Plan B Kicks Off

Get used to this

So here we are with a government spending far more than it can raise in revenue, building up a catastrophic pile of debt, and facing an election in just two years time. Spending cuts are needed to balance the books, but more cuts this close to an election just ain't gonna happen. What on earth can be done? George is prepping Plan B.

George's Plan A is to pray for growth, and in both the 80s and 90s it was a resurgence of growth that came to the fiscal rescue. Unfortunately, with debt overhangs and busted banks all around us, we're now in a much more difficult position than we were back then. The growth rescue looks to be way off, and George knows it.

Which is why he's now busily working on Plan B. It's the traditional plan for over-borrowed governments everywhere, and its ingredients are as follows:

1. Engineer higher inflation by printing money - in an open economy like the UK it's quite easy because currency depreciation soon gets prices moving up.
2. Fail to index tax thresholds in line with higher prices - that boosts income tax revenues as earnings respond to higher prices (aka fiscal drag), adding to the higher revenues flowing from VAT. 
3. Limit spending in cash terms- hold spending departments to strict cash limits.

Over the last several months, George has taken action on all three components.

First, he confirmed in the Budget that under his new flexible friend Governor, the Bank of England will no longer be restricted to a 2% inflation target. In future, it will be allowed to set itself "intermediate thresholds", such as keeping "interest rates low while unemployment is high, provided inflation is not expected to rise too much". How much inflation is too much? That's for him and the Governor to choose, and you to fret about as you watch your savings disappear down the plughole.

Second, he's increasing the higher rate income tax threshold by only one percent a year, even though inflation is running much higher. The £150,000 threshold at which the top rate of income tax applies is frozen altogether, as is the £100,000 threshold above which the personal allowance starts being clawed back. The higher is inflation, the more harshly these measures will bite, with around half a million additional taxpayers being dragged into higher rate tax over the next two years. Similarly, the threshold for Inheritance Tax has been frozen at £325,000 since 2009.

Third, he announced in the Budget a huge increase in the scope of departmental cash limits. He said:

"The public spending framework introduced by the previous government divided government spending into two halves: fixed departmental budgets and what is called Annually Managed Expenditure. Except in practice it was annually unmanaged expenditure – and it includes almost the entire welfare budget as well as items like debt interest and payments to the EU.  

We will now introduce a new limit on a significant proportion of Annually Managed Expenditure. It will be set out in a way that allows the automatic stabilisers to operate – but will bring real control to areas of public spending that had been out of control."

Exactly how it's going to work is unknown, but the intention is clear enough. And it promises a revolution in the way that welfare spending is controlled. Because instead of pre-committing to pay whatever bill the agreed rates of welfare benefit generate, he's saying the total amount will be cash limited. Benefit rates and entitlement rules will have to be flexed to fit within a cash ceiling, and that will have to include upratings to cover inflation.

As for debt, higher inflation will obviously erode the real value of government obligations fixed in cash terms, notably its issues of so-called conventional gilts. True, its index-linked gilts will have to be adjusted in line with the higher inflation, but since they only comprise one-quarter of total gilt issues, the Chancellor comes out well ahead.

Of course, there is a serious risk that what he gains on the debt erosion swings he will lose on the debt interest roundabouts. If the markets lose confidence, as they did when a similar scam was tried back in the 1970s, interest rates on new gilt issues will shoot up and debt servicing costs will take off. Even so, because the existing stock of debt has such a long average maturity, it will take a couple of decades before the full impact is felt.

So that's Plan B. And it's worth noting what the world's most successful central bank ever has to say about it:

"Government debt fosters the risk of inflation. Central banks, too, are usually exposed to the strong pressure that burdens states with high levels of debt. This is because the higher the pressure on the government to get the public debt under control, the greater is the temptation to exert pressure on the central bank to lower interest rates via monetary policy measures... 

If, in order to safeguard its solvency, the government pressures the central bank to set a lower interest rate than is compatible with price stability, demand increases too quickly, and this ultimately leads to higher inflation. In this case economists speak of a regime of fiscal dominance: interest rates are no longer set according to the requirements of price stability but instead are dictated by the state’s need to reduce its financing costs. 

Measures taken by central banks in the past, under the influence or control of the state, to lower interest costs or to reduce the overall debt burden, have ranged from straightforward interest rate reductions to purchasing government bonds in secondary markets and to direct monetisation of government debt.  

To be able to resist this political pressure, central banks have traditionally been granted a high degree of independence. This was, among other things, a response to the experiences of the 1970s and 1980s. This era of oil price shocks posed a major challenge to monetary policy-makers. It became apparent that countries with independent central banks had much lower inflation rates – and similar or even higher growth – than countries whose central bank was answerable to the government.  

Central bank independence is therefore essential to inspire confidence that the central bank will keep inflation low. However, a high government debt burden can generate doubts about its actual independence and undermine its credibility, even if it has not actually changed its monetary policy course. Once doubts arise about of the monetary policymakers’ capability to defend their independence against political interference, they risk losing control of inflation expectations and thus over inflation itself."

That's the Deutsche Bundesbank speaking - the rock-solid guardian of German economic stability right up to   when the Germans were bounced into the Euro.

My advice? Get down to the building society, draw out all your cash, and get yourself some of these:

Yes, I know - easier said than done. Personally I'm going to contact the Major's old mucker Mr Gomulka who apparently has a lock-up full of them.

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www.gudanggrosiran.com Categories: inflation

Proverbial Hawks

No Proverbial Hawks listed

So Deputy Governor Bean says that he and his colleagues at the Bank of England are watching inflation "like proverbial hawks".

Hmm. You have to wonder whether Proverbial Hawks watch the right bit of the field.

Because today's inflation figures have yet again surprised on the upside. CPI inflation has moved back up to 3.3%, and RPI inflation is back up to 4.7%. Inflation has been above the official 2% target for 39 out of the last 48 months, and with VAT going up to 20% in January that record is set to get even worse. Some hawk.

In Tyler's experience what actually happens is this: the economics establishment lock themselves into a particular world view and find it incredibly difficult to admit they've got it wrong. Even when the numbers start telling a different story, people cling on to their world view and explain away the numbers as a temporary aberration.

OK, the facts are these.

