Consciousness of Sheep
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One of the biggest errors made by economists and politicians is the belief that inflation is the same thing as rising prices. Indeed, most of us have been taught that rising prices are precisely what inflation is. This, however, is to mistake the symptom for the disease. Everyone who has measles gets red spots; but not everyone with red spots has measles.
The disease – inflation – results in the appearance of rising prices; but is actually the devaluation of money. When, for example, governments print or borrow money into existence they, in effect, steal a tiny fraction of the value of the money that was already in circulation. Similarly – and far more damagingly – when commercial banks loan money that they create out of thin air, they also steal value from everyone else. The important point here is that once this theft has taken place, there is no going back; money is permanently devalued.
There are, however, other reasons for rising prices. And unlike monetary inflation, these are self-correcting. For example, global oil prices have begun to break out of the $40-$60 “goldilocks” band in which consumers and energy companies can just about keep their heads above water. Most economists believe this to be dangerously inflationary. Indeed, almost all previous recessions are the result of monetary tightening (usually by raising interest rates) in response to an upward spike in oil prices. Since oil is used to manufacture and/or transport every item that we buy, if the price of oil increases, then the price of everything else must increase too.
But the price of oil is not increasing in response to money printing. Rather, it is the result of declining inventories which point to a global shortage of oil early in 2018 – traders are currently bidding up the price on futures contracts to guarantee access to sufficient oil to meet anticipated demand. Since oil is considered “inelastic” (we have little choice but to pay for it) the assumption is that rising wholesale prices will be passed on to consumers, causing general inflation. Frank Shostak from the Mises Institute challenges this assumption:
“Whether the asking price set by producers is going to be realized in the market place, however, hinges on whether or not consumers will accept those prices. Consumers dictate whether the price set by producers is ‘right’. On this Mises wrote, ‘The consumers patronize those shops in which they can buy what they want at the cheapest price. Their buying and their abstention from buying decides who should own and run the plants and the farms. They determine precisely what should be produced, in what quality, and in what quantities.’
“If consumers don’t have the money to support the prices asked by producers then the prices asked cannot be realized.”
The determining factor, then, is not the price of goods and services set by the supplier, but the collective purchasing power of consumers. Another way of stating this is that price is determined by consumers’ access to money. Certainly, if banks and governments are busy pumping newly created money into the economy, then consumers will pay the rising prices asked by suppliers. What, however, will consumers do if – like in Britain today – access to new money has been limited to a tiny percentage of the very highest earners at the same time as the majority of consumers have seen their wages stagnate as a consequence of government austerity policies?
Shostak argues that in this case:
“If the price of oil goes up and if people continue to use the same amount of oil as before then this means that people are now forced to allocate more money for oil. If people’s money stock remains unchanged then this means that less money is available for other goods and services, all other things being equal. This of course implies that the average price of other goods and services must come off.”
Clearly there is a difference between something as ubiquitous as oil and those other goods and services that must fall in price unless more money is printed into existence. The difference is this; each of us has a series of “non-discretionary” purchases that we have little or no choice but to make every month. These include:
- Rent/mortgage payments
- Utility bills
- Debt interest
- Council tax
- Food
- Transport
- Telephone/broadband
In addition, we make various “discretionary” purchases of goods and services that we want rather than need. These include pretty much everything else that we buy, including:
- TV subscriptions
- Cinema
- Eating out
- Going to the pub
- Music downloads/subscriptions
- Electrical equipment
- Clothes
- Home furnishings
If prices rise without a commensurate increase in our access to money, then we as individuals attempt to do what government is trying to do to the economy as a whole – we cut back on everything that we consider discretionary. In this way, the rising price of oil does not result in generalised inflation; it merely redistributes our spending across the economy.
The same is true when the exchange rate changes; as it did last year in response to the Brexit referendum result. The fall in the value of the pound on international markets causes the price of imported goods and services to rise. It does not, however, add to the stock of money in the economy – only banks and governments can do that. So, given time, the general result of the fall in the pound is that we will spend less on discretionary imports and, where necessary, on domestic discretionary purchases in order to bring our outgoings back into line with our income.
Another mistake made by economists and politicians is the belief that rising prices will generate political pressure for additional public spending and for wage increases across the economy. Indeed, one of the greatest economic mysteries of our age is why apparently full employment has failed to translate into rising wages. The obvious answer, of course, is that working people have traded employment for low wages.
There is good reason for this. Since 2010, government attempts to run a budget surplus have sucked money out of the economy. Public spending and social security payments (the two ways new government money enter the economy) have been savagely cut. If government refuses to spend new money into the economy, only the banks can. But since 2008 the banks have stubbornly refused to spend money into the “real economy,” preferring instead to pump up asset bubbles that add no new value to the wider economy. Only those working people fortunate enough to get a foot on the housing ladder get to benefit from this; but even they can see the illusion – a house may have risen in price since it was bought… but it is still the same house; no commensurate additional value has been added. The same is true for bubbles in bonds, shares, cryptocurrencies, luxury property, collectibles and fine art.
