Putin's war exposed our Achilles' heel and the real, enduring deadweight on the UK economy
Source - Daily Telegraph - 19/07/23
Inflation is stuck at 9.3pc. The currency is in free-fall, probing all-time lows against the euro. The economy has been in stagflation for five quarters.
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Household debt exploded to an all-time high of 98pc of GDP in the madness of the Covid credit boom. The property bubble has since burst. House prices have fallen by 16pc.
The central bank is raising interest rates into the teeth of the storm but markets suspect that rate-setters – succumbing to ‘mortgage dominance’ – are holding back because they dare not inflict more pain on debtors. The financial regulator said households had “never been under so much pressure”.
Such is the messy state of affairs of Sweden. It is a formidable AAA country with deep economic strengths, well-positioned to reap the immense gains of clean-tech
Sweden is going through one of its boom-bust cycles, akin to the banking crisis of the early 1990s. It will bounce back.
I bring up Sweden’s woes only to counter the fallacy of post hoc, ergo propter hoc, or what economists call Granger Causality.
The fact that A happened after B does not mean that A caused B.
Blaming everything on Brexit is intellectually sloppy.
What do Sweden and the UK have in common? They both have the property disease and easy access to credit in good times, which amplifies cycles. They also have a central bank that hosed petrol on the fire just as pandemic inflation was taking off.
“We are now where we are because the Riksbank pursued the strange policy of negative interest rates in the middle of a boom,” said Swedish journalist Andreas Cervenka. He is calling for a truth commission.
The Riksbank and the Bank of England both fanned the flames by launching a second round of pandemic QE in late 2020, adding stimulus as house prices went mad.
Threadneedle Street did so even though the broad money supply was by then picking up, which was not the case after the Lehman crisis when QE was needed to avert a collapse in money.
Outgoing rate-setter Silvana Tenreyro argued in a speech this April that QE is just a bond maturity swap and works only by influencing interest rates. “There is no separate ‘money’ channel that can unleash inflation,” she said.
From this unscientific premise, she argues that Covid QE2 was a liquidity insurance policy against “market dysfunction” but that since this dysfunction never happened, the bond purchases had almost no effect. No effect!
One does not have to accept the quantity theory of money, whether the Fisher and Friedman variants in the US, or the Marshall and Pigou variants at Cambridge, or the old Bundesbank variant. But one cannot credibly pretend that this exalted tradition does not exist.
The evidence for a ‘money’ channel is overwhelming, which is why the European Central Bank was established with a dual pillar system that tracks M3 money (before the ECB fell to the lira bloc).
When a central bank buys bonds from non-banks, it has a potent effect on broad money, shaping prices 18-24 months later.
If the Bank of England thinks there is no ‘money’ channel – and deputy governor Ben Broadbent seems to share this view – we have a serious lapse at the heart of our economic institutions. It also means that the Bank will be blind to the danger today as the money supply goes into accelerating contraction.
Reason Two for Britain’s outlier inflation is reliance on natural gas for electricity and home heating, a legacy of the North Sea boom.
The 13-fold rise in gas prices during Putin’s energy war exposed Britain’s Achilles’ heel.
The Netherlands has the same reliance and had an even higher inflation rate last autumn, peaking at 17.1pc on the Eurostat measure.
That has destabilised the price and wage contracts, just as it has in the UK, and is why Dutch pay settlements are rising at a modern-era high of 8.2pc (AWVN data).
Dutch inflation fell to 6.4pc in June, which suggests a better pass-through to consumers than the drag from the UK’s energy price cap. Although Dutch core inflation is still higher than in the UK.
Other high-gas states in Europe also have stubborn inflation: Czechia 12.5pc, Austria 7.8pc, Germany 6.8pc, and Italy 6.7pc.
This gas dependency is becoming a dead-weight for the UK economy. Imported energy is the biggest element in the trade deficit and leaves the country exposed to wild and destructive swings in energy prices.
The Office for Budget Responsibility argues that gas addiction is a “fiscal risk” with “wide reaching implications for the UK economy and public finances”.
I would go further. If Britain clings to gas it will pay a mounting economic penalty, progressively undercut by cheaper renewables and the learning S-curve of clean technology.
It will become a backwater as China runs away with the energy revolution. It will also throw away its own success story as a clean-tech leader.
Reason Three for higher inflation is that Britain, like the Netherlands, did not fully suppress price signals during Putin’s energy war. France froze electricity and gas prices with its bouclier tarifaire.
This defied the International Monetary Fund, which said the policy discouraged energy saving. But it did stop inflation setting off an incipient price-wage spiral. It worked for France.
If Brexit caused a jump in prices – and I think it did – that effect was a) after the initial devaluation in 2016, and b) in the months after the end of the transition when companies were struggling to adjust. The latter is hard to measure because Covid overwhelmed everything.
The post-transition shock was mostly a one-off hit. The effect is working slightly in the opposite direction by now.
Firms are learning how to manage the new system. Flanders has simplified customs procedures at the ports of Zeebrugge and Antwerp, and rolled out the red carpet for UK companies. This forces other ports to raise their game or lose business.
I struggle to see how Brexit trade barriers are causing an inflationary process at this juncture.
Which leaves immigration, and the imputed productivity losses from migration barriers in most anti-Brexit modelling.
This argument is by now shopworn. Professor Jonathan Portes from King’s College, London (no Brexiteer) says Britain has one of the most open and liberal regimes for legal immigration in the world.
Net inflows have doubled to 606,000 and many reach the work force one way or another. Payroll employment has hit a record 30m and is back on its pre-2016 trajectory.
Are there pockets of labour shortages? Of course, but there are shortages in Europe too. Is the visa regime for specialised workers slow, costly, and bad for the economy? Absolutely. But that does not explain the contours of British inflation over the last year.
Powerful global forces are going to pull down inflation in any case over the next few months. China is in deflation. Headline inflation in the US has fallen to 3pc. Producer price inflation is negative in the eurozone. Global dollar liquidity is contracting.
This exogenous effect will accelerate the process within the UK as lower energy, food, and input costs finally pass through with a lag. By then we will start to feel the delayed effects of 13 rate rises and aggressive quantitative tightening.
If Britain is still worried about inflation this time next year, I’ll eat my hat.
Now read: Like it or not, Brexit is a part of Britain’s inflation problem
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