In the two years since Lehman blew up and we were told we faced the unfathomable horrors of deflation, the overall price level has increased by 5.2% (CPI). Prices have not fallen. We have not had deflation.

The impetus - as we've blogged many times - has come from import prices. The combination of weak sterling and soaring world commodity prices has pushed up the cost of our imports by 10%.

The Bank and others have argued that we can live with that, because it hasn't fed through into wage increases. In other words, there is no 70s style wage-price spiral in the making.

But wages have certainly not been flat. Despite the rise in unemployment and widespread concern about job security, average earnings have still gone up by over 3%. And although the recovery has only just started, one-third of firms are already reporting skills shortages. As they say in labour market circles, watch this space.

Of course, there is that other explanation for the Bank's inaction - the not-so secret plan to inflate away the UK's debts.

Like we've said before - sell money.

PS A great shame that Mr Dale has pulled the plug on regular blogging. He was one of the original UK political bloggers and was always well worth worth reading. He'll be missed.

Gudang grosir baju anak murah - harga pabrik !!
www.gudanggrosiran.com Categories: inflation

The Real Question - Who Pays?

A seriously bum rap

Here's what's supposed to happen: you borrow some money, and then you repay it. And the emphasis is on the word "you".

Now, what's so hard about that? The practice has been around for centuries, and nobody can honestly claim ignorance of the rules.

Yet somehow, when borrowers decide they can't make their repayments, it's rarely seen as their fault. Instead, the blame is landed on the lender, either for making it too easy to borrow in the first place, or for demanding repayment in times of difficulty. Tyler has never thought it fair that poor old Shylock loses his ducats because some smart-ass amateur lawyer gets the borrower off on a technicality, especially when Shylock would still have had to honour his own debts to his depositors. But you're meant to cheer.

And so to the current Irish crisis.

The Irish have borrowed A Lot of money. Their citizens borrowed a lot to buy property, their government borrowed a lot to... ummm... spend, and their banks borrowed a lot to punt around, largely on property loans. Their external debt is now a staggering 1300% of GDP, most of it now effectively nationalised through the government formally guaranteeing its banks' debts.

Here's how it ramped up during the go-go years to reach its current €1.74 trillion (chart is in millions of Euros, taken from the highly informative Ireland After NAMA):

So who's to blame?

Well, yes, the Irish of course. For borrowing so much. Obvious.

But Tyler is just listening to J Humphrys summarising the situation for BBC R4 Today: "...the vultures are circling Ireland... the country may be forced to hold out the begging bowl... the vultures may then turn their rapacious attention elsewhere..."

Those greedy flesh-ripping lenders - why does anyone put up with them?

But what's the real question beyond the tabloid emotion? The real question - as we all surely understand by now - is who's going to pay? Not just for Ireland's debts, but for Greece, Portugal, Spain, Italy, etc etc.

As regular BOM readers may recall from this blog, traditionally there have only ever been four options for governments with too much debt. Let's review them to see who actually ends up paying:

1. Repayment - ie the government runs budget surpluses. Taxpayers pay.
2. Default - most likely in the form of a partial default via debt restructuring (aka haircuts, debt for equity conversions, or coupon conversions). Lenders pay. 
3. Inflation tax - where debt is denominated in fixed money terms (as most is), governments can work off their debts by engineering inflation - effectively a gigantic stealth tax on debt holders. Lenders pay, including anyone who has been foolish enough to save their nest egg in a building society account.
4. Growth - GDP growth is the holy grail of indebted governments. Growth makes a given amount of debt less significant relative to GDP and tax revenues with each passing year. It's a get-out-jail free card for both the borrower and the lender.

But this is where Ireland and the others have a problem. Because they're members of the Euro, and that pretty well nukes options 3 and 4. As everyone in the real world always understood, the Euro makes it impossible for individual members to crank their own printing presses. Ireland and the others can't impose an inflation tax, and can't depreciate their currencies to stimulate growth - they're locked in.

Which means the only options are either to repay - whatever the tax and spending implications - or to default.

Now, the average Irish/Greek/Portuguese/Spanish citizen is going to opt for default - no question. But sadly, the lenders aren't nearly so keen. And since the lenders largely comprise banks based in other member states of the EU (including Britain), those members are not keen either.

Which is why Ireland and the others' membership of the Euro has brought a fifth option into play - transfer the debt to taxpayers in other countries.

And that's precisely what is being done with the EU's €750bn bail-out package, agreed during the Greek crisis in May. Taxpayers elsewhere are being forced to guarantee up to €750bn of loans to basket cases like Ireland.

Fortunately, the UK's share of these guarantees is limited, because - thank God - we aren't members of the Euro (keeping us out was one of only two useful things G Brown ever achieved). But even so, it could still be well over £10bn (including both our €8bn share of the European Financial Stabilisation Mechanism and our €4bn share of increased IMF lending).

But spare a thought for the German taxpayer. They've always run a tight Lutheran ship in terms of their own borrowing, but now they're being called upon to guarantee tens of billions of Euros in loans to the wild free spending PIIGS. And they will note that the EU's announced €750bn bail-out fund only covers a fraction of the total external debt of the PIIGS, which comes in at over €5 trillion.

Of course, at the level of the entire Eurozone, there IS an alternative. As several commentators have argued over the last few days, the European Central Bank could fire up the presses. It could flood the world with Euros just as the Fed is flooding the world with dollars. It could do so until Euro inflation - currently around 2% - takes off.

But if you're a normal everyday punter in Germany, why would you feel any better about that? You almost certainly never wanted the Euro in the first place, and went along with it only because you were assured it would be the rock solid Deutschemark by another name. How are you going to react when your Euro savings are obliterated simply to shore up the PIIGS?

At the end of the day, a bout of Euro inflation looks increasingly likely - all the other options are simply too hard for Europe's rulers to swallow. German taxpayers are going to be left feeling just like these American furry animals feel about the Fed's antics on the dollar printing press (HTP JWK):



PS If by any slight chance anyone is reading this thinking the inflation storm won't affect us, today's re-acceleration of UK inflation to 3.2% - above market expectations - is an excellent reminder of reality.

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www.gudanggrosiran.com Categories: debt, euro, inflation

Inflation Squeeze

Are your pips squeaking yet?

Much squawking over British Gas putting up its prices by 7% - surely they're profiteering at our expense.

