The economic news in Britain goes from bad to worse. Though interest rates are close to zero house prices are falling and retail sales are collapsing. Latest GDP figures for what they are worth show an economy that has flatlined. Given that inflation is said to be 5% real wages are falling and what is even more astonishing given the very low interest rates disposable income is also falling. Meanwhile the Coalition’s hope that job losses in the public sector would be made up by job creation in the private sector are proving delusional. With house prices and retail sales falling retail chains are closing outlets and are laying off people by the thousand. I visited Portobello market for a walk today and was horrified at how many of the shops there are boarded up. A few months ago the government and the media were congratulating themselves on a manufacturing recovery. That has proved to be a mirage with manufacturing output such as it is is now contracting. Meanwhile despite all the brave talk of a fiscal consolidation and of spending cuts the budget deficit is actually growing as tax receipts fall and social security spending rises because of the economy’s decline.
All this is extremely dangerous. The Bank of England has said that it will not raise interest rates whilst the economy remains so weak. In truth it has no choice. Given the fall in real wages and in disposable income any rise in interest rates at a time when household budgets are under such strain and house prices are already falling would lead to a foreclosure and repossessions crisis the like of which we have probably never seen. House prices would go into freefall causing the weak underlying position of the banks to become exposed. We could in that case easily find ourselves facing a bank run and credit shutdown worse than the one in 2008 and this at a time when the government’s fiscal position and therefore its ability to take palliative action is far weaker than it was in 2008.
On the other hand keeping interest rates so low at a time of inflation punishes savers and prevents capital accumulation, which is vital for the economy’s long term return to health. How is the financial system going to recover to the point when it can start to lend if people are being deterred from saving? As it is the money the Bank of England and other Central Banks have pumped into an unreformed financial system through such devices as quantitative easing has largely vanished into the black hole of speculation in products like derivatives and commodities. This has provided a temporary boost to the Stock Market and enabled the bankers to pay themselvers their accustomed bonuses but it has done nothing to cure the underlying problems in the economy or in the financial system.
In addition despite protestations to the contrary there is no doubt that the slack monetary policies and poor fiscal discipline of the world’s Central Banks, first and foremost the US Federal Reserve Board but also the European Central Bank, the Bank of China and the Bank of England, is the cause of the worldwide inflation as confidence in currencies such as the dollar, the euro and the pound has weakened and as the speculation they have encouraged has pushed up prices for commodities like oil and food. This in turn has led to the decline in disposable income and falling demand that is causing the present problems.
What makes this picture even more alarming is that there are clear signs that things are going wrong everywhere. Economic news from the US appears to be every bit as bad as it is in Britain with the fiscal position over in the US being actually and significantly worse than it is in Britain. The problems of the Eurozone are so well known as to require no discussion. In India inflation is now running at 10% and the economy shows all the signs of severe overheating. China is reporting industrial production as flat in the first three weeks of June suggesting a severe fall off in global demand whilst its massive fiscal and monetary stimulus has generated inflation within its own economy (currently running at around 6%) and left its financial system exposed to bad debt.
It seems to me that what is happening is that the massive reflationary exercises carried out in the US and China and elsewhere at the end of 2008 and at the beginning of 2009 have now run their course. They did not fix the underlying problem of the world economy, which is a grotesque excess of debt caused by a banking system that is completely dysfunctional and a trade system that is completely unbalanced. On the contrary by adding more debt, by creating inflation, by increasing trade imbalances, by weakening the fiscal position of governments and by postponing a proper reform and restructuring of the financial system, they may have made things worse.
The response of policy makers to this gathering crisis is the same everywhere: play for time in the hope that something will turn up. Thus Greece gets its bailout though everyone acknowledges that it will in the end only make matters worse since Greece has no prospect of repaying its debts. In Britain and the US the Bank of England and the Federal Reserve Board insist they will keep interest rates low despite the havoc this is causing through the inflation it is generating. Real action to deal with the underlying problems, such as a genuine nationalisation of the banks accompanied by an orderly cancellation of debts and a review of the system of international trade, continues to be furiously resisted. Even the most moderate proposals to deal with the real cause of the problems fail because of the resistance they meet. When the German government sensibly raised the possibility of Greece’s creditors agreeing to a partial debt write off or “hair cut” the response bordered on the hysterical. In the absence of any real action it is difficult to see what it is that will turn up to turn things right but let us hope that whatever it is it turns up soon.