Our currency has gone West and stagflation will soon be upon us
By Liam Halligan 9:02PM GMT 22 Jan 2011
The UK's Consumer Price Index rose 3.7pc during the year to December 2010. While this was, apparently, a "shock increase" – up from 3.3pc the month before – regular readers of this column weren't surprised.
The UK is experiencing a sharp "double dip" – even if the economy escapes slipping back into recession. British GDP expanded 2.7pc between July and September 2010, compared with the same period the year before. Fourth-quarter growth, though, was much slower.
When the numbers are published on Tuesday, we could be told that between October and December the UK didn't grow at all.
Sterling's decline and the impact of our particularly nasty credit crunch on productive capacity, always meant that the UK was prone to inflationary pressures.
Those, in turn, were in danger of being aggravated by higher commodity prices, given Asian demand and the slow development of new mines and oil wells due to the limited availability of global risk capital.
As this column has long predicted, such events are now coming to pass. It brings me no pleasure to point out that "stagflation" could soon be upon us and I expect no special plaudits.
It strikes me as common sense that we were likely to reach this miserable impasse, even if my "hawkish" scribblings have, until recently, been the minority view.
For more than two years now, opinion formers in the UK and elsewhere have been transfixed by City bankers and their academic lackeys who've argued that, far from inflation, we face "deflationary" dangers instead.
Their cure, conveniently, has been for central banks to "print money", issuing electronically-created credits then using them to bail-out said bankers. Such "quantitative easing" has also, handily enough, helped cash-strapped governments as the credits have similarly been employed to buy sovereign debt to fund "Keynesian" fiscal boosts.
As a result, on both sides of the Atlantic, currencies are being debased and government bond markets, in the UK particularly, are now propped up by pillars of funny money.
Inflation won't only mean that the Bank of England has to raise interest rates, compounding the difficulties of Britain's highly indebted consumers. Rising price pressures also make it harder to justify more QE – not that it was justifiable in the first place, at least not to anyone with the capacity for independent thought.
As inflation intensifies, even if central bankers refuse to raise base rates, borrowing costs in the market go up anyway. That's already happening – as anyone trying to re-negotiate their mortgage will tell you. "No more QE" is not want the bond market wants to hear.
Higher inflation, coupled with a falling currency, in turn makes it even tougher for the UK to sell un-indexed, sterling-denominated debt instruments – which is precisely what the majority of the gilts we place on the market happen to be.
For the next three or four years at least, we're due to issue such gilts in near-record quantities. No wonder those of us who've shouted about inflation have been lampooned, pilloried and subjected to personal abuse.
Such home truths are unlikely to be debated at the World Economic Forum in Davos this week, the annual gab-fest of the Western world's self-appointed economic elite.
Or at least they won't be debated in such stark terms, and not from the public platforms, the sponsors wouldn't like it.
Be in no doubt, though, throughout the Swiss mountain resort, behind numerous stiff card invitations and soft, cupped palms, subversive views on inflation and the dangers of QE will be frantically discussed.
The prime-time Davos debates will likely focus on the question of "global imbalances" – the gaping current account deficits between the West and the fast-growing emerging markets.
The consensus view is that such deficits are "unnatural" and "dangerous" and "something needs to be done" about them. I find this line of argument deeply disingenuous.
When the "sub-prime" fiasco first hit, many Western politicians claimed it was caused by such "global imbalances". So the credit crunch, along with the deepest Western recession in generations, wasn't the result of regulatory myopia and massive financial fraud. It has nothing to do with the Western world keeping interest rates too low for too long, or our governments and citizens spending like crazy, gorging ourselves on debt. The "global imbalances" thesis says it wasn't us, it was "them" – China and all those other cheating Eastern countries that had the audacity to produce and extract goods the rest of the world wants, run current account surpluses and build themselves a platform of economic stability.
I exaggerate – but not a lot. It really is the "Davos view" that the rest of the world "flooded the West" with savings, "forcing" us to keep interest rates low, so we "had to" take on more debt.
In reality, capital moves around the world all the time. As long as it is financing lawful activities, nothing should be done to stop it. The "global imbalances" thesis is a myth, a tawdry exercise in Western self-pity and blame-shifting. Taken further, it could even be used to justify protectionism and madcap capital controls.
With such protectionist dangers now far more acute than they were this time last year, I sincerely hope our leading lights will speak more objectively, shifting the Davos "imbalances consensus" towards what we need to do to put our government and household finances back on an even keel. But I'm not holding my breath. Blaming "foreigners" for one's own failings is so much easier.
The flip side of those current account imbalances, of course, is the massive stock of foreign exchange reserves now at the command of the non-Western world. Central banks in the old G7 today account for reserves amounting to less than 20pc of the global total, less than 10pc excluding Japan. All of this begins to cast doubt over the dollar's role as the world's reserve currency, not least given the continued reluctance of China, Russia and the other reserve-rich nations to keep buying US T-bills. And with "reserve currency status", America's ability to keep running loose fiscal and monetary policy, while shifting the bill on to the rest of the world, will be severely curtailed.
I happen to think that the dollar will retain reserve status for some time to come. While central banks have started using smaller "commodity-backed" currencies to park their wealth, such as the Australian dollar, the US dollar retains a 60pc share of the world's known reserve allocation.
Having said that, some kind of "basket arrangement" could emerge sooner rather than later, with central banks from the US, China and the other big economies creating a synthetic accounting unit in which they can all store part of their reserves. That would create natural checks and balances, hopefully lessening the danger of "currency wars".
The great unknown in this is the euro. The Davos crowd will tell you that the euro won't break up, given the strength of the core countries' "political will". I think that's tosh. The euro was created because the last generation of German leaders felt that, for political reasons, they owed the rest of Europe an apology.
It seems to me that the coming generation of German leaders feel, that for financial reasons, the rest of Europe owes an apology to them. And who can blame them?
So here's another prediction: within the next 18 months, at least one peripheral country will leave the euro and Germany will do nothing to stop that. And once that's happened, it could be followed by several more.
I hate 18 months...AGGGGGGG
By Liam Halligan 9:02PM GMT 22 Jan 2011
The UK's Consumer Price Index rose 3.7pc during the year to December 2010. While this was, apparently, a "shock increase" – up from 3.3pc the month before – regular readers of this column weren't surprised.
The UK is experiencing a sharp "double dip" – even if the economy escapes slipping back into recession. British GDP expanded 2.7pc between July and September 2010, compared with the same period the year before. Fourth-quarter growth, though, was much slower.
When the numbers are published on Tuesday, we could be told that between October and December the UK didn't grow at all.
Sterling's decline and the impact of our particularly nasty credit crunch on productive capacity, always meant that the UK was prone to inflationary pressures.
Those, in turn, were in danger of being aggravated by higher commodity prices, given Asian demand and the slow development of new mines and oil wells due to the limited availability of global risk capital.
As this column has long predicted, such events are now coming to pass. It brings me no pleasure to point out that "stagflation" could soon be upon us and I expect no special plaudits.
It strikes me as common sense that we were likely to reach this miserable impasse, even if my "hawkish" scribblings have, until recently, been the minority view.
For more than two years now, opinion formers in the UK and elsewhere have been transfixed by City bankers and their academic lackeys who've argued that, far from inflation, we face "deflationary" dangers instead.
Their cure, conveniently, has been for central banks to "print money", issuing electronically-created credits then using them to bail-out said bankers. Such "quantitative easing" has also, handily enough, helped cash-strapped governments as the credits have similarly been employed to buy sovereign debt to fund "Keynesian" fiscal boosts.
As a result, on both sides of the Atlantic, currencies are being debased and government bond markets, in the UK particularly, are now propped up by pillars of funny money.
Inflation won't only mean that the Bank of England has to raise interest rates, compounding the difficulties of Britain's highly indebted consumers. Rising price pressures also make it harder to justify more QE – not that it was justifiable in the first place, at least not to anyone with the capacity for independent thought.
As inflation intensifies, even if central bankers refuse to raise base rates, borrowing costs in the market go up anyway. That's already happening – as anyone trying to re-negotiate their mortgage will tell you. "No more QE" is not want the bond market wants to hear.
Higher inflation, coupled with a falling currency, in turn makes it even tougher for the UK to sell un-indexed, sterling-denominated debt instruments – which is precisely what the majority of the gilts we place on the market happen to be.
For the next three or four years at least, we're due to issue such gilts in near-record quantities. No wonder those of us who've shouted about inflation have been lampooned, pilloried and subjected to personal abuse.
Such home truths are unlikely to be debated at the World Economic Forum in Davos this week, the annual gab-fest of the Western world's self-appointed economic elite.
Or at least they won't be debated in such stark terms, and not from the public platforms, the sponsors wouldn't like it.
Be in no doubt, though, throughout the Swiss mountain resort, behind numerous stiff card invitations and soft, cupped palms, subversive views on inflation and the dangers of QE will be frantically discussed.
The prime-time Davos debates will likely focus on the question of "global imbalances" – the gaping current account deficits between the West and the fast-growing emerging markets.
The consensus view is that such deficits are "unnatural" and "dangerous" and "something needs to be done" about them. I find this line of argument deeply disingenuous.
When the "sub-prime" fiasco first hit, many Western politicians claimed it was caused by such "global imbalances". So the credit crunch, along with the deepest Western recession in generations, wasn't the result of regulatory myopia and massive financial fraud. It has nothing to do with the Western world keeping interest rates too low for too long, or our governments and citizens spending like crazy, gorging ourselves on debt. The "global imbalances" thesis says it wasn't us, it was "them" – China and all those other cheating Eastern countries that had the audacity to produce and extract goods the rest of the world wants, run current account surpluses and build themselves a platform of economic stability.
I exaggerate – but not a lot. It really is the "Davos view" that the rest of the world "flooded the West" with savings, "forcing" us to keep interest rates low, so we "had to" take on more debt.
In reality, capital moves around the world all the time. As long as it is financing lawful activities, nothing should be done to stop it. The "global imbalances" thesis is a myth, a tawdry exercise in Western self-pity and blame-shifting. Taken further, it could even be used to justify protectionism and madcap capital controls.
With such protectionist dangers now far more acute than they were this time last year, I sincerely hope our leading lights will speak more objectively, shifting the Davos "imbalances consensus" towards what we need to do to put our government and household finances back on an even keel. But I'm not holding my breath. Blaming "foreigners" for one's own failings is so much easier.
The flip side of those current account imbalances, of course, is the massive stock of foreign exchange reserves now at the command of the non-Western world. Central banks in the old G7 today account for reserves amounting to less than 20pc of the global total, less than 10pc excluding Japan. All of this begins to cast doubt over the dollar's role as the world's reserve currency, not least given the continued reluctance of China, Russia and the other reserve-rich nations to keep buying US T-bills. And with "reserve currency status", America's ability to keep running loose fiscal and monetary policy, while shifting the bill on to the rest of the world, will be severely curtailed.
I happen to think that the dollar will retain reserve status for some time to come. While central banks have started using smaller "commodity-backed" currencies to park their wealth, such as the Australian dollar, the US dollar retains a 60pc share of the world's known reserve allocation.
Having said that, some kind of "basket arrangement" could emerge sooner rather than later, with central banks from the US, China and the other big economies creating a synthetic accounting unit in which they can all store part of their reserves. That would create natural checks and balances, hopefully lessening the danger of "currency wars".
The great unknown in this is the euro. The Davos crowd will tell you that the euro won't break up, given the strength of the core countries' "political will". I think that's tosh. The euro was created because the last generation of German leaders felt that, for political reasons, they owed the rest of Europe an apology.
It seems to me that the coming generation of German leaders feel, that for financial reasons, the rest of Europe owes an apology to them. And who can blame them?
So here's another prediction: within the next 18 months, at least one peripheral country will leave the euro and Germany will do nothing to stop that. And once that's happened, it could be followed by several more.
I hate 18 months...AGGGGGGG