As so often, it depends which hand you use to look at it. On the one hand, wholesale gas prices have risen by 25% since the spring, so British Gas is being perfectly reasonable in passing it on. But on the other hand, the previous fall in wholesale prices was not passed on so it's a bit rich to pass on this latest increase.

The truth is that the energy companies have to earn a crust - ie they have to make a profit. They set their prices to us on the basis of prices in the world wholesale market. But the latter fluctuate all the time, whereas we consumers expect tariffs that stick around for a while. So the companies have to smooth things out by taking a view on future wholesale prices.

And they don't always get it right. This chart from Ofgem shows how their net profit margin per customer has varied over the last few years, from a peak of about £75 pa right down to a loss of £150.

Tyler fully understands that the energy companies are not our friends, and given half a chance would rip our faces off without compunction. But we cannot expect them to protect us from cost increases on the world markets where they buy their supplies. All companies have to make profits to pay shareholders for the use of capital. They are not - nor can they ever be - charities.

Unfortunately, it isn't just energy prices - what's happening in the energy market today looks horribly like a portent of what's about to happen right across our economy.

Consider. A couple of weeks ago we blogged the alarming explosion in world commodity prices. At the time we noted that the Economist's commodity price index was up by 35% over the preceeding 12 months in sterling terms. That was bad enough, but the picture now - just two weeks later - is even worse. After a further 6% hike in the last week alone, the 12 month increase in commodity prices now stands at a 1970s apocalypse-style 44%.

44%!

In just one year.

And understand this - the bulk of that increase has not yet fed through to us in our homes and high streets.

Meanwhile the inflation rate in China has jumped by nearly one percentage point in just one month.

Frankly, we're scared. What can we do?

We turn to the appointed guardians of the Pound in Your Pocket - the Bank of England. How do they propose to protect us against the inflationary dragons rising in the East? What do they have to say in their latest Inflation Report?

Here's what:

"... recent increases in commodity and other world export prices could lead to renewed upward pressure on inflation. That upward pressure could be heightened if some companies need to rebuild their profit margins, which were compressed during the recession...

...there is a risk that commodity prices will continue to rise. That would cause further increases in companies’ costs, and lead to higher inflation over the forecast period... That would also exacerbate the risk that the prolonged period of above-target inflation might cause companies’ and households’ expectations of future inflation to increase. That could feed into price and wage-setting decisions, offsetting the downward pressure on prices from spare capacity."

Hmmm...

Could... would...?

Is and will, more likely.

The Bank must surely be getting embarrassed about these quarterly inflation reports. For as long as anyone can remember, their forecasts of inflation have almost always turned out to be too low - far too optimistic. We've blogged this many times (eg here), but just as a reminder, here is a selection of the Bank's forecasts, starting from February 2009 and ending with this week's. Focus hard and spot the pattern:

Chart 1 - Bank of England inflation forecast February 2009

Chart 2 - Bank of England inflation forecast February 2010

Chart 3 - Bank of England inflation forecast November 2010

Spot it?

Back in February 2009, the Bank forecast that the inflation rate today would most probably be between 0% and 1%. They reckoned there was a 1-in-4 chance that prices would actually be falling (ie the Dreaded Deflation), and the chance of inflation being over 2% was put at well under 1-in-10.

Crank forward to February 2010 (just 9 months ago), and the Bank had nudged up their forecasts a bit - they now said inflation would most likely be between 0.5% and 1.5% by now. But they still thought there was a good chance of lower inflation, and still a 1-in-5 chance of deflation (despite the fact that the printing presses had been running in overdrive for a year).

And now? Well, today's CPI inflation has actually turned out to be over 3%. And even the Bank's own November forecast acknowledges it's back on a rising track.

And yet - despite their obvious inflation optimism in the past, despite their massive money printing, despite the further weakening of sterling, and despite the world commodity price boom - they still reckon that inflation will fall back below 2% pa within a year. It's almost as if they start all their forecasts from already knowing the answer - ie inflation will somehow soon be back below the 2% target.

Look, can we all agree on what's really going on here?

For years Britain has been consuming beyond its means, and in future we'll have to consume less. We're going to be squeezed. The real question is who's going to be squeezed the most?

Here's the abbrieviated list of squeeze options:

• Squeeze the rich - aka raise the top rate of tax and execute tax avoiders - popular with the Grun, the BBC, and the Bishop, but the rich simply up sticks and leave
• Squeeze the poor - aka means tested welfare cuts - very unpopular with the poor, the Grun, the BBC, and the Bishop, and looks like the same old Tories
• Squeeze the middle class - aka general tax rises and universal welfare cuts - very unpopular with the middle class, the Mail and the Telegraph... oh, and the Grun, the BBC, and the Bishop as well
• Squeeze the public sector - very unpopular with the public sector, the unions, the Grun, the BBC, etc etc

Now, if you're at the controls, you look at that and decide none of it looks altogether appealing - the losers are far too obvious.

But inflation, well, that's different.

You see, inflation is one of those things that not only spreads the misery far and wide, but you can also blame it on someone else. Ah yes, you say, those fiendish Orientals with their monstrous appetite for commodities... I gave them a damned good talking to in Seoul, but what can you do? They've made our lives a misery! And what about those crazy Yanks?! I haven't the faintest idea what they thought they were playing at with that huge printing press - it was sheer madness! All out of our hands though - we are victims of global circumstance (we'll conveniently overlook the fact that much of the inflation reflects sterling's 25% depreciation).

The Bank of England makes much of the fact that higher price inflation has not fed though to higher pay rises in the manner of a 70s wage-price spiral. And that is perfectly true - so far.

But while that may give some comfort on the prospects for inflation, it does nothing for those who are currently being squeezed by inflation itself. Obviously that includes pensioners and others whose savings income has plummeted, but it also includes those still at work. Because since the crisis broke back in 2008, inflation has already exceeded average pay growth by 2%, implying  a 2% cut in real living standards (even before taking account of higher taxes).

This squeeze is set to get worse as inflation ticks up. Those with inflation linked incomes (such as public sector pensioners) will be protected. Everyone else - including those still in work - will be squeezed.

So next time you get whacked in the wallet by some headline grabbing price rise, don't blame British Gas and don't blame Mr Sainsbury.

This is being done to you quite deliberately by those at the very top. Somebody has to pay, and they've decided it should be you.

