The UK’s economic problems were made at home

The price of oil fell sharply yesterday. The mood has changed in energy markets in recent days – at least for the short term. It is a reminder to all those who think the price of oil and related commodities can only go one way that there could be a price retreat in a market where everyone who needs oil has probably bought lots forward just to be on the safe side. Readers of this blog will know I have felt for some time that there is speculative as well as business money behind the oil rise, and this could unwind at any time.

I do not deny the long term case for higher oil and other commodity prices. Of course the arrival of 2,500 million Indians and Chinese at the western party will make a long term difference to the prices of commodities relative to other things – they will get dearer as these large countries get richer. Such changes rarely occur in a steady straight line, and we should expect interruptions to the upwards march when there is too much speculation in the market, or when there are pauses to demand growth owing to the trade cycle. We are likely to experience some reduction in demand from the west over the next year, as the economic slowdown has an impact. This would be reinforced by mild weather, and offset to some extent if there is a really cold winter.

The volatility of the oil price should act as a warning to the incompetent UK authorities that they should concentrate on fighting downturn more than on fighting inflation. No-one looking at the UK economy today can plausibly think its main problem is accelerating inflation. Its main problem is clearly collapsing demand and a weak banking sector which will keep growth well below trend for the foreseeable future. In such circumstances upwards movements in commodity prices are unlikely to lead to second round inflation in the UK – the higher prices do show up in the price indices, but just mean people have to buy less of something else, as consumers have no way of passing the price increases on. They are not going to get an inflationary wage increase.

If commodity prices do decline and stay lower the rises in the RPI will subside quite quickly. The downturn will not suddenly come to an end. Maybe if and when this happens even the ponderous and foolish UK authorities will see they have set interest rates too high for current conditions, just as surely as they set them too low for conditions a couple of years ago thanks in part to the UK government’s meddling with the targets, and in part thanks to the government’s passion shared with some in the banking sector for off balance sheet finance. Maybe the Treasury will speed up its review into the functioning of the money markets, and conclude what is obvious to most sensible commentators that the money markets are still short of cash and helping to throttle the economy. What do we pay all those salaries of Ministers, senior Treasury officials and Bank of England officials for, if they cannot see these blindingly obvious truths and need outside experts to come in a write reports as if next year would do for fixing this problem?

All the PM is able to do is to tell us the UK is well placed to ride out the international storm. Both parts of this idiot soundbite are wrong. This is not just an international problem. A large part of the UK housing and mortgage collapse was made in the UK. Northern Rock was not big in US sub prime, but big in UK mortgages. It was the Bank of England and Treasury that mishandled money markets last summer and led to the run on the Rock. The UK is not well placed. Thanks to its profligate government and hapless monetary authorities it is one of the worst placed economies to handle the downturn. If you want to cure a problem you first need some honest analysis of what is wrong. Until the UK government admits its past mistakes I do not hold out a lot of hope of it getting the next moves right.

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4 Comments

  1. Neil Craig
    Posted July 9, 2008 at 12:11 pm | Permalink

    "Of course the arrival of 2,500 million Indians and Chinese at the western party will make a long term difference to the prices of commodities relative to other things"

    This depends very much on to what extent commodity production is a fixed sum. It may seem intuitive that the amount of oil in the world is fixed, assuming abiotic oil isn't involved, but the amount extractable depends very much on technology which in turn is enhanced by having 2.5 billion extra investors. It also depends on the amount the US refuses, on environmental grounds, to exploit, which is slightly dependent on its place in the world pecking order. Beyond the energy commodities are all, to a large extent, substitutes for each other & we know that it is possible to produce as much nuclear energy as the world could want. Currently the west (including Japan & S Korea) have a technological edge over China & India there but they are clearly going to catchn up on technological quality as well as quantity.

    As Julian Simon proved in his famous bet with Paul Ehrlich, commodity prices, vis a vis GNP have been & will remain a decreasing cost. The only possible exception being in countries which are in comparative economic free fall compared to the world average – which brings us back to us.

    All the stuff about "the age of cheap energy/food etc is over" is rubbish. If only we would just stop kowtowing to the "Greens". The age of cheap energy, commodities & wealth of all sorts has barely begun, at least for China & India and we are currently making an even greater historical error than the Chinese did in 1430 when they banned exploration & open sea shipping & gave the world to the Europeans.

  2. adam
    Posted July 9, 2008 at 5:22 pm | Permalink

    good speach by Sammy Wilson today in the cost of living debate

  3. mikestallard
    Posted July 9, 2008 at 6:31 pm | Permalink

    John, you know a lot more about money than I ever shall. So your remarks on the threat of a downturn being more important than inflation must be taken seriously.
    However, I would like to remind you and your readers that the Labour Party is now £25,000,000 in debt and seems to have little chance of recouping this from major donors. Its traditional membership melted away ages ago too. That leaves the TU people who have their own ideas on how to cope with inflationary problems as they affect their own members…..

  4. Matthew
    Posted July 13, 2008 at 7:46 pm | Permalink

    John, could you comment on the debate that speculation cannot be behind the price rise in oil as it is wholly using futures contracts, which unless hedged in the physical market, do not impact on it, and further the lack of stocks (outside of government stockpiles) suggests that is not happening?

    reply: I have set out how and why I think there is a speculative element to the rise.

  • About John Redwood


    John Redwood won a free place at Kent College, Canterbury, and graduated from Magdalen College Oxford. He is a Distinguished fellow of All Souls, Oxford. A businessman by background, he has set up an investment management business, was both executive and non executive chairman of a quoted industrial PLC, and chaired a manufacturing company with factories in Birmingham, Chicago, India and China. He is the MP for Wokingham, first elected in 1987.

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