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In Brief: Insensitive for other reasons; Johnson in trouble; Currency shock ahead

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OVO error of judgement

Energy company OVO has come in for criticism after advising people to cuddle up to their pets to keep warm this winter.  One of the reasons people began to keep animals indoors in the first place was precisely because they could be used in the same way as we use hot water bottles today.  So yes, we could use pets as a heat source… except that far fewer of us can afford the pet food these days.  Other suggestions include eating porridge, putting on an extra layer and doing star jumps.  But while the advice may upset metropolitan liberals – who are about to get a taste of how the other half lives – for Britain’s burgeoning precariat they are simply part of an energy-constrained way of life.

The various political parties’ responses to the dramatic rise in gas and electricity prices is instructive too.  While the Labour Party has been the loudest critic of the OVO faux pas, its gut response – scrapping VAT – has been typically middle class.  Of all the possible responses available to government in response to the energy price crisis, this is the least effective and most pro-middle class.  The saving on the average bill would amount to about a pound per week off everyone’s bills, irrespective of their household income.  Restoring the triple lock on pensions and returning the £20 which was cut from benefits last year would be the best approach, since it would target those least able to afford higher bills – but Labour isn’t interested in this, and the government won’t do it because they would lose face.  Instead, the most likely reform will be to the Warm Homes Discount which currently provides some households in receipt of some benefits to claim a £140 rebate.  The government is also under pressure from its own backbenchers to scrap the green subsidies which account for 25 percent of people’s electricity bills.

None of these immediate responses is sufficient to address the prolonged – and likely irreversible – energy squeeze which is caused in part by the failure to invest during the pandemic, in part by increased demand/competition across the global economy and, in part due to the depletion of finite global reserves.  The reality is that energy is going to get increasingly expensive from here on.  And faced with this predicament, the advice from OVO is insensitive only in the sense that it doesn’t go far enough.  The growing precariat gave up trying to do anything so extravagant as warming an entire house years ago. Keeping yourself warm is all that matters.  And at best this means warming a single room.  More often it really does involve putting on extra layers – indeed, the market for sleeping bag suits is exploding these days.  Depending upon their respective energy ratings, an electric blanket or a good hot water bottle (probably best not to use both together) is a lot cheaper than heating a bedroom.

Maybe one day soon, we will also be reminded of the original purpose of a public house – not a place to drink alcohol, at least, not primarily, but rather a place to keep warm during the long winter nights.  That is so long as the pubs haven’t all closed by then.

The government’s woes are just beginning

The political froth on the beer this week concerns Boris Johnson’s boozy partying while the rest of the UK was on lockdown.  For the moment, the Tory Party looks prepared to leave him in place… ideally until after the local elections in May.  This said, at least three senior Tories – Truss, Sunak and Hunt – are overtly positioning themselves as potential successors, while party managers plan out the most favourable way of deposing a Prime Minister without triggering a constitutional crisis.

The straw which Johnson himself is clinging to is that with the UK likely to be the first economy to slip from the covid pandemic into the endemic phase, our economic fortunes may improve considerably.  This though, is likely to be nothing more than wishful thinking. 

Currency woes ahead

While it is likely that the pandemic is coming to an end, there are nothing but dark economic clouds gathering on the horizon.  Last year’s decisions to cut £20 from benefits, to scrap the triple lock on pensions, and to raise National Insurance – a tax on employment – to fund the NHS and social care, were based on the false expectation of a post-covid boom similar to the boom which followed World War Two.  Instead, the threat of new restrictions in the run up to Christmas served to drive even more nails into the coffin of the hospitality and retail sectors at what would normally have been the most profitable time of the year. 

And then we had the gas crisis, with wholesale prices rising to more than 900 percent of the price at the beginning of 2021, before settling back at around a 400 percent year-on-year increase.  Because the UK depends upon gas for 50-60 percent of its electricity generation, and as a consequence of “green” policies which allow windfarm generators to duck the cost of intermittency, higher gas prices have translated into big increases in the price of electricity too.  And to add insult to injury, various “green” levies – effectively private taxes – are added to people’s electricity bills, and along with Value Added Tax, account for a third – 30 percent – of the final price.  Businesses are already struggling with these costs, and will have been dismayed by comments by Chris O’Shea, CEO of Britain’s largest energy supplier Centrica, that increased energy prices will persist for at least 18 months, as global “green” policies result in countries around the world switching from coal to gas.

Households have been shielded from higher prices to some extent because of a state-imposed price cap.  But in February, the regulator will set a new cap based on current prices which will come into force at the beginning of April.  This will take the average household bill to roughly £2,000 per year, assuming households continue to consume electricity and gas at the same rate – which is highly unlikely.  Instead, we are likely to see an acceleration of the “energy death spiral” as consumers cut their energy use in an attempt to keep bills manageable.

The immediate political consequences are clear enough.  On 1 April 2022, households are going to be hit with an eye-watering increase in energy bills on the same day that new local and national taxes are increased, along with higher prices of regulated services such as rail fares and water charges.  And while the media have covered some of the salary increases in a few sectors and mostly concentrated into a handful of locations – most notably London – the majority of us will be having below-inflation pay increases if we are fortunate enough to be having an increase at all.  What this means is that far from paying the higher energy bills, most of us will be cutting our usage – putting even more pressure on energy supply companies that already have cashflow problems.

Household energy is not even the darkest storm cloud on the near horizon.  While the media has fixated on Downing Street parties and the rising price of gas, the Brent Crude oil price has quietly crept up to $85 per barrel.  This is another reason why those fortunate enough to be able to work from home may count themselves lucky.  For anyone obliged to commute, this will result in another rise in petrol and diesel prices which are already close to their historical high at £1.46 per litre for petrol and £1.49 per litre for diesel ($7.57 per US gallon for petrol and $7.72 per gallon for diesel).  As with electricity and gas, this is likely to result in businesses and households cutting back on consumption to some extent.  But a large part of the cost of fuel is hidden within the cost of everything that is transported within the economy.  Higher transport costs mean the cost of everything else rising too.

To some extent, utilities like gas and electricity, along with fuel, are considered by economists to be “inelastic.” It is assumed that we simply have no choice to pay for them.  But this is not entirely true.  For example, the labour shortage in London suggests that some former workers have opted to take lower-paid jobs closer to home, thereby saving the costs of commuting or paying an exorbitant rent for a shared room in one of London’s seedier districts.  This is particularly true of the thousands of European citizens who left during the first lockdown and have not returned.  Nevertheless, it is far harder to escape paying the price of these non-discretionary items than it is to avoid making discretionary purchases like buying electrical goods, taking holidays abroad, or having a meal in a restaurant.  And it is in these discretionary sectors where we can expect the greatest damage to result from increased costs which simply cannot be passed on.

While the unfolding crisis is essentially an energy crisis, the reality is that we have paid far less for energy than the value it provides in return.  And even with the current price increases, energy and fuel are unlikely to account for more than a quarter of most businesses’ overall costs.  By far the biggest cost in almost every business, from the corner shop to Microsoft, is the wage bill.  It follows that rising prices are going to translate into layoffs.  And since almost all low-skilled and semi-skilled jobs have already been cut or outsourced to the maximum, this means that a sizeable part of the managerial middle class is about to join the Universal Credit queue.

If you are a government that has recently borrowed some £300bn into existence to pay for your hubristic attempt to control a virus, this is incredibly bad news.  Not only is the boom that you were hoping for not going to put in an appearance, but the tax base that you were relying on to repay that debt is about to shrink big time.  Not only are cash-cows like fuel and energy going to cease delivering at anything like pre-pandemic levels, but the loss of jobs – particularly higher-paid professional and managerial ones – will result in a massive cut in the income tax and national insurance receipts that account for a large part of government income.  Nor are business taxes available to plug the gap because these too will be falling as businesses attempt to balance rising costs with lower incomes.

This raises a particularly unpleasant question: If the UK government cannot repay its debts, can they keep borrowing or are we facing a currency crisis which could see interest rates rising and import costs spiralling upward even as the domestic economy is flushed around the u-bend?

As you made it to the end…

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