The productive sectors of the economy have been systematically starved of investment; with the result that private sector wages have fallen in the same way as their public sector counterparts. The result is that not only is the stock of money not rising in an inflationary manner, it is actually shrinking in the real economy outside the bubbles. We witness this geographically to some extent. The area of Central London around Whitehall, the City of London and the Silicon Roundabout is like an oasis of prosperity in the economic desert that Britain has become since 2008. Similar, but smaller prosperity oases can be found in other towns and cities; particularly in the southeast. But the further north and west we travel, the more obvious the decline becomes; until we reach those regions of Northern England, Northern Ireland, Scotland and Wales that never got around to recovering from the recession in the 1980s.
Economically, people are responding to this in the only way they can. The working poor – increasingly dependent upon in-work benefits and foodbanks – have not only cut their discretionary spending; they have been eating into their supposedly non-discretionary spending too. As Jamie Doward in the Guardian reports:
“More than a third of people who earn less than the “real living wage” have reported regularly skipping meals to save money… A poll carried out for the Living Wage Foundation also found that more than a third of people earning less than this had topped up their monthly income with a credit card or loan in the last year, while more than one in five reported using a payday loan to cover essentials. More than half – 55% – had declined a social invitation due to lack of money, and just over half had borrowed money from a friend or relative.”
Nor is it just the 5.5 million UK workers earning less than the Living Wage who are changing their behaviour. Those higher up the income ladder are changing their spending habits too. Cat Rutter Pooley in the Financial Times reports that:
“In-store sales of non-food items fell 2.9 per cent over the three months to October and 2.1 per cent in the past year — the worst performance since the BRC started compiling the data in January 2012. Clothing sales were particularly hard hit, according to the report, with unseasonably warm weather holding down purchases. Online sales growth was also lacklustre, at less than half the pace of the three- and 12-month averages.”
This latter point is particularly important because until now economists and politicians have peddled the myth that high street sales were falling because consumers were buying online. The reality is that they are falling because – with the exception of food – we are not buying anymore. The news of the fall in high street shopping comes just a day after the British Beer and Pub Association reported a massive fall in the sale of beer. On the same day, energy company SSE threatened to shut down its energy supply business as a result of falling profits. Back in December last year, we reported a similar shift in purchasing behaviour as people cut back on personal hygiene products.
Shostak’s point – that if the money stock remains constant, a rise in the price of oil (or imports) is not inflationary is correct. However, what we are witnessing in the UK is something even more dangerous. Faced with a falling stock of money (outside of the asset bubbles) we are witnessing a generalised deflation as people cut back on their discretionary (and in many cases non-discretionary) spending. This does not end well, as our spending cuts erode the profitability of the businesses that we depend upon for our employment. As Oscar Williams-Grut recently reported in Business Insider:
“The UK economy is in pain and it is the retailers who have been crying out first. Major UK retailers John Lewis and Next became the latest shops to warn of a slowdown in consumer spending on Thursday, in yet another sign of a serious slowdown in household spending that could be disastrous for the UK economy.”
It is into this climate that the Bank of England economists chose to raise interest rates even as their Treasury counterparts were putting the final touches to the next turn of the government’s austerity screw expected in this month’s Budget. Ann Pettifor explains that:
“Economists at the Bank and the Treasury are ignoring the lessons of history. In the 1930s interest rates were held at 2 per cent for more than 20 years, as part of far larger scale reform to the financial sector, and a determined effort to recover from the 1929 Crash. But while necessary, low rates were insufficient to restore decisive momentum. By 1934 the Treasury (under a Conservative government) had revived government investment.
“Treasury economists in the 1930s – led by Keynes – had the courage to disregard diktats from the City of London spokesmen and their allies in the economics profession. Tragically for millions of British people, and for Britain’s future, that intellectual courage is sorely lacking today.”
The one consolation is that when Britain’s poor have finally cut their spending to the bone, and a swathe of businesses have been forced into bankruptcy, it is the rich who are going to face the biggest losses. The Positive Money campaign highlights the Bank of England/Treasury dilemma:
“The Bank of England faces its current predicament thanks to an ongoing failure to think beyond a limited, orthodox form of the central bank’s role. By keeping rates low, it risks inflating asset bubbles even further. But with incomes so weak, now is the wrong time to raise them.”
This lesson will only be learned retrospectively. Once it becomes apparent that millions of British workers are not going to be repaying their debts, banks will crash. Once it becomes apparent that British workers cannot provide the government with the tax income to pay back its borrowing, the bond market will crash. Ironically, JPMorgan has already christened the coming collapse; as Joe Ciolli at Business Insider reported last month:
“JPMorgan has already coined a nickname for the next financial meltdown. And while the firm isn’t sure exactly when the so-called Great Liquidity Crisis will strike, it figures that tensions will start to ratchet up in 2018…”
Liquidity refers to the ease or otherwise with which an asset – like a share, bond or a house – can be converted into cash. Nominally, your house might be worth £216,000 (the UK average). But if you had to sell it during a crisis in which there are lots of sellers and very few buyers, it is actually worth a lot less. The same, of course, is true for all of the other assets that governments and central banks have been inflating since 2008. When the time comes, Britain will be particularly badly hit because our economy has been all but hollowed out. The supposed “wealth” that makes up a large part of our GDP comes from the movement of precisely the asset classes that the coming Great Liquidity Crisis will render worthless. The difference compared to 2008 is that this time around the banks are too big to save and individual central banks and governments are too small to save them.
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