More economic pain

Stock markets around the world remain in free fall. It’s not surprising to readers of this blog – there’s plenty to be pessimistic about.

There are two big changes underway. The long term change is the shift in economic power from west to east, from an Atlantic centred world to the economies of the Pacific Basin; from the EU and east coast USA to west coast USA, India and China. In the process 2,500 million poor people gradually come to the consumer party, creating huge extra demand for energy, food and raw materials of all kinds. This argues for long term investment in commodities and commodity producing economies, and in the fast growth economies of the East themselves, but only when the price is right.

The short term change is the collapse of some of the debt structures built up in the US and Europe in the heady days of easy money and rapid expansion between 2001 and 2006, as erratic Central banks shift uneasily from being too loose to be being too tight. Simultaneously the fast growth economies of Asia are catching the inflation bug. So they too are entering a phase of credit tightening and interest rate rises, which will slow them at the same time as the credit crunch slows or stops the western world. This should produce both lower growth and some respite to the vertical climb of commodity prices. It has already produced sharp falls in many Stock markets despite the good growth of many underlying economies.

There is only one major Central Bank clearly fighting recession rather than inflation – the Fed. The rudderless Bank of England lurches from mistake to mistake under the unsure Darling. It first created the inflation with interest rates that were too low, then it created the credit crunch in the UK by starving the money markets of liquidity, next it started to put interest rates down, then it panicked about inflation and decided it had to keep interest rates up. Its performance has been a bit like a drunk trying to walk in straight line along the money motorway, whilst trying to avoid the fast moving vehicles of inflation and recession. The European central bank allowed inflation to get out of hand by adopting too easy a policy. Ever since it found out its mistake it has stubbornly refused to change rates at all. Maybe it understands that Ireland and Iberia need very different rates from Germany, but there is nothing they can do about that.

We are in for more bad news over the summer, as the Asians tighten the screws to curb inflation, and as the West learns more of the damage from its own erratic monetary policies and the resulting credit crunch. It seems likely that the US will be the first major economy to experience any upturn in fortune, given the consistent policies to avoid slump. The tax cuts, liquidity injections, easier money policy and low interest rates all point in the same direction, and at some point will bring the economy round. The balance of payments is improving rapidly, consumers are saving and rebuilding their balance sheets, and the dollar is beginning to strengthen.

The UK remains in the weakest position of the major economies, along with Italy. The UK still has both an overborrowed government sector and overborrowed consumers, a weak currency and a fiscal position deteriorating all too rapidly. Several years of falling competitiveness, rising taxes and little investment in infrastructure has left it in a bad place, made worse by the erratic money and banking policies pursued by the regulators and the Central Bank. The RPI and the CPI soared again this month, and there is worse to come before the inflation subsides. There is plenty of deflation in the clothing and shoe shops, in the estate agents window and in the commercial property market, but plenty of inflation left at the petrol pump and in the food market. Redundancies in building, construction and finance are now coming all too rapidly, and will be followed by other sectors as the consumer squeeze runs its full course.

The falls in the Chinese and Indian Stock markets have already been large, but we are still in the early stages of the tightening in these countries and cannot be sure how far the authorities take it before they, like the US, turn their attention to reflation again.

(Regulatory notice- This blog is not offering investment advice)

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6 Comments

  1. Stuart Mark Turner
    Posted July 16, 2008 at 11:01 am | Permalink

    Dear Sir,

    Given that the British economy is now experiencing all of the factors you so ably described above, would you agree that the chapter 11 style reforms Mr. Cameron wishes to introduce would not help our economy at all. Indeed this measure would simply serve to prop up failing businesses causing further inefficiencies in our economy, surely it would be far better to lower business taxation and keep interest rates low in order to prevent many viable companies becoming insolvent.

  2. Acorn
    Posted July 16, 2008 at 12:13 pm | Permalink

    Whoopee; all is saved, the two pence duty on fuel is postponed. The nation's financial problems have been solved; what are you whining about Redwood?

    As the bin men have not arrived this morning, I take it there is another public sector strike on. Though you have to hand it to these trade unions, they have learnt the concept of "gearing", from the financial sector.

    Your school caretaker goes on strike; it is impossible to run a school without a caretaker (not); school closes for a day. So you have one person on strike, not getting paid. The rest of the school is on strike; but, getting paid! Clever init.

    Before you write about public sector strikes and the la-la land of public sector trade unions; the following is a bit of prep for Redwood fans.

    First commit this to your little grey cells. "The Government does not have any money of its own". The public sector and its beneficiaries – the socialised economy – are totally dependant on the non-socialised economy for its resources. All the nations assets – even the coal and the oil – belong to the people who by default, are born into the non-socialised economy. It goes wrong when some clown invents the public sector. Unfortunately, they do not teach this fact in economics classes anymore.
    http://tpa.typepad.com/waste/files/life_is_easier

    From PESA 2008, you will see in chapter 5, table 5.3 that the government pay bill is £154 billion; about 28% of government spending.
    http://www.hm-treasury.gov.uk/media/1/F/pesa0809_

  3. Neil Craig
    Posted July 16, 2008 at 12:29 pm | Permalink

    When Mervin Peake writes his statutory letter about inflation to the Chancellor (& PM) he should say that the only alternatives are higher interest rates or lower government borrowing & that if the government doesn't make serious spending cuts the Bank will have a legal duty to produce a significant interest rate rise.

    It may be, in the traditional civil service manner, that he will write an anodyne letter & give such advice privately & while this would be kinder to Gordon it would be the wrong move. The public have to know that there is no free lunch, that the choice is that stark. Without knowing it there can be little sensible public debate about the way forward & no front row career politician is going to be the messenger of bad news.

  4. adam
    Posted July 16, 2008 at 1:21 pm | Permalink

    "employment in this country is at its highest level ever" GB

    HA.
    Maybe according to Zanu Labour traktor production statistics.

    Along with 13000 migrants from europe, fake nhs waiting lists, 2% inflation and comments from the paranoid delusions of the fabian society that feral youths dont exist and are an invention of the nasty tory toffs at the Daily Mail as part of a class war.

    8 million r on benefits. when will the government admit this.

  5. adam
    Posted July 16, 2008 at 1:47 pm | Permalink

    Why do the tories through IDS on the daily politics support this ridiculous labour nonsense that public sector pay needs to be below inflation in order to fight inflation.
    What a lot of rot.
    GOVERNMENT TAXES THE MONEY OFF THE PEOPLE and according to the fake budget all the money is allocated for spending anyway, so it will end up back in the economy.

    If governmnt cut dep. budgets, non jobs and consultants they could afford sensible pay offers.

  6. mikestallard
    Posted July 16, 2008 at 5:38 pm | Permalink

    "Its performance has been a bit like a drunk trying to walk in a straight line along the money motorway, whilst trying to avoid the fast moving vehicles of inflation and recession." – classic!

    I think myself it must be a question of whom you trust to run/ruin the economy.
    Gordon is a busted flush.
    Cameron and the Conservatives seem to me to look right. They aren't overselling and they are keeping cool. It is going to be a crisis when they take over.

    That excellent website above is quite surprising in that it really does show that (disastrously) the NuLabs have been throwing a lot more money at the Public services year by year. Suddenly threatening to slash it is going to cost them the election.

  • 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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