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Inflation at the top – stagnation at the bottom

Image: Elliott Brown
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How do you convince people that the worst recession in living memory is not so bad after all?  One way is to follow the Bank of England’s lead and give so gloomy a forecast at the beginning of the crisis that anything short of the complete collapse of the economy looks like good news.  That is how they attempted to spin the slight uptick in GDP in June.

The problem is that the initial post-lockdown spending growth very quickly petered out as consumers returned to their homes to continue with social distancing until a cure or vaccine for Covid-19 can be developed.  As John Llewellyn in the Financial Times explains:

“One reason why the UK has suffered more than other European countries is that it went into lockdown late, and emerged correspondingly later. When lockdown finally came, it was stringent, not least with the closure of schools, which kept many parents at home.

“What now? Clearly, humility is in order. Economies are being driven in large part by a virus that is not yet well understood. Nor is it clear when, or even if, there will be an effective vaccine. In the near term, it looks as though a pick-up has begun across Europe. The UK, with its hesitant consumers, may be rebounding less confidently than some.”

A consumer-led “V-shaped” recovery looks unlikely; and for good reason.  Despite the UK government providing massive bailouts to favoured corporations through the Covid Corporate Financing Facility and subsidising the wages of millions of workers at a cost of nearly £70bn, the retail apocalypse on Britain’s high streets has accelerated.  The result is that tens of thousands of jobs have already been lost despite companies having access to the furlough scheme and to preferential loans.  It appears that these companies are getting their collapse in early to avoid the anticipated rush in October when government support comes to an end.

Apparently borrowing from an earlier Consciousness of Sheep post, Larry Elliott at the Guardian explains why the recession has been mild so far:

“Activist policy has meant, for now, that the recession of 2020 has been a bit like the period between September 1939 and May 1940, something of a phoney war. Figures from the Office for National Statistics show that national income fell by £85bn between the first and second quarters of 2020, but the government suffered by far the biggest drop – of £50.1bn – as a result of its grants, tax holiday and income support schemes. Businesses’ profits dropped by £26.5bn. Households’ income fell by £8.6bn, a modest drop in the circumstances…

“So far households haven’t endured much of the recession, but… that is about to change because the winding down of the furlough scheme is the point at which Rishi Sunak started to offload the pain on to households and businesses.

“Lay offs are inevitable as struggling businesses find that the cost of employing workers is going up. So while the monthly data from the ONS shows economic activity starting to recover in May, the recession in jobs is only just beginning. For most people it is hard to tell whether the economy is growing or not. Being laid off is a different matter. It brings home the reality of recession.”

For the bottom eighty percent of the population, real wages were the same at the end of 2019 as they had been in 2009.  Unlike the manufacturing and heavy industry-based economy of the 1970s, in the 2000s there are few trades unions capable of driving up wages; while successive political attacks on workers’ rights, coupled to punitive welfare systems, have deterred people from actively seeking higher wages.  It is for this reason that despite official figures showing near full-employment, generalised inflation failed to put in an appearance.  Indeed, the retail apocalypse has been driven by a shift in spending patterns toward essentials like food, transport and utilities, causing a massive drop in spending on discretionary items.  That was before Covid-19 arrived.  Today people are even more reluctant to spend on discretionary items because they understand that surviving on Universal Credit means cutting out all discretionary spending (including many items, like transport, which might have seemed essential).  The result across the economy is a massive drop in spending just at the point where businesses need additional sales if they are to recover from the lockdown.

Nor does the drop in consumption end with the bankruptcy of retail outlets; the bigger problem is a dearth of investing at a time when demand is falling off a cliff.  As John Llewellyn explains:

“In major economies, it generally takes three to six years for GDP to regain its pre-recession level. Thereafter, growth sometimes returns to normal speed (although absolute GDP levels are set back). On other occasions, the early years of recovery have been slower than pre-recession.

“There is an important reason for this. The spending component that is hit hardest in recessions is investment. It is an easy item to cut: which chief executive would go to their board amid a deep recession to argue that now is the time to expand capacity? Thus, in the second quarter UK business investment fell by more than 30 per cent.”

Indeed, capital destruction is the order of the day as companies vacate their office space, airlines scrap their least fuel-efficient airliners and cruise ship owners seek an alternative use for their now redundant ships.  Meanwhile, as Phillip Inman at the Guardian reports, what remains of Britain’s car industry is collapsing:

“The UK car industry is only crawling back from a disastrous first six months that saw it produce the lowest number of vehicles since 1954.  So far, automotive firms have reported only about 11,000 job losses after much of the industry furloughed staff. The next few months are expected to be much uglier for job cuts.

“Some analysts believe that one in six of the 168,000 workers directly employed in vehicle manufacturing could lose their jobs by next year, and many more from the 823,000 employed across the whole sector as the UK’s largely foreign-owned car industry retrenches to home soil.”

As spending and investment falls to historic lows, deflation looks likely for the “real economy.”  Because of the way currency is created in a neoliberal economy, we depend upon private borrowing rising at least as rapidly as the interest on private debt if we are to have any growth at all.  With both investment and consumer spending drying up, and with both consumers and companies keen to pay off existing debts rather than take on new loans, we face an imminent collapse in the currency supply.

One proposed solution to this is for the government to take up the slack through a Keynesian programme of public works.  Government can use its ability to borrow at historically low interest rates in order to replace the currency that is disappearing as private debt is being repaid.  Elliott explains the additional twist in this approach:

“So far, the central bank’s actions have mirrored the government’s need for extra borrowing. The Treasury has said it will borrow an extra £300bn this year, and, lo and behold, that is the total of extra lending from the Bank of England.”

In other words, rather than borrow on the open market, the central bank is cutting out the middlemen: simply creating currency out of thin air and handing it directly to the government.  The problem, though is that £300bn is a drop in the ocean compared to the £3,200,000,000,000 of private debt in circulation prior to the pandemic.  If private sector debt contracts faster than government can spend new currency into existence (through a combination of debt repayment and default, and because fewer new loans are being taken) we face a dangerous period of stagnation as the economy readjusts to the new, far less material, circumstances.

It is unlikely that a Tory government will have the political will to engage in the kind of public spending that will be required to prevent the deflationary collapse of the real economy.  Nevertheless, the scale of the emergency requires a level of public spending on a scale that would make Jeremy Corbyn and Bernie Sanders blush.  We would need to see previously unthinkable policies like lowering the state pension age (in order to free up jobs for young people) and raising unemployment and disability benefits to around two-thirds of the average wage, in order to take the edge off the coming collapse in spending.  Beyond that, leaning into emerging economic trends like working from home, online retailing, and far less car ownership will require entirely different policies to those designed to (probably fail to) restore the pre-pandemic economy.

Failure to do so risks generating economic dislocation and political division on a scale that will eclipse Brexit. This is because for those at the top, the Bank of England continues with a quantitative easing programme that its own research shows does nothing for the real economy.  QE merely places even more wealth into the hands of a tiny elite which owns most of the assets.

The irony is that the godzillionaires at the top of the heap are as much prisoners of the system as those struggling to put food on their plates at the bottom.  The political choice to bail out the system after 2008 has left those at the top with a narrowing choice of places to park their nominal wealth.  Only a handful of asset classes have generated returns at anything like the rates regarded as normal prior to 2008.  Of these, only stock exchanges – artificially propped up by the central banks – have offered consistent growth.  This, then, is where the inflation went.  The nominal value of shares far exceeds the real value of the corporations which issued them.  Driven ever higher by newly created central bank currency which has nowhere else to go, stock exchanges hoover up the digital wealth of everyone who has fiat currency to invest.

There will be little sympathy for those at the top, of course.  They have enjoyed the high life while the majority has seen their living standards crushed.  Nevertheless, they also stand on the edge of an economic precipice from which the only way is down.  Asset wealth is not the same as something real and tangible like a loaf of bread.  If the coming depression is as bad as many fear, the value of a loaf of bread will increase through a combination of shortage (fewer shops are selling bread) and higher demand (people are focusing their spending on necessities).  Assets such as shares, fine art or even housing, in contrast are only valued at the margins.  For example, you might say that your house is worth £200,000 because that is what a neighbouring house was sold for.  But that price was only possible because very few people sell houses at any time.  If, though, everyone tried to realise the cash value of their houses at the same time, the over-supply would cause prices to crash close to zero.  The same is true for all of the assets that the rich have attempted to use as safe havens in the gathering storm.  If everyone tries to sell their shares and assets at the same time, they will be rendered worthless.

For a country like Britain, whose oil wealth was squandered and whose banking and financial system is especially vulnerable to the growing crisis, skilled and competent political leadership will be required to navigate a path through the crisis, which does not end with guillotines on Parliament Green.  Best not to hold your breath.

As you made it to the end…

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