While the rate of inflation dipped slightly in the USA last month – probably due to Biden squandering the country’s emergency oil reserves – no such relief was in sight here in the UK. And with inflation still rising, there is little sign of the Bank of England slowing down its rate hikes. There are though, good reasons to believe that the economic models being employed by the Bank of England are simply wrong… among the greatest of which is that the bank’s Monetary Policy Committee has consistently failed to achieve its one goal – of keeping inflation at or around two percent – for the last 14 years! Prior to the pandemic, it couldn’t lift inflation off the floor. And then, after two years of economic vandalism, it could only stand aside and watch inflation fly into the stratosphere. Even our next “worst prime minister ever,” seems keen to remove the bank’s inflation targeting and get them focused on restoring economic growth instead.
The reasons for believing the Bank of England is navigating using the wrong map, however, require a deconstructing of the inflation figures. When this is done, it is clear that almost all of the inflation is the result of external factors such as broken supply chains, global fossil fuel shortages and rising global commodity prices. Things, that is, which will lower demand across the economy without the need for additional interest rate rises to accelerate and deepen the recession. The best the bank can do is to claim that it is getting ahead of the situation by preventing a new wage-price spiral. Which, given the big uptick in strikes this summer, also seems to be backfiring rapidly.
Buried within last months figures though, were a couple of upticks in inflation which ought – but probably won’t – raise alarm. These were in retail and hospitality sectors where, until now, businesses appear to have been absorbing the additional costs. Given that this has happened at a time when consumer confidence is at rock bottom, and when all but the very richest households are reining-in their discretionary spending in order to meet the rising cost of essentials, far from being viewed as evidence of a still expanding economy, it should be seen as the final stage before the economy starts to implode.
Consider the fate of Britain’s once ubiquitous fish and chip shops. Already facing huge increases in input costs, they had desperately hoped that consumers would bear rising prices over the summer, when holiday makers can be more lax with their discretionary spending. It wasn’t to be. As the BBC reported yesterday:
“Fish and chip shops are facing ‘extinction’ amid rising costs, an industry body has warned. Some shops in the West of England say the soaring price of cod, sunflower oil and energy has left them struggling…
“National Federation of Fish Friers President Andrew Crook revealed about 66% of shops had reduced opening hours to save money – equating to a fall in staffing levels of four people per shop. He added: ‘Unfortunately this is potentially an extinction event for small businesses. It’s like nothing we’ve ever seen before.’”
Ironically, staffing cuts like this don’t show up in official unemployment data so long as it is only an employee’s hours which are being cut – something which may account for why the total hours worked in the UK remains lower than in February 2019, and has been falling recently. There comes a time, however, when falling sales and rising costs can no longer be offset by cuts in hours and/or cuts in pay. And it is likely that we are just weeks away from the first wave of redundancies as business costs outweigh business incomes even as banks either refuse further borrowing or charge such high interest rates that it becomes unpayable anyway.
Nor are things set to improve on the supply side. As Rob Davies and Joanna Partridge at the Guardian report, energy companies have begun to disconnect businesses rather than risk future defaults:
“In the latest sign of the deepening energy crisis, business owners said they were struggling to find a supplier in the run-up to the busy October period for renewing gas and electricity contracts, leaving them facing ‘extortionate’ bills or demands for a deposit…
“Teresa Hodgson, landlord of the Green Man pub in Denham, near Uxbridge, was initially told by her supplier SSE that it could not give her a quote for energy because prices were increasing so fast. ‘When I did pin them down, they said before we can go any further, we want £10,000 deposit,’ Hodgson said. ‘When I asked why, because they’ve never had an issue with me, they said: ‘We don’t think a lot of pubs are going to make it this year and we need security.’”
This has all of the makings – albeit at the outer edges – of a classic “death spiral” in which sectors of the economy lose critical mass as they are forced to raise prices to levels that deter customers. Since pubs and chip shops can only claw back their additional costs by raising prices, and since the increased prices crush demand, they are ultimately doomed. And as unemployment rises and demand slumps, the contagion spreads to more critical sectors of the economy, including the energy industry itself. As more businesses close, the energy companies must either attempt to pass even higher costs onto households or – either by choice or by state diktat – take the losses themselves.
This is the one economic process that Marx – sort of – correctly analysed, when he wrote about a crisis of over-production. This is what happens because collectively, the workers who produce the goods and services cannot, as consumers, afford to buy them back because wages are less than the value of the goods produced. In the modern world, the crisis manifests more as one of under-consumption because of the previous ways in which the elites and the technocracy have sought to defer the crisis. These include offshoring production to countries with cheaper labour and fewer regulations and, crucially, the use of debt to plug the gap between what people earn and what the elites need us to consume. It is worth noting that neither option is available to the elites today and that, consequently, countries like the UK, which have been living beyond our means for decades, face the kind of decline in living standards experienced in the defeated states after World War One… with all the hunger, dislocation and extremism which that entailed.
It’s not just the price
Someone should explain to former chancellor Rishi Sunak that the economy-wrecking rises in gas prices are not the result of welfare recipients spending too much on heating. Okay, he probably only said that in a last-ditch attempt to win the votes of the kind of deranged individuals who actually join the Tory Party. And in any case, if the polls are to be believed, Mr Sunak will be spending a lot more time with his hedge fund once Mrs Truss becomes prime minister. However, the apparent lack of understanding of the crisis engulfing the UK economy is one of the few things that both candidates share. And it is not just about the impact of energy prices on the economy… although these are bad enough:
It is the reason why gas prices are out of control which should be sending shock waves through the political class. Because while it may be expedient for politicians on the right to use torturous logic to blame price increases on too much consumer spending, while those on the left point at greedy energy company bosses, the hard truth is that we have arrived at a place that nobody wanted to believe was possible… a place of growing energy shortages.
As readers of this site will be aware, mainstream economists treat energy as just another cheap (until recently) input to the economy. In reality though, energy is the driving force behind everything in the economy. So that, when energy costs surge, profitability and living standards slump.
This has happened often enough in the past because of the “choke-chain” investment cycle – investment in new discovery and production increases supply to the point that it exceeds demand. This brings prices down, lowering profits and deterring further investment, even as lower energy prices promote economic growth across the economy. Eventually, growth causes demand to outstrip supply, causing prices to rise once more. Rising prices make investment in discovery and recovery profitable once again, and the cycle begins once more. And so long as we have had access to more economically and geologically accessible reserves, the process has repeated every decade or so.
This time, as they say, is different, although the economic war with Russia both obscures and amplifies the crisis – especially with gas supplies which are traded across continents rather than globally as is the case with oil. Demand is so great, and access to economically and geologically accessible deposits so constrained, that since at least 2018, we have been experiencing a permanent shortage. Less obviously, as the energy cost of producing the remaining reserves rises, the surplus energy required to power the economy declines irrespective of the quantity produced. This is why those on the left are travelling down a blind alley in believing that we just need to deploy more – low surplus energy – wind turbines and, indeed, why those on the right are wrong to believe that high energy-cost fracked shale gas can come to the rescue. The harsh reality is that the only workable response is to try to manage a reduction of economic activity to bring us into line with the – shrinking – surplus energy available to us. But nobody is voting for that, and no modern politician would dare propose it.
The difficulty, of course, is that beyond the superficial arguments, we are facing a hard physical limit rather than merely trying to alight upon the correct energy policy. And when it comes to hard physical limits, Mother Earth has a habit of exposing hubris and stupidity in short order. Consider, for example, that the entire UK political and media class is currently obsessing about prices. Consider also that Russia has effectively thwarted EU plans to build a gas reserve ahead of the coming winter. And while European politicians talk bravely about bringing back coal, investing in nuclear and deploying more wind turbines, none of these are going to materialise in time for this winter (or next). In this light, a price crisis comes a long way behind the crisis they dare not give voice to… energy shortages.
The problem is this: the last time we faced energy shortages – albeit artificially created ones – was in the early 1970s, when the population’s use of electricity was far less than it is today. Moreover, almost all of the electricity generated in those days was from coal or nuclear. The discovery of massive gas reserves in the North Sea changed everything – those of us of a certain age will remember the national effort involved in converting the UK’s gas system from town (coal) gas to natural gas in the late 1960s and early 1970s. North Sea gas came with some less obvious benefits too. For a Tory Party bloodied by its conflicts with the mining unions in 1972 and 1974, using gas to generate electricity provided a means of fatally weakening the National Union of Mineworkers’ ability to hold the economy to ransom. Moreover, gas could be sold as a “transition fuel” and as an intermittency balancing fuel to a new generation of “green” activists.
And so, as I explained in my last post, Britain gradually stumbled its way into the gas-dependency which is now coming back to haunt us. A political class focussed solely on the next election simply assumed that clever people in the future would find new supplies of gas and/or figure out how to run the economy on some combination of nuclear and wind. And so, as the volume of electricity grew, so too did our dependence upon it. Where houses of the 1960s had been built with just a couple of plug sockets – mostly in the kitchen – today’s houses have multiple sockets – to which we add our own extension cords – to cope with all of the electrical gadgets that we take for granted.
This, though, only points to an inconvenience for the coming winter. For most of us, power cuts are an annoyance – at least so long as they are relatively brief. And in the event that the state rationing scheme works (don’t hold your breath) then at least we will be able to plan around the shortages. The real crisis is far more systemic because in the absence of the kind of planning that governments ceased doing decades ago, problems with any one of our critical infrastructures can rapidly cascade into all of the others. Consider, for example, that most of the UK’s drinking water depends upon electrically-powered pumps. So, when the lights go out, so too does the water… and the internet… and the banking system… and communications… and public transport… and so on.
Some systems, such as hospitals will at least have back-up generators. But whether these can be sustained for more than a short-term crisis will depend upon access to already short supplies of diesel. The same may well be the case for frozen and refrigerated food storage, where mountains of food may go to waste if electricity cannot be restored rapidly. Whole industries which have been organised around a firm supply of energy, may be unable to maintain output if power outages are random and prolonged, with shortages of goods and key components to other industries and services no longer being available.
Eight years ago, emergency planners attempted to scope out the likely consequences of a major loss of electricity across the UK. The results of this Exercise Hopkinson was leaked to the Daily Telegraph, and its conclusions were stark:
“The assessment, which involved officials from all key departments and major industries, took place this summer following 12 months of preparation. It was designed to ensure emergency power plans were ‘fit for purpose’.
“Instead it ‘exposed the fact that, where contingency plans against power disruption exist, some of those plans are based on assumption rather than established fact’, according to a report of the exercise, distributed privately last month. ‘Populations are far less resilient now than they once were,’ it concluded. ‘There is likely to be a very rapid descent into public disorder unless Government can maintain [the] perception of security.’
“Any central Government response to the crisis may be too slow, arriving ‘after the local emergency resources and critical utility contingency measures had already been consumed’. Departments needed to revise ‘critical facets’ of their plans, it found.”
There is no evidence that the departments of state have acted on the results of the exercise. Meanwhile, further power station closures and even greater penetration of intermittent wind-power has left the UK even more vulnerable to a cascading collapse today than it was in the winter of 2014. Hopefully someone will remember to mention it to Mrs Truss when she formally takes over from Boris Johnson next month.
Let’s talk about windfalls
Everyone’s favourite neoliberal propaganda outlet, aka the BBC, has decided to weigh-in on who is benefitting from higher inflation. And it should come as no surprise that the main beneficiaries – the banks – are nowhere to be seen. Unsurprisingly, energy companies are pilloried as the big winners:
“Businesses which extract and refine fossil fuels have grabbed the headlines in recent months due to their record profits. Wholesale gas prices have soared on international markets and oil prices have hovered around $100 per barrel due to demand increasing and supply fears following Russia’s invasion of Ukraine.”
Apparently, the algorithms which have replaced sub-editors in the western media are programmed to add a reference to “Putin’s war” as the cause of our ills… even things like energy price rises which began at least six months before the invasion. Nevertheless, there is a case – environmental concerns aside – for going easy on the energy extraction companies… at least where excess profits are reinvested in exploration and new drilling. This is because of the long timescales involved in fossil fuel production, and because this is how supply and demand economics work. As US oil expert Robert Rapier at Forbes explains:
“People who should know better are still deflecting the blame for high oil prices onto the oil companies. There is still a widespread misunderstanding of how oil and gas are priced… I find that a lot of people think the fact that gasoline prices are at record highs along with oil company profits means oil companies are definitely gouging consumers…
“In my latest Forbes article, I noted that ExxonMobil made $25.8 billion in the past 12 months. People are outraged. But in 2020, the company lost $22.4 billion, and many smaller oil producers went bankrupt. The people outraged about their profits today didn’t care about all those 2020 bankruptcies. Yet those bankruptcies from 2020 helped set the stage for supply shortages today.
“We could change the way oil and gas are priced (or we could ration supplies), but there would be consequences. For example, Venezuela holds the price of gasoline well below market value for its citizens. But that has effectively destroyed the country’s oil industry.”
That’s how supply and demand is meant to work – something everyone needs, like gas for central heating and electricity generation – is in short supply, and so the price increases. In theory – and, setting aside the pachyderm on the sofa of rapidly depleting wells and a shortfall in new discoveries – rising prices ought to attract new investment which, five or ten years from now, will eventually result in more supply and falling prices. Although potential investors may be less inclined to invest if they face windfall taxes just when their investment is paying back.
Investment will be further postponed as a result of the real villains in the current story – our old friends the bankers. The central bankers’ attempt to engineer a recession that has already begun, acts as a double deterrent to real economy investment. On the one hand, the expectation that demand is about to collapse across the global economy makes it less likely that investors will put money into long-term ventures like oil and gas discovery. At the same time, rising interest rates tend to make unproductive financial assets more attractive in the short-term. And even if the central banks reverse course and begin to lower interest rates – something they usually do only after the economy has cratered – it is unlikely to produce an army of investors ready to risk their shirts on risky, long-term real economy investments. As Charles Hugh Smith argues:
“The Fed increasing or decreasing its balance sheet by $1 trillion has zero effect on wages rising for profoundly systemic reasons. And while we’re highlighting the Fed’s complete powerlessness over the input constraints of essentials, let’s also burst the pundits’ delusional fantasy that the Fed raising or lowering interest rates by a point or two has any effect on tax donkeys and debt-serfs whose student loans and credit card balances remain at rapaciously high interest rates.
“The fantasy that the Fed can reduce supply-driven inflation arising from systemic constraints on essential inputs is not just delusional, it’s toxic because it generates unrealistic expectations and diverts policies into dead-ends where real solutions become impossible because the assumptions being made are false.”
The real – and unspoken – winners in the current crisis are the banks. The life support of quantitative easing since 2008 didn’t just keep insolvent banks from closing, it generated reserves so great that the banks no longer needed to attract savers’ deposits, and so could cut back on real economy functions like providing savings accounts and operating physical branches. Big gains have come in the last couple of months too, as a result of central bank policy. Consider that the interest on an average mortgage has doubled since last year. And yet, this has involved no additional work for the banks, and no greater cost than sending out letters to tell beleaguered householders that they are going to have even less income left over at the end of the month. Indeed, mortgage rates are the low ones – overdraft and credit card debt, which is now piling up as people struggle to make ends meet, is paying big dividends to the banks, which continue to lend recklessly because they believe the central bank will bail out any losses. Notice, however, that despite rising interest rates, nobody is offering you a decent return on a savings account. Moreover, long-term savings and pension funds – which depend on returns from shares – are beginning to take a hit as investors seek safer places than the stock market to park their assets. It should be a familiar story by now – heads the banks win, tails you lose.
Maybe now is the time to recognise that we have embarked upon a period of global re-pricing in which countries like the UK, which have been living beyond our means for decades, need to get used to paying the proper price of the things we buy – including the wages paid to the workforce. And if we are also entering a period of windfall taxes as one means of redistributing wealth to the poorest, then surely a windfall tax on the banks is the easiest and most popular one of all.
As you made it to the end…
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