Prices and money

Early in 2008 when interest rates were too high for comfort and likely to help bring more banks down, I called for much lower rates. At the time I said inflation would tumble anyway, as the inevitable recession bit.

As expected the recession came, and inflation has fallen sharply on the RPI measure, less so on the CPI measure. It is time to reassess the inflationary outlook, as interest rates have now be held well below normal recession levels for some months , and quantitative easing is well underway.

UK inflation has proved to be more obstinate on the CPI measure than the deep recession would suggest, for three main reasons. The first is the collapse of the pound in 2008. As I warned at the time, a money policy which lurched to being too easy would drive the pound down, which would leave us very exposed to imported inflation. We are now living with the consequences. Forward currency cover is running out for importers. Stocks of cheaper imports are running out. New product is costing more.

The second reason is the commodity price revival, brought on by Chinese restocking and probably by speculative activity on the back of quantitative easing, Oil has more than doubled from its bottom levels earlier this year. Although sterling in recent weeks has been getting stronger, abating the import price issues, commodity prices have been going up more quickly than the currency, leaving more price pressures in the system.

The third reason is the behaviour of some industrial companies. Usually in recession as volumes fall away companies offer price cuts to try to induce more spending on their goods, or at least to encourage gains of market share. This time round the volume reductions have been so enormous – a halving of demand is typical in the automotive areas for example – that some companies are taking a different view on price. They are saying to their customers our overheads per unit of output have risen sharply, thanks to the big drop in your orders. As a result we cannot afford to offer you any price cuts. In some cases they may even propose price increases, to try to reduce the losses on the limited output they can sell.

In both the US and the UK industrial work forces are on the whole co-operating with management to combat the huge falls in demand. In many cases employees have volunteered for more short time working, extended factory holidays and the like to cut both output and their pay in the hope that will enable them to keep their jobs for the upturn. In other cases Unions and employees have reluctantly accepted the need for substantial redundancies and factory closures, as companies desperately try to cut their costs and output as demand plunges.

Employees seem to understand that the banks are not prepared to pay for ballooning stock and work in progress that cannot be sold, and not prepared to pay for large losses in industrial customer companies. They have their own losses to finance instead. Companies have to run down their stocks of raw materials and finished goods, and have to cut employee costs. Most companies embarking on such reductions are also cutting out management jobs as well. Where the cuts are made by short time working, managers may also have to go onto shorter weeks for less pay.

UK inflation will be higher than it should be owing to monetary and fiscal looseness, the commodity surge and the weakness of the pound last year. The authorities must not ignore inflation. It is down for the moment, but not necessarily out.

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38 Comments

  1. Mick Anderson
    Posted June 23, 2009 at 6:32 am | Permalink

    There are other curious features. I am self-employed as an R&D engineer and have never been busier. It looks as though my (increasing) client list has cash in the bank and is using it to pay for my services, rather than gain no interest on it.

    Resale-orientated clients are commissioning work because they don’t trust their suppliers and want to start selling their own product. They are using this as a way to fill the time available while they can’t sell effectively. Some in this category say that their suppliers have stopped development, and are worried by the signals this sends.

    The contract manufacturing companies on my client list are on short time and letting staff go. This is because their customers work has evaporated. However, those with a history of having their own products are preparing for the end of the recession/depression with product development now.

    All of my clients are smaller companies (with one exception, up to 25 staff). If these small firms are the backbone of the British economy, personally, I’m receiving mixed messages. All the signs say that there is a bad recession, and I’m certainly seeing the evidence in rising costs (fuel, food, component parts) and taxation.

    I’d like higher interest rates now to bring some realism back to the economy. From a selfish perspective, this inrush of new work would be replaced by some return on my savings, and I could take a day off without feeling guilty.

    • jean baker
      Posted June 23, 2009 at 9:34 am | Permalink

      You’re fortunate not to be adversely affected by the deep recession. Please may I ask, what is a R&D engineer ?

      • Mick Anderson
        Posted June 23, 2009 at 11:31 am | Permalink

        R&D is lazy typing for Research and Development. I work in the electronics industry.

        Officially I invent the things that my clients wish to manufacture. In practice, I play with high-tech toys for a living….

        • jean baker
          Posted June 23, 2009 at 1:13 pm | Permalink

          Hope you patent your inventions and thanks for taking time out to reply.

        • Adrian Peirson
          Posted June 24, 2009 at 4:44 am | Permalink

          In my time as an electronics engineer, it was always agreed in the employment contract that all ‘inventions’ belonged to the company, not only that but they even argued that anything I might invent at home belonge to them as well and as if that wasn’t enough they argued that they could also lay claim to anything I might invent in the future since it could be argued that my experience with them might well have been a major contributing factor.

      • Mick Anderson
        Posted June 23, 2009 at 4:02 pm | Permalink

        Hi Jean,

        Actually the laws associated with patents don’t help someone like me.

        Taking a patent out means publishing rather a lot of information about your work, and often my clients would prefer it to remain confidential. I take the view that when they have paid for my time, they are entitled to the fruits of that time. Technically I could still apply for a patent as the designer and developer, but that’s going to annoy my clients.

        Also, a patent is only any use if you have really deep pockets. In practice, you have to wait until someone appears to pinch your idea, then you have to be able to afford to prove what they have done and sue them for damages. Even if I can prove that an idea was originally mine, I can’t afford to defend a patent.

        So I simply have fun doing what I do, with a fast-flowing stream of new projects to move forwards. I’m very fortunate to be able to look forward to every days “work”. Most engineers are well aware that they’re never likely to be rich….

        • jean baker
          Posted June 24, 2009 at 8:13 am | Permalink

          Innovative IT ‘whizz kids’ (R &D engineers) are invaluable to clients needing ‘fast flowing stream of new projects’ and those I know are paid handsomely ! Worth their weight in gold, I’m told.

  2. alan jutson
    Posted June 23, 2009 at 7:04 am | Permalink

    John

    You sum up the position very well.

    In addition, those that have been made redundant are finding it very difficult to get back into any sort of work, let alone a career of their choice.

    I am afraid that unemployment will continue to rise for a long while yet, and will eventually only start to come down slowly over a long period of time.

  3. Colin D.
    Posted June 23, 2009 at 7:18 am | Permalink

    Surely a fourth reason for inflation is, or soon will be, Quantitative Easing? This deliberately chosen technical sounding term is designed to fool us, but is just a euphemism for printing money. We all know what happens when you print money – the currency is devalued, our savings whittled away, debts nicely vaporized, and the end result is disastrous inflation.

    • Waramess
      Posted June 23, 2009 at 11:01 am | Permalink

      I believe you hit the nail on the head. Left wing economists point to the slack in the economy being able to absorb the increased supply of money but this is pretty unconvincing stuff.

      More likely is the paucity of investors that wish to invest in gilts has prompted the Bank to fill the breach. A very short term fix.

      Economics, being more of an art form than a science, will require us, as always, to wait and see

      • jean baker
        Posted June 23, 2009 at 1:21 pm | Permalink

        “We all know what happens when money is printed …. the currency is devalued”.

        Perhaps the current scenario supports Mandleson’s recent proclamation (undoubtedly on behalf of Labour) of abolishing sterling in favour of the Euro. Federal Europe, centralized banking etc. the ‘unspoken’ aim ?

  4. Brian Tomkinson
    Posted June 23, 2009 at 7:21 am | Permalink

    JR: “The authorities must not ignore inflation.”

    Quite correct, but that presupposes that the government doesn’t want to inflate its way out of debt.

  5. Brigham
    Posted June 23, 2009 at 7:39 am | Permalink

    I have been expecting price reductions, but I just got my house insurance renewal with a price increase of 25%. They were going to renew it automatically unless I called to cancel. When I did they appeared surprised and offered to negotiate. As a rule I do negotiate each year, and my premiums have not increased for the past seven years, but this time I’d had enough and cancelled. If everyone did this I think prices would be a lot more realistic.

    • alan jutson
      Posted June 23, 2009 at 10:09 am | Permalink

      You describe exactly what has been happening for years.

      Existing loyal customers often pay more than a price offered to a new prospective customer.

      The Building Societies and banks have been doing this for many years with new improved taes for new customers.

      Given that new customer cost more to find and attract than existing customers, this does seem a strange way of running a business.

      I agree re-negotiate every time.

  6. oldrightie
    Posted June 23, 2009 at 11:02 am | Permalink

    The bank bailout is nor working, QE is not helping, inflation is soaring in people’s shopping baskets ,due to huge energy taxation and oil prices. The end of the economy we once relied upon is nigh. Only a massive £100 billion drop in the Government borrowing requirement can achieve anything. The EU wil engineer a rescue in return for our surrender.

    • jean baker
      Posted June 23, 2009 at 1:31 pm | Permalink

      Blair’s abolition of financial regulation in 1997 ‘broke banks’ within 12 years; Nulabor’s involvement/bailout is not working. Has centralized EU banking been the envisaged plan all along by the ‘Hail Brussels’ laborites ? Stealth, media spin and manipulation is their longstanding method of ‘government’.

      • oldrightie
        Posted June 23, 2009 at 4:18 pm | Permalink

        Very succinctly put, