Does the government really want lower inflation?

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It would be funny if it weren’t so tragic. Presenting the Bank of England’s Inflation Report a week ago Sir Mervyn King said inflation “has now fallen within touching distance of the 2% target… The big picture is of a further decline in inflation.”

It’s one thing for the Bank of England to get its medium and long term forecasting wrong, as it almost invariably does, but quite another to get it so wrong over JUST SIX DAYS. Instead of CPI falling, it rose from 2.4% to 2.6% while RPI(the determinant of rail fare increases) rose from 2.8% to 3.2%.

Why is the Bank of England paying bonuses?

Given the Bank’s appallingly costly, misbegotten policies, it beggars belief that there have been over 8,000 bonus payments to Bank of England staff of up to £30,000, totalling £25.3 million, in the five years since the credit crunch began.

The immediate prospects for inflation

As ex-MPC member Andrew Sentance has explained, Sir Mervyn and the MPC have a one-sided view of the government’s 2% CPI inflation target. Although 2% is supposed to be the level around which inflation revolves, CPI, which recently rose as high as 5.2%, has only been below 2% in 9 out of the past 76 months. The MPC appears to be terrified of CPI falling below 2% but all-too-relaxed when it goes above. No doubt we will hear soon that the rise, as always, was due to factors beyond the MPC’s control. We should not forget, however, that the cost of imports is higher as a result of the Bank presiding over the biggest drop in sterling since 1931, only part of which has been made back since.

Despite Sir Mervyn’s comments on the weakness of the world economy, there are good reasons for believing that inflation is unlikely to diminish much in the near term. World oil prices have rebounded to levels they were last seen at in early May. The worst American drought since 1936 has seen a surge in the price of corn, soybeans and wheat, with food price pressures increased by a drier than usual monsoon season in India and a lack of rain in Russia, while Western Europe has had too much rain. In addition, that bounce in the RPI will mean sharply higher rail fares next January.

QE and inflation

If you print money then – all other things being equal – the value of individual currency units will decrease, pushing up prices. That’s why George Osborne objected so vociferously when Quantitative Easing began, saying that “printing money is the last resort of desperate governments when all other policies have failed.” He has been more supportive of QE of late and the Bank of England has ordered up a total of £375 billion from Mervyn’s Magic Moneymaking Machine.

That’s almost as much as the combined annual budget for health, education and social security. Yet while Bank of England officials remain mystified that QE has had pitifully little success in boosting the economy, they admit that the early bout of QE might have pushed inflation up by as much as 1.5%.

As well as the appalling effect upon pension funds and annuity rates, QE is an inflation time bomb waiting to go off. The majority of the money is being retained by the banks. But unless the Bank of England is incredibly nimble and adept at reversing QE (and what are the bookies’ odds on that?) at some stage that money will find its way into the wider economy. It won’t only be £375 billion either. Because of the fractional reserve banking system, it will be far more than that. The inflationary impact could be horrendous.

Do the authorities actually want inflation to fall?

As a nation, we are awash with debt. A McKinsey report recently found that the total of government, household, corporate and financial sector debt is almost five times the UK’s annual Gross Domestic Product. How can this debt ever be paid off?

The government hasn’t even tried to pay off its share of the debt. The Deputy Prime Minister Nick Clegg, and the Chancellor himself during his Budget speech, seem confused about the difference between the debt and the deficit. But it is only the deficit – the amount borrowed each year – that the Coalition is trying to reduce. Having hit a record £163.4 billion in 2009-10, the intention was to cut this dramatically. So far, it has barely been dented. Even when the Chancellor was at his most optimistic, total government debt was still set to rise, four years out, to £1,500 billion, roughly the same as annual GDP. That forecast was dependent upon rapid growth, which has not materialised. With the economy doing so abysmally, tax revenues will be lower than expected and public expenditure higher. As a result, although we have yet to see revised figures, government debt will surely rise far higher than £1,500 billion.

There are only three ways to get rid of debt. Pay it off, default or inflate it away. Without growth, there is as little prospect of paying off the government’s debts as there is of Mervyn King admitting any responsibility for the state of the economy. The government would hardly consider defaulting. That leaves only the possibility of inflating it away. Some would argue that is exactly what has been happening and explains why the Chancellor has not been more severe with the Bank of England over its dreadful record on inflation.

The United States has a similar problem, with debt climbing almost to $16,000 billion, approaching its mandatory debt ceiling. Bill Gross, boss of bond fund manager PIMCO, wrote recently that “the primary magic potion that policymakers have always applied in such a predicament is to inflate their way out of the corner… unfair though it may be, an investor should continue to expect an attempted inflationary solution in almost all developed economies over the next few years and even decades. Financial repression, QEs of all sorts and sizes, and even negative nominal interest rates now experienced in Switzerland and five other Euroland countries may dominate the timescape. The cult of equity may be dying, but the cult of inflation may only have just begun.”

It is a view echoed over here by the likes of Tim Price of PFP Wealth Management. He objects to the “outrageous manipulation by the monetary authorities” of government stocks “when so many pension funds are being coerced / financially repressed into holding them. Now is the time for pension trustees to stand up for the interests of their pensioners rather than caving in.” But he too is fatalistic about the end outcome: “Explicit inflationism seems like the inevitable end-game for grotesquely indebted governments and their increasingly desperate monetary authorities.”

Keynes said: “The best way to destroy the capitalist system is to debauch the currency. By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens.”

Despite this month’s rise, inflation may well come down modestly in the near future. But the prospects after that remain pretty gloomy. The debauchery continues.

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3 Comments

1. Nick

   August 15, 2012 at 2:21 pm

   How true…

   Surely MPC and the chancellor should be charged for neglect of duty from the future generations..

   My expectation is that if there is one member who decides to leave this race to the bottom (either germany/north europe or usa) then UK economy will become like Zimbabwe..

   And it is disgusting that this is happening in order to save the banks the financial reckless individuals.

   Recommend (8)
2. DL

   August 17, 2012 at 3:09 pm

   This article’s conclusion really frightens me – as a pensioner who is reliant for income on a pension and interest on savings what on earth can we do to mitigate some of the effects of inflation coupled with “zero” interest.
   Is it not time for the government to re-nationalise more banks and infrastucture such as the railways, telecoms, and energy industry and by so doing curb some of the excesses of the private sector and use the profits to improve those sectors whilst maintaining a “hands on” approach to curb excessive pay and the credit industry.
   As far as the BoE is concerned those in charge need to go back to school and re-learn the basics of economics – supply and demand and the ability to pay.
   I feel very strongly that the EU in its present form is doomed to fail – we need to get back to the old EFTA association.
   This may be the time when price controls are once again needed.

   Recommend (3)
3. Edward

   August 23, 2012 at 4:43 pm

   That is marvellous, Mervyn’s Magic Moneymaking Machine

   Too right they are inflating the debt away, screwing penisons funds and annuities as they go about it!

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