Britain Is Headed For Stagflation - Part 3 of 3

The other feature that has been developing for several years is that those factors that reduced commodity prices have started to reverse. Not only have productivity gains slowed globally, but China has seen rapidly rising wages. In addition, the value of the Yuan has been rising. So that although China remains the world's workshop, and supplier of vast quantities of consumer goods, which remain cheaper than equivalent commodities produced in more advanced economies, the prices of these Chinese goods is not as cheap as they were, and those prices are likely to continue to rise.

Finally, we have the situation with primary product prices. After the start of the new long wave boom, in 1999, raw material prices rose sharply as rapid increases in demand could not be satisfied by supply. But, rising industrial productivity meant that, despite these higher material prices, the cost of production of commodities fell.

The end of the rise in productivity more or less coincided with the point also where investment in raw material production started to bring huge amounts of new supply on to the market, around 2013-14, which led to significant oversupply and sharp falls in the global prices of oil, iron ore, copper, agricultural products like milk, and so on. In other words, the prices of commodities were initially constrained, because rapid productivity growth offset higher material prices, and when productivity growth slowed, that was offset by falling material prices. But, now we have a slowdown of productivity along with a stabilisation and steady rise in global material prices. For an economy like the UK, which relies on importing large amounts of energy, food and materials, and now also finished commodities, and whose currency is sinking like a stone, that is very bad news.

The UK can do little about the volume of these things it needs to import, and the continued falls in the Pound mean that their sterling price will continue to rise, sharply raising the cost of living. At the same time, the UK offsets these import costs by the export of services, but the demand for these services is not likely to rise significantly, simply because of a lower Pound. On the contrary, Brexit means that large sections of that service industry will relocate to Paris, Frankfurt or Dublin. In fact, one model for am independent Scotland, inside the EU, would be to offer Edinburgh as such a centre, where large large portions of the UK financial services industry is already located.

One factor mitigating a UK slowdown in growth is that despite the prognostications of the perennial catastrophists, global growth appears to be rising. The US economy grew by 2.9% in the last quarter, and it continues to create large numbers of new jobs, in excess of what is required to cover the growth of the labour force, reducing its unemployment rate, and even drawing some workers back into the labour market that had left it. Wages are rising, in the US, as a result, and that provides a basis for increased demand for those new ranges of consumer goods referred to earlier.

The election of Trump may cause a political shock that disturbs that, but, in fact, Trump is committed to a bigger fiscal stimulus than was Clinton. That stimulus will be financed by higher levels of public borrowing, which is one reason that the yields on government bonds have been rising sharply since Trump's election. Another reason, in the case of US Treasuries is that 65% of US debt is held by China, and given Trump's threats to China, it makes sense for China to sell its holdings of US assets before Trump can confiscate them, as he has threatened to do with Mexican assets to pay for the construction of the wall!

In Europe too, especially in its power house, Germany, recent survey data indicates a pick-up in growth, and inflation. Europe and much of the world is moving to a higher rate of growth, at a time when global productivity growth is slowing, when the glut of primary products is ending, when monetary policy and the inflation of financial assets has reached the end of the road, but Brexit means that Britain will be cut off from the main beneficial aspects of that growth, whilst suffering all the consequences of it, in rising inflation, and rising interest rates.

In other words, rising inflation, as global primary product prices, and consumer goods prices rise, rising rates of interest making the UK's huge trade deficit ever harder to finance; a collapse in financial asset and property prices, as rising interest rates reduce their capitalised values; a falling Pound, intensifying all those factors; a growing lack of competitiveness, as Britain, outside the EU, suffers from a lack of economies of scale and from tariff and non-tariff barriers on its exports.

But, Brexit, like Trumpism, also represents a resort to protectionism for all of those inefficient sectors of the economy. It means that the inefficient home producers will use it to increase their prices. It is a repetition of what happened in the UK's sclerotic economy of the mid 1960's and after, that led to nationalistic campaigns to limit imports such as “I'm Backing Britain”.  The Brexiteers are hoping that Trump will ride to their rescue, as they are isolated from the huge EU market, but Trump's protectionist policies, and pursuance of "America First", will have the opposite effect.  It will mean a contraction of trade, from which Britain as a relatively small economy will suffer.  Outside the bargaining power of the EU, any deals that Trump might do with Britain will reflect the fact that the US is a huge $17 trillion economy, whereas Britain is a tiny $2 trillion economy.  Any benefit will go to the US at the UK's expense, as happens with any such deal between parties with vastly unequal bargaining power.

And, of course, not only are such reactionary campaigns doomed to failure, but they initially reduce workers' living standards, as they have to pay these higher prices made possible by the excess liquidity sloshing about the system. Then, especially where workers are heavily over-borrowed, they lead to demands for higher wages, which protected firms then pay, in the belief they can simply recover the pay rise via yet higher prices.

The difference today from the 1970's is that the UK is a much less significant economy, as others, like China, India, Japan, and elsewhere have developed. Moreover, the amount of liquidity in the system, and the degree of inflation of asset prices is at historic and and unprecedentedly high levels; the degree of private household debt is huge, whilst wages are low and productivity is falling. In the 1970's, the UK was entering the EEC, with all of the advantages that provided of a larger market and lower costs that brought with it, whereas today it is proposing to cut itself off from those benefits.

Back To Part 2