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The year of the white swan

Economists attempt to explain away the failure of their forecasts with the metaphor of the black swan – something so rare and unexpected that nobody can be held responsible for failing to notice it.  The Great Financial Accident of 2008, the DotCom bubble and the stock market crash of 1987, we are told, were caused by black swan events.  This, of course, is very convenient for the highly-paid economists who continue to be employed despite failing to predict one crisis after another.  For the rest of us, it creates a profound sense of impotence, since if the experts cannot model the economy (and thus develop appropriate policies) what chance have we?

The problem with the economists’ black swan claim is that it is largely nonsense.  Far from being caused by rare and unpredictable events, almost all recessions are the result of an entirely predictable political misunderstanding of and response to inflation.

Whatever else we understand by the term “Neoliberalism” – the prevailing economic and political orthodoxy of the past four decades – it is first and foremost a response to the inflationary wage-price spiral of the 1970s.  Neoliberalism is the set of – primarily financial – measures designed to squeeze inflation out of the economy.

The theory is that inflation is caused by governments printing and spending too much new currency.  Each new dollar or pound printed into existence effectively steals a fraction of the value of the currency already in existence.  This was experienced as rising prices by American and British consumers in the 1970s.  But in reality – as savers of the period could attest – it was the falling value of the currency itself.

The administrations of Margaret Thatcher and Ronald Reagan sought to correct this by dramatically lowering the stock of money in circulation.  With insufficient money to go around, businesses failed and unemployment increased dramatically.  This brought inflation under control.  But in the longer term, interest rates as set by the central bank would become the mechanism through which inflation would be controlled.  If the economy faltered, the central bank would lower rates to stimulate borrowing.  But if prices began to rise, the central bank would raise interest rates; forcing households to spend more of their income servicing their debts and less on purchases.

The trouble with this approach is that not all price increases are the same.  Increasing the amount of money in circulation – whether through government spending or private borrowing – devalues money on the demand side.  However, there is also a supply side cause of price rises that ought to be treated differently, but almost invariably is not.  This is what oil investors refer to as the “choke chain” – the cyclical nature of investment in the recovery of the raw resources at the base of the global economy.

Commodity investors do best when they put their money into commodities whose price is low but whose supply is expected to fall short of demand.  But investment as a whole tends to follow a herd mentality.  Those early investors do best if they cash out when the price of the commodity is high.  But the very fact that prices are increasing results in even more investment further driving up prices.  The paradox, however, is that the shortage of the physical commodity coupled to the influx of investment results in new exploration and recovery projects.  Eventually, new supplies are brought to market and demand is sated.  The price falls back once more.

For ordinary households, the cyclical commodity choke chain acts like a separate interest rate – especially when the commodity relates to the energy that drives the economy.  Oil in particular, because it is ubiquitous in transport and manufacturing, dictates the balance between discretionary and non-discretionary spending for both firms and households.  If the price of oil (or coal, cement, steel or copper) increases, then so too does the price of everything made from or transported using it.  When this happens, it looks a lot like inflation.  But it isn’t.  Rather, it is a shift in purchasing away from discretionary items (trips to the cinema, new phones, meals out, etc.) to non-discretionary items (fuel, heating, food, etc.).  Prices across the economy as a whole do not change because increases in one area are counterbalanced by falls elsewhere.

The trouble is that Neoliberal economists do not see the world in this way.  For them, all price increases are equal; and the solution is always a rise in interest rates.  For example, in 2006 the global price of oil began to increase.  The consequence was a generalised price increase that, in turn, began to shift spending patterns across the economy.  This was not, however, allowed to run its course.  Instead, the US Federal Reserve Bank did what economists always do – they jacked up interest rates.  For those at the bottom of the income ladder (households and firms) the result was a double whammy of rising prices and rising debt servicing costs.  Where they might just have kept their heads above water when faced with either one of these, faced with both, they began to sink.  The result was the collapsing debt house of cards that we now know as the Great Financial Accident of 2008.

What makes 2018 look scary is that debt levels have crept back close to 2008 levels.  An army of zombie households and firms have been treading water for the best part of a decade – servicing but barely reducing their debts.  On top of this, governments have indebted themselves in their efforts to keep the banking and financial sector alive.  But 2018 is the year central banks have pledged to unwind the life support of quantitative easing and to begin “normalising” interest rates.  Both public and private debt is about to get a lot harder to service; with the likely result that spending will have to be cut even further.

Unfortunately, 2018 also looks like the year when the smart investors move their money into commodities.  The oil glut – itself the result of investment during the record high prices of 2010-11 – that saw prices plummet in 2014 is coming to an end.  Oil prices are currently bouncing around $60 per barrel and are expected to hit at least $80 per barrel in the course of the year.  However, where investors piled into the US shale (fracking) bubble in 2011, this time around institutional investors want to see sustained high prices.  The expectation is that there will be no repeat of the shale boom to balance supply and demand in the immediate future.  This 2018 is likely to see a further squeeze on discretionary consumption.

Nor is oil the only commodity whose price has been creeping up.  Copper – often regarded as the trend setter for commodities as a whole – has seen steady price increases since the 2015-16 low point.  The expectation is that 2018 will see a continuation of this trend and a rise in commodity prices across the board.

We already know how central banks are going to respond to the generalised price rises that will impact the economy as commodity price increases filter through.  They are going to do what they always do.  They are going to jack up interest rates.  As happened in the run up to 2008, they will oblige firms and households that are already struggling with rising prices to divert more of their income into servicing their debts.  Inevitably this will trigger defaults and bankruptcies as consumer spending drops and firms and households can no longer pay their way.  The only question that remains is whether governments have the ammunition needed to bail out and stabilise the situation one last time or if the market correction/recession of 2018 is going to be the one that collapses the global economy.

It is entirely possible that some “black swan” event may provide the economists with credible cover for their failure.  A war on the Korean Peninsula or a Gulf conflict that closes the Straits of Hormuz would cause widespread economic disruption.  So too would something more mundane such as the failure of the UK’s Brexit negotiations.  But even if these types of event do not materialise, the rising trend in commodity prices and the pre-programmed central bank response are sufficient to explain the economic downturn.

It is for this reason that we should more properly refer to the coming downturn as a “white swan” event – one so predictable as to be unremarkable.

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