Following the surge in US Inflation reported last week, we now have a surge in UK inflation. The rise was double what some economists had been predicting, but, as with US inflation, certainly not double what I had been predicting. In fact, as with the US inflation data, I believe that this official figure significantly understates the real rate of inflation in Britain currently.
All of the points made in my previous post in relation to US inflation apply to the latest UK data. It should be fairly obvious that if you significantly curtail supply of goods and services, by a government imposed lockout of workers, whilst at the same time handing out free money tokens to consumers, to continue consuming, then the inevitable result is that monetary demand exceeds supply and so market prices rise. Add into that rising costs and reduced productivity -in the case of Britain productivity that was already disastrously low – and add in a huge excess of liquidity, already pumped into the system, then rising prices must follow, and in current conditions those rising prices are likely to become systemic.
For the reasons previously set out, the actual official figures for inflation are likely to significantly understate it. Price rises for large numbers of goods and services were undoubtedly muted, or even negative, so long as these were goods and services that consumers could not buy as a result of lockdowns. Yet, those goods and services continued to be included in the basket used to calculate the rate of inflation. Its interesting that one main component of the rise this month in UK inflation has been the increase in fuel costs. That is inevitable as the lockdown starts to be relaxed, and people again begin to use their cars, after three months of them sitting unused outside heir houses.
In fact, given concerns over using public transport, for fear of COVID infection, it can be expected that people will seek to isolate themselves in their own vehicles even more where possible. In coming weeks, we are likely to also see a spike in demand for cars, for that very reason. As an example, the demand for private jets has soared. In fact, as Bloomberg reported recently, its not just the super-rich who now form this demand. An eight-seat jet to take a family to Spain and back can be hired for around £12-15,000. Clearly not cheap compared to Easyjet, but well within the capacity of a middle-class family off for a month's holiday at their private villa.
Yet, car production has been shut down for three months, because consumers could not go to showrooms to order cars, so there was no point in car production. A spike in demand for new cars coming after the stopping of supply, is likely to cause new car prices to rise at least in the short term. Rising money profits for car makers, may well lead to them needing to take on additional workers, though much car production now is automated, but there will still be a rise in demand for car components, and so on, that is likely to cause rising prices and employment in all those associated spheres too. In the case of Britain, where Brexit makes things multiple times worse, costs are already likely to be rising fast.
UK inflation came in at 1%, on a year on year basis, and rose 0.45% over the previous month. That compares to a 0.6% rise, year on year, in the previous month, and a month on month rise of only 0.1%. In other words, the rate of change over the month has risen fourfold.
Taking core inflation, it rose 1% year on year, compared to 0.6% in the previous month. The rise in month on month core inflation was again around 0.45%, as against just 0.1% the previous month. But, as with the US data, looking backwards gives a distorted picture. The current month on month data if continued for the next year would mean a rise in inflation of around 5.5%. Again, that is more than double the Bank of England's inflation target of 2%. Yet, for the reasons set out previously, even this inflation figure is likely to significantly understate the real situation.
The Bank of England may be prepared to endure a 5.5-7.5% rate of inflation. They endured more than 5% under Mervyn King, but, under current conditions, will the bond markets? These rapidly rising prices mean that all the things the government has to buy to keep hospitals, schools and so on running rise in price that much more sharply. It means all the things they have to buy to build and maintain roads, schools, hospitals and so on rise sharply. And that means that the amount the government has to borrow to pay for all of these things, whose prices are rising also rises sharply. It means that the things that workers need to buy also rise sharply, which means their wages need to rise, so that employers will seek to cover those rising costs, with yet more rising prices, facilitated by the fact that the government has poured huge amounts of liquidity into circulation via the Bank of England. As many of those workers are employed by the government itself, it means its own wage bill rises sharply, and because it can't raise taxes in current conditions, it can only fund it by borrowing even more money. But, the government borrowing had not yet even really started, as it needs to make up for falling tax revenues, whilst having to spend much more on welfare benefits as unemployment soars, following the ending of the furlough scheme, and the need to spend trillions of pounds bailing out large strategic industries undermined by the imposition of the lockout.
The triple lock on pensions alone means that as inflation rises sharply, the government will have to pay out much more for pensions. Where workers can't immediately get higher wages to compensate for higher prices, they too will have to borrow even more just to pay bills. Millions of businesses, deprived of sales over past months, whose cash flow position will have been destroyed, and unable, like the big companies, to issue their own bonds or shares, will also have to borrow on a large scale to get workers back to work, and to buy in materials etc. As monetary demand surges in certain areas, whilst other areas are destroyed more quickly than they were being destroyed before the imposition of the lockdown, businesses, in the expanding areas, will have to borrow to expand, whilst some of the struggling businesses will try to cling on by borrowing at any cost just to pay their bills.
However, its viewed, borrowing is going to increase massively, and the more inflation rises, the more that borrowing will increase. The delusion that printing money tokens could reduce interest rates will be exposed for being precisely that – a delusion. Small borrowers will face either the impossibility of borrowing, or else will face much higher rates of interest from lenders. The large companies will be able to issue bonds and shares, but potential buyers of those assets will give less and less for them, as they see the potential for making large real terms capital losses on them as inflation rises, and as yields on many bonds are already negative in real terms. To the extent that large firms are bailed out by the government, this only transfers the borrowing from those firms to the government. And, the same applies to shares.
In recent days stock markets have reached new all-time highs, despite the dire state of economies exposing for all to see that share prices and performance have nothing to do with the health of the economy or even profits, but are driven purely by speculation and a search for capital gains, fuelled by the astronomical amounts of liquidity that central banks have pumped into the system for that purpose. The Case-Schiller Cyclically Adjusted Price-Earnings Index for the US S&P 500 is now at 32, the same level it was at just prior to the 1929 Wall Street Crash. A chart of the Dow Jones prior to the 1929 Crash, maps almost perfectly to the performance of the Dow over the same time span, to the current position. It is an indication of just what an unsustainable bubble these asset prices are now in, and that applies to bonds, and property just as much as for shares. In current conditions of rising inflation, huge levels of borrowing, leading to rising interest rates, a dramatic bursting of those bubbles is now imminent, and inevitable.
The Bank of England and Federal Reserve might be prepared to accept higher levels of inflation, but that rising inflation, together with ever increasing fiscal deficits, ever rising amounts of debt issuance on a scale never seen before, means that the bond markets will not. Speculators may at first look to other assets to speculate in, which is why the price of gold and of Bitcoin have risen. Its likely that prices for other speculative assets like wines, art and so on will have risen, but ultimately all these assets are in speculative bubbles too. Bitcoin has no value, the price of production of gold is around $1200 an ounce compared to its current market price of just under $2,000. Property prices are at astronomical levels totally unrelated to any historic average or relation to values. The bursting of the bond bubble may come from speculators simply boycotting new issuance, as they divert money to these other speculative assets, as a hedge against inflation, or they may just sit on cash, in the knowledge that it will result in much higher yields in the short term, as asset prices adjust. But, that adjustment will not be pretty. It means that bond prices collapse rapidly, and, as they do, it will cause a collapse in share and property prices, followed soon after by a collapse in the prices of all those other speculative assets. Cash may look a bad option in the short term, as inflation rises, but in the medium term, it will prove the much safer haven.
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