Wednesday, 10 October 2012

Bank Of England To Abandon Inflation Fight

In a speech to the London School of Economics, last night, Mervyn King said that the Bank of England might abandon the idea of setting monetary policy to control inflation , in order to avoid an economic crisis. Most people would say, given that the Bank of England has failed to meet its inflation target for most of the last five years, that it already had! During large parts of that time, inflation on the RPI basis has been more than twice that target, and for some of the time almost three times the target. On the basis of the real figure for inflation as it affects ordinary working people, inflation has been even higher than that. Wages, pensions and other workers income, of course, have failed to come anywhere near those figures. That the Bank is now formally proposing abandoning the target, it has failed to meet for so long, is no coincidence.

Earlier in the year, the Bank of England once again pronounced that inflation would fall below the 2% target by the end of this year. The difference was, that, as official inflation rates did begin to fall, many economists looking at a deteriorating economic condition, believed they may be right this time. I didn't. As I've pointed out several times in the past, just because economic activity is depressed does not mean that inflation falls. That is basically a Keynesian view based on the idea that prices are determined by demand pull or cost push pressures. In other words, higher economic activity can cause consumers to be prepared to pay more for commodities, the additional demand pushing prices up, and vice versa. Similarly, rising costs can cause suppliers to increase prices, causing buyers/workers to seek higher wages to cover their increased costs, and vice versa.

The former assumes there is sufficient money in the economy to allow the additional demand to be monetised, or else that suppliers can simply increase their prices to meet increased costs. Similarly, it assumes that falling demand will cause suppliers to lower prices, rather than that they will simply reduce the amount of supply, whilst keeping prices high, or even raising them. The 1970's/80's stagflation showed that is not true. It combined an even lower, prolonged level, of depressed economic activity than today, with inflation up to 27% p.a. Given the massive amount of money printing there has been compared to the 1980's, the only surprise, is perhaps that inflation has not been even higher.

That is explained by several facts. Firstly, consumer price inflation was kept low because of a huge influx of cheap manufactured commodities from China. Increased money supply was soaked up in the increased volume of items consumed.

Secondly, a lot of the money supply was in the form of credit creation. The real price of consumer goods bought is not captured in CPI or RPI data because it does not capture the real price consumers pay for all those goods they buy using credit of one form or another. If you buy consumer goods, for instance, via a credit card which charges you 30% p.a. interest then a £100 item really costs you £130, if you don't pay off your credit card for a year. Some consumer credit, for example, on store cards charges even higher amounts than that, and the amounts on pay day loans run up to 4000% (four thousand!) a year. In other words, the real amounts people are paying, because we know that a large and increasing number of people have used lots of such credit to continue consuming, is significantly higher than ticket prices. This is one way in which Money Capital has been draining surplus value from productive capital, because all of this money that consumers have been handing over to these lenders, is money that otherwise could have gone to buying actual goods and services. Its notable that, when mortgage rates were slashed in 2007, the huge savings for mortgage payers went in part to reduce credit card debt, whilst retail sales continued to surprise on the upside, because with less interest to pay each month, consumers had more to spend on goods and services.

Thirdly, precisely because a large part of the things consumed in Britain – food, energy, manufactured goods – are imported, the money that was printed, and found its way into circulation, went into the pockets, and from there the bank accounts not of British companies and workers, but into the pockets and bank accounts of foreign companies and workers. That is why those measures of Money Supply which look at the growth of Bank Deposits have not grown as much as economists expected. Its because the growth of bank deposits has instead happened in China and elsewhere! As a consequence, the money printing in Britain, as with the money printing from the US, has not caused the huge leap in consumer inflation in those countries that would be expected, but has instead caused a large increase in inflation in china and other rapidly growing economies. However, ultimately, that catches up with you. High Chinese inflation has caused Chinese wages to rise sharply too, and now the prices of Chinese goods being imported to the UK are rising fast too. That means that all that cheap Chinese clothing etc. that kept consumer prices low in the UK for years, is coming to an end.

Fourthly, whilst cheap imports on a massive scale kept consumer price inflation relatively low, the rest of the huge amounts of money printing went into the kinds of things the Bank of England, and Federal Reserve, wanted to see, the buying of shares, bonds, and property. That pumped up absolutely huge bubbles in these things, which gave their owners the illusion that they had become more wealthy. It thereby, prompted them to borrow even more money against these fictitious assets, which then went into even more speculation in them, which pushed their prices even higher. Such a process is well known. When individuals do it, its called a Ponzi Scheme, and its perpetrators usually end up going to gaol. When governments and Central Banks do it, its called Quantitative Easing, and they are given all kinds of awards for their ingenuity! The other advantage for the US and UK from such a strategy was that almost perpetually rising Stock and Bond Markets, meant that countries like China, accumulating lots of money they needed to invest, had every reason to invest it in US or UK Stocks and Bonds.