Gudang grosir baju anak murah - harga pabrik !!
www.gudanggrosiran.com Categories: inflation

Nurse!

American pie - now worse even than the clothes in Don's vid

[Warning - contains scenes of US monetary growth that some viewers may find distressing]

On the day of the US election results and the latest round of Fed dollar printing, Tyler was intending to do another of his "just like the 70s" retro-posts. You know - an incompetent discredited President wildly out of his depth in a busted economy, a central bank deliberately debasing the currency, and a frightened demoralised populace looking for scapegoats. Kind of idea.

But once he sat down to start typing, Tyler realised it's actually worse than the 70s.

Let's consider US monetary policy. Back in the 70s the US Federal Reserve Board was far too lax in the face of rising inflation, an inflation that spilled over to the rest of the world and brought huge increases in the world price of oil and other commodities. Following the de-linking of the dollar from gold in 1971, the US currency was soggy throughout, falling by about 20% overall (in trade-weighted terms).

Eventually of course there was a day of reckoning. Inflation was threatening to get seriously out of control - like it always does after such monetary laxity - and the legendary Paul Volcker was appointed as Fed Chairman to sort it out. Which he did, but only at the cost of sky high interest rates and two recessions in three years.

Now here's the thing - the Very Scary Thing. Compared to today's Fed, the high inflation, weak dollar,  pre-Volcker 70s Fed was an absolute model of monetary rectitude.

We need to look at the so called monetary base. No, don't skip forward to the end - the monetary base is really quite simple (at least in theory). It comprises the money issued directly by a country's central bank - the Fed in this case. That's all the notes and coin in circulation, plus the money commercial banks hold on deposit with the central bank.

And what's the significance of this monetary base?

Well, most of what you and I think of as money comprises not the notes and coins we have in our wallets, but what we have sitting in our own bank accounts. The bank is where we keep our money, and we spend it by writing cheques or flashing a plastic card. In other words most of our money is merely an entry in our bank's accounting ledger - it is not a direct obligation of the central bank.

What that means of course is that most of our money depends not on the central bank, but on the commercial banks being able to honour our cheques and plastic (which can sometimes get a little scary, as we recently rediscovered on the pavement outside Northern Rock).

However, modern banks are not allowed to create this accounting entry money willy nilly ad infinitum. Against every extra bit of money they create, they have to hold a fraction of its value as reserves with the central bank - those central bank deposits we already mentioned as part of the monetary base (this is called the fractional reserve system).

That places an upper limit on how much money the commercial banks can create relative to how much money the central bank has issued in the form of the monetary base. And it means that the size of the monetary base is crucial in determining how much money can get created in the economy overall.

That's why the monetary base is sometimes called "high powered money". It is very high octane, and it needs to be handled with great care.

Still with this?

Good.

Because over the last two years the Federal Reserve has increased the supply of this high octane monetary base by an astonishing amount. It's Quantitative Easing programme has more than doubled the monetary base. In two years they have printed more high powered money than had been printed in the whole of previous US history:

Take a good hard look at that chart. Scary or what? It makes the high inflation 70s Fed look like a bunch of puritan tight wads. It is a monstrous historic act of monetary irreponsibility.

And even worse - even worse - the Fed are reportedly about to do even more. Even more!

Now of course, what they say is that they are having to do this to stave off depression, or at least, the dreaded double-dip. That although they've stoked up the supply of high powered money, the overall money supply - the stuff that US citizens have in their own bank accounts and which they can actually spend - has barely moved. And indeed it hasn't (M2, the most widely used measure, is up barely 3% year-on-year).

But that is only what's happened so far. There is now a superabundance of the Fed's high octane fuel sloshing around, and sooner or later there's going to be a spark. An inflation spark.

Maybe it will be the current lift-off in world commodity prices. Or maybe it will be a collapse of the dollar. Or more likely it will be both, feeding into a vicious spiral just like back in the 70s.

And what happens then?

I'll tell you.

Accelerating inflation means money is worth less. You need more of it just to stand still. The real world money supply starts to grow. And because of all that high powered money in the reserve accounts of the commercial banks, and because they have every incentive to exploit excess reserves, the money supply can grow quite fast.

Higher prices will feed higher money growth, higher money growth will feed a weaker dollar and yet higher prices, which will feed yet higher monetary growth.

It could all happen very quickly. Suddenly the Fed is facing an inflationary conflagration with no off-switch.

Reverse the printing presses pdq?

Yeah, sure. And you honestly think the Obama/Bernanke combo is capable of doing that.

No. The horrible truth is that the US has embarked on a 70s style inflation, only with even more fuel on board.

And the even more horrible truth is that it may well be deliberate. Faced with the prospect of a US economy weighed down for decades by the huge debt burden it's built up, its current rulers have decided they'd rather take the escape hatch labelled inflation. Who cares if the rentier Chinese get burned?

There will of course, be consequences down the line. But they'll be for someone else to sort out.

Bye bye Miss American Pie.

Meanwhile, we've said before and we'll say it again - sell money.

Fast.

PS We don't usually do this, but Rob has suggested in the comments that we should redraw the graph with a log scale. Good suggestion so here it is:

Conclusion? The rate of increase under Bernanke really has been higher than at any time since 1918 (ie the line is steeper than it has ever been before). As we say in the main post, the monetary base has more than doubled in the last two years, something that took five years during that last ramping up you can see in the late-30s/early-40s (and you know, at that point there was a war on).

PPS It's not quite a Chevy to the levy, but we must mark the sad passing of 84-year old Pontiac - the original all-American muscle car. And the reason we care is that Mrs T's Dad owned a Pontiac back in 50s London. No, he wasn't rich but he did work in a garage, and this car had clearly been brought over originally for some rich yank stationed here. A pic is in order (not that said Dad is in this particular pic):

Gudang grosir baju anak murah - harga pabrik !!
www.gudanggrosiran.com Categories: inflation

Screwing Savers

So the Deputy Governor of the Bank of England thinks savers should stop moaning and start spending. He says:

"Savers shouldn't necessarily expect to be able to live just off their income in times when interest rates are low. It may make sense for them to eat into their capital a bit... Very often older households have actually benefited from the fact that they've seen capital gains on their houses."

So now we know. Savers should not expect the Bank of England to protect them against the ravages of inflationary finance. The Bank's official advice is to spend your savings pdq before they disappear.

According to the Bank of England's own stats, the average interest rate on High Street savings accounts is a derisory 0.23% pa. Yet inflation is currently running at 3.1% on the CPI measure and an eye-watering 4.7% on the RPI measure. So after taking account of inflation, the real rate of interest is somewhere between -2.9% and -4.5% (the chart above uses the RPI).

As we've discussed many times, inflation is the ultimate stealth tax. It is a tax imposed by governments on those holding its debt (or at least its debt that isn't specifically indexed against inflation). And anyone holding their savings in a simple savings account at a bank or building society - still more anyone holding their savings in £20 notes under the mattress - is paying towards that tax.

And let's just remind ourselves of the Bank's shocking record on inflation. Since 2003, when the 2% pa CPI inflation target was first set, inflation has averaged 2.5%, and at times during the last couple of years it has been far higher:

And the prospects for future inflation don't look a whole lot better. Sure, the Bank regularly tells us that the current inflation overshoot is temporary, and that "inflation expectations remain well anchored", but frankly they've been singing that same tune for months now. And every time they publish a new Inflation Report they postpone the moment when inflation is expected to return to target. Just as a reminder, see if you can spot the difference between these successive forecasts:

Chart 1 - Bank of England inflation forecast February 2009

Chart 2 - Bank of England inflation forecast February 2010

Chart 3 - Bank of England inflation forecast August 2010

Spot it?

Yes, that's right - back in Feb 2009, just before they put the printing press into overdrive, they reckoned inflation now would probably be between 0% and 1%. A year later in Feb this year, they reckoned it would be between 1% and 2%. But now we're actually here, it's turned out at 3.1%.

Yet despite this dismal forecasting failure, they still continue with pretty much the same old story - there's no need to worry about that roaring printing press because inflation is about to fall below target.

Well, frankly, roaring printing presses should always worry us. And they should always worry savers in particular.

Of course we're not alone in our concern. The excellent Liam Halligan has consistently warned of inflation disaster ahead, and there are others. And now even those who have previously supported the roaring presses are starting to worry.

This morning we get a startling recantation from the Telegraph's Ambrose Evans-Pritchard. He is now alarmed by recent statements from the US Fed, seemingly intent on debauching the dollar:

"I apologise to readers around the world for having defended the emergency stimulus policies of the US Federal Reserve, and for arguing like an imbecile naif that the Fed would not succumb to drug addiction, political abuse, and mad intoxicated debauchery, once it began taking its first shots of quantitative easing.

My pathetic assumption was that Ben Bernanke would deploy further QE only to stave off DEFLATION, not to create INFLATION. If the Federal Open Market Committee cannot see the difference, God help America.

We now learn from last week’s minutes that the Fed is willing “to provide additional accommodation if needed to … return inflation, over time, to levels consistent with its mandate.”

NO, NO, NO, this cannot possibly be true."

Well done to Pritchard for apologising to those of us who have always taken the other view, but I'm afraid it may be too late. Those of us who recall the 70s remember only too well the global inflationary havoc caused by a soft money Fed intent on monetising the post-Nam post-Big Society Federal debt.

So what to do*?

First, get rid of your savings accounts. Don't wait for the Bank of England to rob you of your savings - do it now.

You need either to switch into index-linked gilts (although note that short maturities are priced to deliver a negative real return - so you'll still lose some of your capital), or switch into a real asset. You're probably too late for gold or grain futures, but the struggling UK property market - yes, that old one - might be worth a look. Cam's government have made it quite clear planning restrictions will be maintained, so if you can drive a fire sale deal, long-term supply shortages (at least in the South East) are far more likely to protect your savings than a building society account on 0.23%.

Of course, if you're a widow or an orphan dependent on the income from your savings, then you're stuffed. Just like always, you are set to be the schmucks who have to pay for the mess visited on us by a bunch of vainglorious incompetent politicos.

Why do we elect these people again?

*Terms and conditions apply. The value of investments can go down as well as up, and Tyler hereby affirms amd asserts that he is in no way qualified to offer investment advice to you or anyone else. Including himself.

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www.gudanggrosiran.com Categories: central banks, inflation

Enron Labour

Allow me to introduce the finalists for Labour's Got A New Leader*

Today's revelations of Labour ministers flouting the rules governing the proper use of taxpayers' money ought to shock us.

"Labour ministers rammed through hundreds of millions of pounds of spending on pet projects before the election against the explicit advice of senior civil servants. Senior mandarins throughout Whitehall resorted to the ‘nuclear option’ – writing to demand written orders from ministers because they disapproved of the decisions."

According to Jonathan Baum, General Secretary of the First Division Association, which represents senior civil servants (and of which Tyler was once a member):

‘This is very much a nuclear option in government departments. ...it is very clear that the permanent secretary was very concerned about the spending decision but was overruled by the minister. When a permanent secretary asks for the letter of direction from a minister it is because they feel a serious decision is being taken which they feel is not right.’

We don't yet have all the details of precisely which decisions were rammed through like this, but the bottom line is clear enough - Labour ministers abused their power in a desperate last-ditch attempt to buy votes... with our money. Shocking. Absolutely jaw-droppingly breath-takingly shocking.

And yet... are we really shocked? Can we any longer be shocked by what that appalling bunch did during those 13 abysmal years?

From the very start they lied and cheated their way through office. They systematically abused our trust with their Enronised debt figures, their bubble economy, their illegal war, their fiddled dumbed-down exam results, their fudged crime statistics, their gross distortions over immigration, and their unbridled pillaging of the public purse.

As the indispensable Jeff put it last week (and please do read it if you haven't already):

"Unemployment is higher today than in 1997, as are taxes. The pound is worth less than 13 years ago, as are many private pension schemes. Personal insolvencies are at record levels. Worst of all, the state is borrowing one pound in every four that it spends, and our collective debt is set to double by 2014-15 to about £1.4 trillion, equal to one year's GDP.

The "success" of New Labour's economic expansion was a sham, based on a simple formula: spend more than we earn; pass off consumption as investment; wallow in self congratulation. Through the "boom" times of 2003-2007, all of Mr Brown's budgets involved massive borrowing. He told us we were getting richer, while in effect making us poorer.

In those five years alone, he clocked up £160 billion of debt. These are harsh, unavoidable facts. The legacy of that profligacy will bear down on British taxpayers for generations. As Niall Ferguson, professor of history at Harvard, has concluded, Mr Brown's stewardship of the economy was a "disaster".

But look, we are where we are. It's too late to wish away 1997. The main thing now is this: when the Brothers Millipede next appear arm in arm on the stage, glottal stopping in the limelight, and singing their saccharin ditties of progressive consensus and fairness for all, just remember.

Remember that Labour always always wreck our economy. Remember they always wreck our public finances, and they always leave a gigantic mess that someone else has to clear up and we have to pay for.

There are no exceptions. From Ronald McDonald, to Jerusalem Clement, to Wislon, to Uncle Jim, to Bliar, to Brown, it is always a disaster.

So please - one last time - never ever give them another chance.

PS Today's inflation numbers are once again very unsettling:

All measures of inflation are up, and RPI inflation is now running at 5.3%, the highest for nearly two decades. The Bank of England may still be relaxed about this, but we most certainly are not. Anyone on a fixed income - which these days includes pretty well everyone working in the private sector outside the banks - is being squeezed dry. And as for savers on their 0.5% interest rates, they've been so squeezed they're now little more than a dessicated husk.

And sterling? Well it paused for breath today, but it still looks very groggy. As we blogged yesterday, getting a grip on our public spending problem will be good for sterling in the longer term. But in the short-term it may actually make sterling a bit soggy since lower spending allows the Bank to keep interest rates lower for longer. Of course, if the Bank were suddenly to realise the jolly old inflation genie was out of its bottle again, then rates would go up and sterling would firm.

So what happened to the point that sterling would collapse if we didn't cut spending? Well, it's still there. If George doesn't cut spending, HMG will have to borrow more, a chunk of it from abroad. Which is fine as long as investors remain confident that they'll get repaid, and as long as we give them a good rate of interest. But if for some reason, confidence cracked - like for example, the markets suddenly got the crazy idea the coalition couldn't actually agree on spending cuts - then there'd be a rush for the exit. The point is that currencies are driven by a whole raft of different pressures, and they are just about the least predictable of all the key asset prices: someone once described them to Tyler as "the balancing residual in the global financial system". But what we do know from our own experience is that confidence is key. Which is why these cuts are vital to the value of sterling.

*Footnote Talking of Enron, did you see that the award winning (here) British play of that name (pic above) has just bombed on Broadway. It closed after two weeks losing an estimated $4m. The British theatre establishment are aghast, blaming those low-brow insular Yanks for not appreciating good art. Another explanation goes along the lines of US audiences not being prepared to stump up $120 a seat to watch a bunch of anti-capitalist anti-American propaganda cooked up by a state-funded theatre company from an irrelevant socialist country thousands of miles away. And come to that, who said it was OK for my taxes to be used to put on the play in the first place? If people want to watch anti-capitalist anti-American propaganda, fine. But they should pay for it themselves.

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www.gudanggrosiran.com Categories: deceit, inflation, new labour

Labour's Legacy Of Misery

We've blogged the Misery Index before. It was first devised when Labour last had a go at wrecking our economy, back in the 70s. It comprises the sum of the annual increase in the RPI and the unemployment rate, which are two key statistics in gauging economic misery.  

The latest reading has pushed the index up to 12.4%, comprising 4.4% RPI inflation and an 8% unemployment rate.

So they really have done it again. When Labour came to power, the index was running at 10% and falling. It is now 12.4% and rising.

And today's unemployment stats show quite clearly that Brown's apparent miracle of stabilised employment in the teeth of recession was no more than a cruel illusion. And the unemployment rate of 8% compares to the 7% they inherited.

What a disaster.

PS Tyler lunched with a friend who has now completed his contingency arrangements to bail out on 7 May. He has a private pilot's licence, and even if the air space eco police have again closed us down, he's off. He reckons remaining here with Brown still at the controls will be far more hazardous to his health than any conceivable cloud of volcanic ash. But he'll need an early start - our guess is that the runways could be pretty packed that day.

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www.gudanggrosiran.com Categories: 2010 Election, inflation, new labour, Unemployment

Debt Trap - Lessons From History

1819 - what happens when government debt gets too high

[Warning: this is another of those posts that turned out to be quite long]

Are we too worried about the government's spiralling debts? According to the left-wing economics consensus the answer is yes. They reckon that gross debt of 83% of GDP, increasing at 11 percentage points pa (OECD projections), is perfectly sustainable into some unspecified "medium term".

One of the arguments they use to support this line is that Britain has had much higher government debt in the past, and it didn't trigger a disaster. So let's take a look at the facts.

The following chart is taken from the quite outstanding website ukpublicspending.co.uk. It shows Britain's public sector debt as a percentage of GDP since 1800 (pedant point - yes, there were some coverage and definitional changes through the period, but they don't affect the big picture):

As we can see, by the end of the very expensive Napoleonic Wars in 1815 our national debt had soared to over 250% of national income - an all-time record. It then took an entire century to get it back down to just 25% in 1914. At which point of course, Britain got involved in not one but two very expensive world wars, and the debt ratio soared again, reaching 240% of national income at the end of WW2. Then began another long decline, reaching 25% of GDP again by the beginning of the 90s. And we know the story since then all too well.

There are two immediate points to make. First, all three of the previous spikes resulted from the need to pay for do-or-die wars - we really had no choice. Second, it takes a awful lot longer to reduce debt levels than it does to increase them - debt that takes a few years to incur takes decades to work off.

Still, on the face of it, you might well think the left-wing economists have a point - we have had much more debt at various points in the past, and we always seem to have survived.

But let's take a closer look at just how previous governments managed to work off the debts.

There are only ever four options:

1. 
   
   Repayment - 19th century governments routinely repaid large amounts of debt - ie they ran budget surpluses. And in truth, there have also been three brief periods of repayment during Tyler's lifetime - first when Jenkins was forced to tighten fiscal policy after Labour's 1967 devaluation, second when My Brilliant Chancellor was at the controls in the late 80s, and third when Prudence was temporarily in charge during the late 90s.
2. 
   
   Default - Unlike many other governments around the world, HMG has not had an outright default since the 17th century. However, it has had quite a few partial defaults via what is known as debt conversion. The most recent was in 1932, when the National Government converted £2.1bn of War Loan paying a 5% coupon into a new loan paying just 3.5%, making all its holders significantly poorer at a stroke.
3. 
   
   Inflation tax - prior to the 1970s all HMG's debt was denominated in fixed money terms, and even today, the vast bulk of it still is. What that means is that governments have been able to work off their debts by engineering inflation - effectively a gigantic stealth tax on debt holders. Of course, that doesn't work with the inflation protected index-linked gilts introduced in the 70s, and crucially it doesn't work if the markets get their retaliation in first by hiking interest rates to compensate for anticipated inflation (see below).
4. 
   
   Growth - GDP growth is the holy grail of indebted governments. Growth makes a given amount of debt less significant relative to GDP and tax revenues with each passing year. It's a get-out-jail free card for both the borrower and the lender. The trouble is that highly indebted governments always find it difficult to stimulate and promote sustainable growth - in particular, they have little scope for tax cuts.

In his book The Cash Nexus, historian Niall Ferguson estimates how important each of these factors has been over the last two centuries. Up until 1914, while there were a number of debt conversions, most of the work was done by honest-to-goodness repayment and GDP growth. With Britain on the gold standard, the inflation tax played virtually no part.

What a contrast with the post-WW2 period. With the Gold Standard long-since ditched, governments of all complexions let rip with the printing press, and debt holders suffered horrifically. Ferguson estimates that in the half-century between 1947 and 1997, government debt increased by over 1200% in money terms. Yet because of inflation, in real terms the debt actually declined by 27%, which is one hell of an inflation tax.

But although the inflation tax was very useful to HMG for several decades after WW2, it turned out there was a slight problem - after a while debt holders simply stopped trusting the government. Instead, they started demanding much higher interest rates on government debt to protect them against the inflation tax. Which meant that government had to issue even more debt to fund the higher debt servicing costs.

Here's how that played out in terms of the average interest rate on public sector debt over the last 200 years:

As we can see, once investors lost confidence in the government's reliability, their angry reaction pushed the cost of HMG's borrowing way beyond anything that had ever been seen before - even in the panicky conditions of WW1.

Which brings us to the key lesson for today.

Back in the 19th century the government was able to fund its deficit at an average interest rate of well under 4% pa. Investors trusted gilts because Britain was the undisputed hub of the global capital market, inflation was controlled by adherence to the Gold Standard, and successive governments had demonstrated by their actions a strong commitment to fiscal discipline.

Unfortunately, we're not in that world any more. Today, our capital market is just one small piece of a much larger global market, which is quite capable of hiking gilt yields back to double digits faster than you can say William Ewart Gladstone.

And that's why we can take no comfort from the fact that HMG debts today look relatively low against past peaks. Because what really matters is not the quantum of debt per se, but what it costs to service that debt.

The following chart shows how public sector debt interest payments have varied as a percentage of GDP:

Straightaway we can see a big difference from the simple debt chart shown earlier: the peaks from WW1, and especially WW2, are lower. That reflected the government's success in keeping down the rates they paid on their war debt. For example, during WW2 there was heavy reliance on forced saving of one kind or another, which was accepted because, well, there was a war on. But HMG most certainly couldn't pull a similar stunt today.

The big peak in debt servicing costs was still at the end of the Napoleonic Wars, with HMG's interest costs pushed up to around 10% of GDP. On the face of it, that makes our current 3% look comfortable. But we need to remember that the burden in 1815 proved completely insupportable. The heavy taxes required to pay the interest fuelled social unrest and a whole series of crises. Far from a comfort, it was in fact an unpleasant lesson to all subsequent 19th century governments about the perils of excessive government debt.

Drawing this together, the key conclusion is that the past offers little comfort in our current predicament. Yes, there have been periods when our debts have been higher relative to GDP, but the key issue is not the debt itself but the cost of servicing it. And on that, the key driver will be the confidence of markets in HMG's commitment to fiscal discipline and low inflation.

And always remember this: today's debt figures hugely understate the true extent of government debt. As we've blogged many times (eg here), unfunded public sector pension liabilities are currently in excess of £1 trillion, and other off-balance sheet Enron items like PFI add a further quarter-trillion. None of those liabilities existed to any serious extent in 1815, which means to get a true comparison we need to inflate today's debt-to-GDP ratio by around 75% of GDP, taking it up to about 150% (thanks to Andrew Lilico for reminding me to mention this - it's so easy to forget).

We're right back to where we started, but you might care to reflect on the following grisly calculation.

On the government's own official debt forecast - ie even ignoring the Enron items - if the market pushes gilt yields up to the same levels we saw in the 1970s, by the middle of the current decade, the debt servicing burden will increase beyond what it was at the end of the Napoleonic Wars.

The tax consequences don't bear thinking about.

Update: It turns out that BBC R4 The Long View is covering this very issue today - 9am repeated at 9.30pm. Worth a listen, if only for Prof Ferguson's contribution.

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www.gudanggrosiran.com Categories: debt, inflation

Does Anyone Know How To Fly This Thing?

Going up

Ladies and gentlemen, this is your Captain speaking. You may have noticed we're currently flying through an area of turbulence. There is absolutely nothing to be concerned about, and we will soon level out. Althoooough... just as a precaution you might want to return to your seat immediately and assume the brace position. And if there are any pilots on board perhaps they would make themselves known to a member of the cabin crew. Priests too... we could probably use a couple of them up here...

****

This is getting scary. CPI inflation has jumped to 3.5% - 1.5% above the 2% target; RPI inflation is up to 3.7%, and RPIX inflation (ie RPI excluding mortgage costs) is up to a belting 4.6%.  Yet according to the Governor, there is no need for alarm. According to him, this is a temporary spike caused by the reversal of the VAT cut, a 70% year-on-year hike in oil prices, and the depreciation of sterling in 2007 and 2008.

Indeed, rather than focusing on the upside risks to inflation, his letter is much more concerned to assure us that he stands ready to refire the printing press should inflation fall too much.

The trouble is, the rest of us - especially those dependent on pensions and savings - are not at all comforted by the Governor's assurances.

Let's just remind ourselves of the Bank's inflation record since the 2% CPI target was set in December 2003. The following chart shows the rolling 12 month CPI inflation rate against the 2% target and the 2.4% average inflation rate actually achieved by the Bank over the period as a whole. Yes, that's right - despite all that alarmist talk about deflation, the Bank still failed to hit its 2% target, overshooting by an average 0.4% pa.

This is not a great record. As we can see, the Bank's grip on inflation has been far from secure. They got so lax in the run-up to the Crash that in September 2008 inflation broke through 5% - two-and-half times their 2% target. Indeed, there are those who argue that if the Crash had not come along at that very moment, the Bank would have had considerable difficulty getting back on track.

And remember too that this period was fairly benign in terms of the global background. For example in the Eurozone inflation averaged just 2% pa.

What's going to happen if, driven by China and the other BRICS, world commodity prices remain under upward pressure. And what if a deeply indebted US government carries on running the dollar presses, just as it did to finance its Vietnam/Great Society spending splurge in the 70s? And most of all, what's going to happen if the markets take fright and whack sterling again?

I'll tell you what's going to happen - far from behaving in the orderly way that the Bank and Will Hutton describe, our inflation rate will lurch upwards.

The stomach knotting truth is that the Bank is losing its commitment to low and stable inflation. Given all the uncertainties, it is much more willing to see inflation overshoot than to risk being accused of nuking GDP growth.

But as we've blogged many times, in anything other than the short-term, you cannot sustain GDP growth by cranking the printing presses. We remember the 1970s; they got very bumpy indeed. And the big lesson was that inflation really does matter. Not only does it rip the faces off pensioners, widows and orphans: it also undermines confidence and investment, with devastating consequences for growth.

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www.gudanggrosiran.com Categories: inflation

Spot The Difference

Chart 1 - Bank of England inflation forecast February 2009

Chart 2 - Bank of England inflation forecast February 2010

Hmm... now let me see...

A year ago, just before the Bank fired up its £200bn printing press, they expected inflation to fall into the range 0-1% pa, with a significant risk of outright deflation (charts relate to Consumer Price Index - CPI).

Today, they have revised up their figures to reflect the fact that inflation is currently running at just under 3% pa, and far from falling, is heading higher. It seems that inflation has refused to die despite the demise of our dear old friend GDP growth.

Undaunted, the Bank reckons inflation will soon fall back again, with apparently still something like a 20% chance of outright deflation.

Yet we know that sterling commodity prices are up 19% year-on-year, and we know that producer output price inflation has already accelerated to 4%.

Hmmm...

I have a very bad feeling about this.

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www.gudanggrosiran.com Categories: inflation

Inflation Tax Kicks In

Here we go again

Remember when the massed ranks of the left and much of the economics commentariat told us that Britain was on the brink of a deflationary black hole, and that the only way of saving ourselves was to slam the printing presses into overdrive?

Hmm, yes, well, this morning we heard that CPI inflation has gapped up by the biggest monthly increase since records began (1996). RPI inflation has increased by the biggest monthly amount since 1979 - ie back amid the wreckage left by the last Labour government.

Since the collapse of Lehman's in September 2008, the UK price level as measured by the CPI has increased by 2.4%. It perhaps doesn't sound much, but it's happened during the deepest recession since the 30s, and the figures do not yet include this month's 2.5% increase in VAT.

So who are the victims?

Ultimately, all of us who depend on the long-term health and success of the British economy: banana republics have never been much good at delivering anything but bananas.

More immediately, anyone on a fixed income is squarely in the line of fire. And most of all, that means pensioners and savers.

As the Telegraph points out, a saver on the standard rate of income tax now needs to earn at least 3.63% on a deposit account, otherwise the net of tax return will be negative in real inflation adjusted terms. Yet currently, there isn't a single easy access account that pays that, and most pay well under 1%.

We're right back to the inflation tax: anyone with a bank or building society savings account, and anyone with a private pension is going to get seriously whacked.

Care? As we've blogged many times (eg here) socialists hate savers. Savers constitute the rentier class living off the backs of the workers. They deserve whatever they get, right up to and including being stood up against the wall and shot.

Of course, the Bank of England - the guys who've actually implemented this madness - they're supposed not to be socialists. In fact, if memory serves, there was once some vague idea that they'd be independent of government.

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www.gudanggrosiran.com Categories: inflation

She Canna Take Much More Of This Captain

Tyler has learned that the Bank of England is following a revolutionary new approach to monetary policy. According to a top secret Bank report, it works by exploiting "the expansion of space-time as a consequence of the vacuum ground-state of higher dimensional graviton fluctuations" (see key formula above).

As you will know, this is the approach long envisaged in sci-fi, most famously in the warp drive that powered the Starship Enterprise. But never before has a central bank had the sheer dilithium balls to fire it up for real. The Bank is boldly going.

So how's it working out?

Today we got an update. According to the Bank, we're rapidly winding up to warp speed, and from its current slump, GDP is about to make the jump to hyperspace:

Growth will be so strong, that we'll have recovered our entire output fall within two years. It will be the fastest strongest recovery we have ever had from any slump.

And it's all thanks to the warp drive's combination of zero interest rates and a roaring printing press.

Unfortunately, at this speed, the old ship is beginning to vibrate rather alarmingly.

For one thing, the exchange rate is down 25% since we first hit the asteroid belt back in 2007 (ERI = Exchange Rate Index - sterling's value against a basket of currencies):

That's one helluva fall, and it's made us all poorer because it has increased the price of imports. Which also means upward pressure on inflation.

And surprise surprise, the Bank is now warning that inflation itself is set to increase:

"Inflation is likely to rise sharply to above the 2% target in the near term, reflecting higher petrol price inflation and the reversal of last year’s reduction in VAT."

Which sounds pretty worrying. Although the Bank reckons it's nothing to worry about, and inflation will subsequently come right back down again later:

Do you believe that? Do you believe it any more than you believed all those dire forecasts of falling prices/deflation?

Er, no.

The fact is that this warp drive technology remains highly experimental and very scary. The various captains up on the bridge may believe they can control it. But down here in the crew quarters we're not at all convinced the ship can take it.

We do not want to perish in an inflationary black hole. And now that the Bank reckons we're back on track for growth, we think it's time to disengage the warp drive, and go back to good old fashioned propellor power.

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www.gudanggrosiran.com Categories: central banks, inflation