preserve the property rights of those with wealth? Because, make no mistake about it, the obsession with inflation is about preserving the property rights of those with monetary based assets.
Now, for one group of those with such rights I have real concern. They are pensioners. We're going to have to accept increased responsibility for providing for them if inflation increases, and thankfully the pension credit system provides a mechanism for doing that. For the small minority of others in society who control most of our cash based assets I regret to say that I have much less concern. Put bluntly, preservation of their spending power is not worth the cost that will be imposed on everyone else. It's a blunt choice we have to make, and an easy one to make. Inflation has to be allowed, interest rates have to fall and stability has to be returned to the housing and mortgage markets which underpin the wellbeing of millions more in this society whose well being will be shattered in the pursuit of stable money for a minority.
So, Gordon Brown has to end the absurd independence of th Bank of England to set monetary policy. He got away with this whilst growth let the economy manage itself. And the Bank pretended they were in charge whilst the upside managed things for them. But I'll tell you (because I have managed companies in downside situations), it's downturns that require real management skill, and real skill requires throwing away the rule book, relying on intuition and taking the action necessary, conventional or otherwise, that achieves results. In this case the result is an economy in which people can afford to live in homes, an economy with as full employment as possible, an economy where we have viable banks, and an economy where we can maintain our long term ability to function in the wider world. All of that is at threat right now because Gordon Brown said the Bank of England must control inflation using interest rates alone, and denied himself the right to interfere. Well, just repeal the legislation that gave that right away I say, get the Bank back under political control and get interest rates down to 2%. That way we have a chance. And given that the inflation is inevitable and quite beyond our control anyway, we'll have to deal with that later. At least with low interest rates we'll have the option to do so. With high rates we won't have the chance.
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You are assuming — I guess? — that we are currently on the downturn of a cycle (or cycles) which, at some future point, will eventually move back towards an upturn. I doubt very much it will. Reasons: end of cheap oil (Cheney & Co foresaw the present resource wars many years ago (as they were instrumental in planning it) and 9/11 was used as the springboard to invade Afghanistan, knocking distance from our old threat the Russians and new foes the Chinese, and then a ruse (along with WMDs, etc., etc.) grabbing Iraq’s oil. Our present economy is largely fake — the finical services (“industries”) don’t feed your children or provide the raw materials for everyday survival. House price inflation is not wealth, it is the road to indentured servitude ~ 70% of UK/US commercial loans are property related. The burden of taxation has been removed from property and placed on wages.
You say, “But is this a price worth paying to seek to stabilise an artificial measure of inflation?” Of course, price inflation is running much higher — recent calculations have placed it between 12-18%, coincidentally, approximately the rate of monetary inflation preceding our present downturn. You say, “Well, just repeal the legislation that gave that right away I say, get the Bank back under political control and get interest rates down to 2%.” We used to have a thing called “credit control” and “minimum reserve requirements” — controls over the growth of credit that have slowly, over the years, faded like the notion of “saving money for a rainy day”. The truth of matter, as I see it, is we have reached peak credit — the spending spree is at its end. There will be no long-term recovery, because our economic model is bankrupt — it is unsustainable; it is a broken model. By holding 2% interest rate, you may affect the speed of the downturn (the angle of its slope so to speak), but it will not change the direction. Therefore, your 2% solution is a Band-Aid; not a fix. This should be a wake-up call that will be ignored.
You say, “And is all this social disruption worth unleashing on our economy just to preserve the property rights of those with wealth? Because, make no mistake about it, the obsession with inflation is about preserving the property rights of those with monetary based assets.” How about, instead, we tax the wealth accumulated through the rise in property values as income? Too late now? Great blog Richard! Thanks.
What about land/location values as the main tax base? Land cannot be hidden in a tax haven. 1% of the population own 70% of UK land – one of the consequences of the Enclosure Acts to which you refer, Richard. Why does the TJN ignore all property taxes in their paper on fair taxation? Land market failure is at the heart of our economic ills. Lax financial controls always end in a land price bubble.
I agree with everything you say otherwise, by the way.
Firstly, how does inflation help preserve jobs, preserve firms in the economy?
How do businesses and individuals survive when inflation robs them of the benefit of their economic activity and trade through rising costs and falling living standards? Answer me that!
All this about the rich elite hording piles of banknotes is a nonsense. Inflation greatly benefits the wealthy elite as us poor mugs are the ones paid in ever more tin like coin and our savings are destroyed.
You have rightly diagnosed the fake boom we have lived through due to problems in the inflation measure not capturing inflation in homes, which are simply capital assets. The resultant money bubble from this lending is now wreaking its way throughout the economy in the form of inflation, and the lenders are having to cut back the flow of credit and purple loan ads.
And now we face a period of deflation in those same absurdly valued goods, but only until a rational balance is struck – not forever! Its not the end of the world! To prevent this to occur by using inflationary tools will just leave a shattered economy and society going nowhere for years.
Lets face it the problem is not collecting taxes, but the immense size of the spending on government non jobs and waste. Where does money come from? The value of money is from production not from debt/inflation fuelled consumption with some lucky people holding inflating assets against which money is printed, the others losing out!
Inflation is ALWAYS someone elses lost! It means you and me and millions of others are working for money today which is to be devalued tommorow. The rich would be the only ones to suffer – HA! I see the suffering ‘rich’ in a trip to italy where such policies where tried.
The rich in your inflationary paradise are not suffering greatly, while ordinary folk with thier million lira houses, supported though inflation bask in the caro vita/dear life!
The place is like the 3rd world, and now has food riots! I have seen real poverty in that country which is still unthinkable in the UK.
And what a paradise – Each worker has a non job which inflation and endless insane government regulation support, and everyone can attend university.
Its a shame you have to beat the queue of 2000 people round the block to catch a whisper from the only lecture theatre, and might leave with your degree when your 30 – if your lucky!.
Inflation in the 1990s has basically destroyed that country and its many industries, dispite the immense talents of its people and the forces holding them down, one or two talents still bob up. Oh – One other thing – if price is the market signal to invest and biuld capacity or clear capacity, then what does inflation eventually do to all markets? What insanity calling for inflation!
So what if houseprices fall? Its about time! It’s better than having a currency like the lira and a government to match.
Why do we not bail out failing UK industries to preserve jobs like the coal miners or type setters at wapping? Because each one of us would be paying higher costs in lower living standards and higher unemployment would occur elsewhere in the economy, through higher energy costs making many businesses unviable.
Firms would face higher costs as a whole and we would lose many trade markets which have to pay for our imports.
Mr Hammond
You say:
Lets face it the problem is not collecting taxes, but the immense size of the spending on government non jobs and waste.
Of course govenment is not perfect. It’s run by people. But please prove this is the problem.
You haven’t. I have not yet seen anyone do so. Where would you begin?
Why does no party facing the prospect of power agree with you?
Could it be you are simply offering a rant, not an argument?
Richard