In fact, the strategy has been used down the ages not to increase people's wealth as the bubbles gave the impression, but to impoverish and enslave them. Everyone who invests in a Ponzi Scheme, like that developed by Ponzi himself , or like the scheme devised by John Law or more recently - Bernie Madoff all rely on people's greed, and their willingness to suspend disbelief. They take people's money, and rather than investing it so as to create real new wealth, they rely on the illusion that new value has been created, by using the money paid in by newer investors to pay high returns to existing investors. Because people see these high rates of return, it encourages even more people to want to enjoy that benefit, so lots more investors pile in, handing over their money, which then gets paid to the existing investors and so on. Until, that is, not enough new investors can be found to provide enough money to keep paying out the high returns. Then the whole thing collapses. It can take years to build up such a bubble, but just a matter of weeks, or even days for it to collapse.

That is what happened with the property bubble in the US and Ireland, which when it popped crashed house prices by between 60-80%. It was a similar bubble that collapsed in Britain in 1990, when house prices fell 40%. The same huge bubble exists in UK property today, but on the basis of the 1990 bubble, and previous property price collapses, it will take an 80% collapse to restore the balance. But, this fulfils a useful function for Capital. In order for capital to fully exploit workers, it requires that they have nothing to sell, nothing to fall back on, but their labour-power. Marx sets out in Capital, how in the 18th century, capitalists complained they could not make decent profits, because workers were only prepared to work for half a week to earn the money they needed to buy the commodities they could not provide for themselves. So long as workers still had a piece of land, or were able to use the common land, to grow most of their own food, and were able to spin wool and cotton, and weave their own cloth and so on, they were not forced to work for capital. It was only when they were forced off the land by the Enclosure Acts, that they were forced to work for hours on end, day after day in the factories. A similar process occurred in France in the early 19th century as Marx describes in the Eighteenth Brumaire of Louis Bonaparte. But, it goes back as far as Joseph in the Old Testament, who showed the Pharaoh how to enslave the Egyptian peasants by lending food to them, in return for their land, children and wives.

So long as workers owned some property it was not possible for capital to exploit them as easily. For example, the period after the Second World War was very similar to today in many ways. In 1947, my parents, like many more newly married couples of the time, were desperate for a house of their own, to bring up their children. This surge in demand sent house prices through the roof, just as has happened in recent years. They bought an old terraced house for £1,000, which was a huge sum at that time, when weekly wages were on average only around £5! I saw some figures recently that gave the average house price in 1950 as nearly £2,000, which is widely out of whack with reality. In fact, had my parents been able to hold on a couple of years, until the surge in demand had settled, and new supplies of housing had arrived, they could have bought a brand new, semi-detached house in the same village for just £250!!! For those who think that house prices could not now fall by 80% that should be a salutary lesson.

The consequence was that during most of the 1950's and 60's, my father had to work from 8.00 in the morning often until 9.00 at night, as well as half a day on a Saturday (even though he was bitterly opposed to overtime working) just in order to be able to meet the mortgage payments, and other weekly bills. So long as capital has people in this position, it can impose lower wages, and longer working hours on them. By the later 60's, with most of the mortgage paid, and with wages having risen, he no longer was compelled to work overtime, or Saturdays. Workers who during the 1960's, and 70's were able to buy a house and no longer were committed to finding rent or mortgage payments out of their wages each month, were able to save also, and build up other reserves. This posed a problem for Capital. Such workers, if they are on strike, can survive for much longer. They are less likely to settle for overtime rather than a real increase in their hourly rate of pay, they are less likely to take up jobs that pay low wages and so on.

The Long Wave Boom after WWII had put large numbers of workers in that position. Just as they had to take property away from the peasants in the 18th and 19th century in order to turn them into compliant wage slaves, so Capital needed to take workers property in the form of their houses, and pensions and savings away from them now, for the same reasons. Clegg's ridiculous proposal for getting parents and grand parents to give up their own property in order to provide deposits for their children on massively bubbled up property, is just the latest manifestation of that. It is, however, a last gasp sign, along with all the other government measures designed to keep the house price bubble inflated a while longer so that the banks are not destroyed when the bubble bursts. But, just like every other Ponzi Scheme, the UK house price ponzi scheme will end, when there are no “bigger fools” prepared to hand over their own hard earned money, to the previous “greedy fools” who thought they had found a way of making money for nothing. The fact, that even with the unsustainably low interest rates, the government schemes, the concentrated propaganda and so on, demand for houses is falling, whilst supply continues to rise, with continued falls in selling prices of around 25%-30% outside London, shows that this particular Ponzi Scheme is also about to collapse.

One of the reasons for that is likely to be not just the rising rates of real unemployment and under-employment i.e. the vast growth of zombie jobs, but the effects of that and rising inflation on squeezing real wages, and therefore disposable income, which is crucial for house prices. That is why the Bank of England is formally abandoning the struggle against inflation. Already in the pipeline we know that food prices are set to rise by around 16% in the next few months. On top of that, the energy companies have announced that in the next few months they will be increasing their prices by around 12%. That is on top of huge rises in train fares, and the increased costs that people will face as a result of the cuts in local government, which means they will now have to pay for services they previously obtained from the Council, or will face sharply higher prices on Council Services, for things like Leisure facilities and so on. Any hope that lower economic activity would cause inflation to fall in coming months has already been dashed, just from these known price increases. On top of all the other incompetences of the Government so far, they are now driving it towards stagflation.

But, the fall extent of that probably is not yet recognised. The bank of England has kept interest rates at unsustainably low levels during all this period, but the costs of borrowing for Banks and Building Societies are determined not by that, but by the costs in global capital markets. Despite all the money printing, uncertainty and fear in those markets still causes interbank lending to periodically seize up, and rates in those markets to rise sharply. That is why Banks and Building Societies have been raising mortgage rates. But, the banks are getting towards the latter stages of the process they always go through when they expect property prices to crater. That process, involves avoiding repossessions where possible, to avoid causing a collapse, which would mean the bank cannot get the value of its loans back, by extending forbearance on arrears, and so on. But, it also involves the banks lending out less money for property, requiring much higher deposits, so the bank has less to lose if prices collapse and the mortgage goes into default, and charging higher rates of interest.

In respect to the latter, banks and building societies have also started moving people from the interest only mortgages that were set up in the 1980's back to repayment mortgages that were pretty universal until that time. As people renegotiate their mortgage, or if they come to move house, many people with interest only mortgages will find this a shock. All those who took out Endowment Mortgages in the 1980's, will find the Endowment will not cover the Capital sum on the mortgage. To move from an interest only mortgage to a repayment mortgage, on a £150,000 mortgage will cost an extra £420 a month!

But, the increase in inflation is also likely to cause the dam of low interest rates itself to burst. Those low interest rates have been sustained on the back of massive money printing, and Financial Repression, as money has been hoarded in vast quantities in money funds, or supposedly safe assets like Bonds, pushing Bond prices higher and yields lower. It has created a huge bubble in the Bond Market, matching those in the property market, and Stock Market. With Yields for UK Gilts at 300 year lows, its fairly obvious that something has to give soon. The “hot money” that flows into these markets can just as easily flow out at a minute's notice into something else. The latest data shows that, in fact, although financial markets rose in the last quarter, it has been on worryingly low volume, which has fallen by around 20%. Funds appear to be draining out of Stock and Bond Markets and into Exchange Trades Funds, particularly those for metals, such as Gold.

If the Bond Vigilantes, get spooked, then vast sums could flood out of UK Gilts in minutes, sending the Yield up sharply. That would destroy all of Osborne's Narrative about low interest rates based on economic competence! Rising inflation, and concern over the UK economy could in any case cause UK Gilt Yields to rise, with or without a collapse of Bond Prices. The IMF's latest report must be all the more worrying for the Liberal-Tory Government on that basis – IMF Report. The IMF has basically accepted that its economic theory has been wrong. Formerly, they believed that the multiplier, the amount that the economy grows or contracts for any given amount of stimulus or contraction was around half. That is, if you cut Government Spending by 1%, it causes the economy to shrink by 1/2%. Now they think that the figure is more like 1.7. That is cut by 1%, shrink the economy by 1.7%!!!

That explains why the economies in Greece, Spain, Ireland, Italy and Britain, have gone into a downward death spiral as a result of the austerity measures imposed, whilst the US, which has used fiscal expansion, has continued to grow. Of course, some of us have been saying that for the last couple of years, without all of the academic research facilities available to the IMF, or the huge salaries paid to its economists! But, it demonstrates just how illiterate the Liberal-Tories economic policies are, and it shows just how trapped by their own political narrative they are. That is why despite everything, the only thing they can continue to say is that they will keep doing the wrong thing, and digging a deeper hole. But, without being able to use fiscal stimulus to rescue the economy, the only thing left is monetary policy. That is why even if inflation soars, Mervyn King and the Bank of England will have to keep pumping out more and more money, despite the fact that money printing isn't working either!

If Capital wants to save its investments in the UK economy, their own interests appear to be best served by getting rid of the present set of incompetents. But, whatever capital does or does not do, workers themselves should organise to bring the misrule of Cameron and Co. to an end as soon as possible. Miliband and Balls may be not much better, and certainly they offer workers no real long term solution to their problems, but workers are not indifferent to the state of the economy, which affects their lives on a daily basis. It is in our immediate interests too, that the present incompetent and illiterate policies are stopped, so that there is a chance of bringing some relief. But, in the end, the only real solution for workers lies in our own hands, taking over the means of production ourselves, establishing at a minimum a European wide federation of co-operatives, increasingly integrating the plans of these companies to do away with the uncertainty and fear that the Capitalist market engenders, and building upon it, our own worker owned and controlled provision of all those things we need, and which we cannot rely on the Capitalist State providing such as education, health and social care, as well as provision for old age, via worker owned and controlled pension schemes. In short we need to begin to replace Capitalism.

No comments: