Consciousness of Sheep
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Following Trump’s restart of the attacks on Iran, the Brent Crude oil price is back at $100 this afternoon. And as sure as night follows day, economists and pundits are talking about interest rate rises to ward off the ensuing inflation. As the BBC reports:
“’More expensive fuel and energy can ripple through the wider economy, increasing costs for businesses and ultimately feeding through into the price of food and other goods,’ said Jonathan Raymond, investment manager at Quilter Cheviot.
“’This creates another headache for central banks as they continue their battle against inflation.
“If energy prices remain elevated, policymakers may come under pressure to keep interest rates higher for longer or even raise them. This would come as a blow to mortgage holders and borrowers already feeling the strain.’
“The Bank of England, which sets UK interest rates, has held them at 3.75% in its last four meetings.
“Paul Dales, chief UK economist at Capital Economics, said he believed the Bank will ‘almost certainly’ hold them again. But he said analysts still expected that interest rates could be cut next year if energy price rises ease.”
One reason for anticipating interest rates being held is that the Bank of England’s hawkish Chief economist Huw Pill was laying the ground for a rate hike even before the Iran conflict flared up again. And at face value, he seems to have a point. Oil – or more correctly, oil products – are ubiquitous. And so, if the cost of oil rises then so too must the cost of everything made from, made with or transported using oil products. Nor is oil the only hydrocarbon impacted by the latest manifestation of US imperialism. Qatari gas has been keeping the lights on in Europe for several years since the EU/NATO technocracy chose to disconnect from cheaper Russian gas. And with Qatari LNG tankers unable to pass through the Strait of Hormuz, and with European gas storage at half that required for the coming winter, electricity and gas prices are going to be rising too… along, of course, with the cost of everything produced using that energy.
As with almost all mainstream economists though, they are wrong. This stems from the failure of neoclassical economics to explain the origins of money (which is also why so many politicians make the mistake of treating government like a household and a bank like a building society or credit union). Since neoclassical economists treat banks as mere intermediaries between patient savers and eager borrowers, they tend to believe that the money in circulation comes only from government via the issuance of notes and coins (approx. £99 billion) and government spending (approx. £1.3 billion). But this overlooks the £2.2 trillion – technically ‘bank credit’ – created when businesses and households borrow privately.
Almost all – 96 percent – of the currency in circulation was created as interest-bearing debt. And that has been a slow-burning economic problem for the past 18 years. Because banks don’t simply intermediate, they gamble. Not, of course, in the way that you or I might put a tenner on the outcome of a horse race or football match. But by using state of the art computer modelling to calculate risk. And for nearly two decades now, those computer models have been broadening the calculation of risk to encompass all but the biggest businesses and wealthiest households. This is the so-called ‘K-Shaped’ recovery, in which the majority of us got poorer even as the fortunate few – those who can still access credit – got richer.
Nor is this limited to domestic economies like the UK. In the Eurodollar system, international banks also create money – this time US dollars – out of thin air when they make loans. But what they do have in common with the UK’s domestic banks is that since the 2008 crash, bolstered by the lockdown supply shock and the US-sponsored conflicts in Ukraine and Iran, those banks too have become extremely risk averse… to the point that the world economy is in the grip of a massive dollar shortage in which even governments struggle to access the dollar-denominated loans they need.
Put simply, we are living in an economy – domestic and global – in which there is nowhere near enough money to go around. And it is this relative lack of money rather than the cost of oil products and the goods made and distributed with them which determines prices.
“Tell that to the local plumber filling up his van with diesel fuel this morning,” you might object. And you have a point. Filling stations are able to pass on costs in the short term in response to rising wholesale prices. But the plumber’s problems are only just beginning. Plumbing supplies will also be rising in price, making the cost of doing business much higher. Some of that cost will be offset against tax (which is why rising costs have a negative impact on government) but most will have to be passed on to customers… customers, that is, who don’t have much money and who struggle to borrow. At the increased prices he or she will have to charge, the plumber will likely lose customers – particularly those who can afford to wait for non-urgent work.
Even if the local plumber – and, indeed, tradespeople across the economy – are able to raise prices for urgent work, this doesn’t necessarily feed into general price rises because most of the transactions in the economy are entirely discretionary. So, it is likely that after paying the extra price of fixing leaking pipes and fused electric systems, households will have to cut back on things like meals out, TV subscriptions and annual holidays. In an economy where there is not enough money to go around, increased prices for essentials translates into falling sales – and ultimately falling prices – in discretionary goods and services. As Frank Shostak from the Mises Institute explained a decade ago:
“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.
“Note that the overall money spent on goods does not change. Only the composition of spending has altered here, with more on oil and less on other goods. Hence, the average price of goods or money per unit of good remains unchanged.”
This is actually an optimistic reading of the situation. Because one consequence of rising oil prices is that bank lending (aka money creation) gets even tighter as banks become even more risk averse. So that “the overall money spent on goods” does change… for the worse. Idiots on central bank monetary policy committees raising interest rates only adds to this deflationary process – one reason why government bond spreads are inverted as private financial corporations expect central banks to have to quickly turn to interest rate cuts when the impact of deflation appears in the form of business failures and higher unemployment/inactivity.
Responding to rising oil prices, Jean Claude Trichet, the former Chair of the European Central Bank, became infamous for erroneously raising interest rates into two massive crises:
“He did so in July 2008 amid surging energy prices driving inflation higher, not knowing a month later that stresses in French money market funds – let alone the Lehman Bros’ subsequent fall – heralded a crisis and collapse in the global economic and financial system. In mid-2011, notwithstanding the deepening euro area crisis, he did so again amid higher energy prices, fretting in part about possible wage price effects.”
The good folk at the Bank of England would do well to learn the lesson… higher oil prices are not inflationary!
As you made it to the end…
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