A couple of months back the authorities were claiming they would keep a lid on the money supply. If we had had a Tory government those claims may have had some credibility. With a Labour government however, there was no chance. This step was as predictable as the timing of a new day and anyone who read this blog from back in December would have been aware of what was coming. And so now we are here. Yesterday the Bank of England announced it was expanding the money supply.
So what now?
Well it will take at least 18 months to feed through but come the middle of 2010 prices will be rising strongly whilst interest rates will still be being held artificially low at close to zero percent. This will cripple savers but be a welcome relief for all those who are in debt. Not because they owe any less in nominal terms but because the real value of what they owe will shrink fast.
Why will this happen?
The biggest debtor in the land is the government and they have to balance the books or risk turning the UK economy into a basket case like Zimbabwe. The only way to balance the books is to shrink the real value of the debt. The only way to do that is to take interest rates down and put inflation up. The steps to do both of these have now been taken. It now just needs time to work its way into the economy.
The risks ahead.
The risk in the next 18 months is not, actually, economic depression. The risk is over-stimulation of the economy. You may well think this sounds crazy when jobs are being lost at a seemingly tremendous rate and the media treat every announcement of a pay freeze like a national calamity.
The reality is, however, that most of the companies that have failed so far would have failed anyway. They were not producing the products or selling the types of goods and services that the 21st century wants. The banking crisis has simply caused them to fail all at roughly the same time.
Even the shrinking of the banking sector is widely accepted – including by the Governor of the Bank of England – as an overdue "correction" to a period of unsustainable excess. Worse still on that one, an excess which many people had been raising concerns about for quite some time but were powerless to stop. The motivation of avarice is too strong and is, in fact, the main reason that economic cycles exist in the first place.
With so much bad economic news around and a media industry that uses every modern means of communication to amplify it (this is not a criticism of the media industry, just an observation) it is no wonder people are spooked into stopping or slowing their spending plans. After all, you can only spend it once.
The risk this raises, though, is that the government will wrongly see any "lack of progress" in its official statistics as evidence that the medicine isn’t working and so administer more of as we get towards the second half of this year.
The result would be that by 2012 we could be in an "unwise boom" with already relatively high inflation being fuelled by previous decisions taken to stimulate the economy which cannot quickly be reversed. Whilst he may have been the Chancellor who "removed boom and bust", he is likely to be better remembered as the Prime Minister who brought it back again.
Shouldn’t the authorities know all this stuff? you may ask.
The truth is they do. I have no monopoly on wisdom or source of omnipotence. The problem is that they have to be seen to be acting when the official statistics show no "green shoots" in the type of time frame that the media and others want to see.
If I were Gordon Brown I would have a quiet word with the Head of the ONS.
"Listen me old mucker", he might say. "Are you sure you are measuring things the right way? Do you really have your finger on the pulse of the 21st century digital economy or are you still counting boxes produced in Bradford? Counting them well, I’ll grant you that, you have had 150 years of practice to get it right, but nevertheless, counting stuff that will never grow again. Are you really sure you have it right?"
Unfortunately the truthful answer to this is that the ONS have no way of knowing. You can only measure something if you know where to look and what to look for. Like everyone else, the ONS lag the economic cycle. The data they produce is always out of date even when it is the latest information and, as a basis for decision-making at turning points in economic cycles, fundamentally flawed.
So, watch carefully what steps are taken through the rest of this year and I’ll keep you posted for what it means.
In the meantime, if you have the ability to spend then do so. The value of your savings is going to erode surprisingly quickly in the next few years so watch out for it. If you’re unemployed it will be tough this year because new hires will be low for a while yet. But they will come back eventually. And with an ageing population and caps on immigration, the demand for flexible "babyboomer workers" will be stronger than it was for the previous generation of miners, car workers, shipbuilders and so on to find re-employment.
So, the future will not be terrible, just different. It may be a bit rough this year, and taking the opportunity to learn IT skills and creative skills if you haven’t got them would be a wise move if you have the time, but do not lose hope. Give it time.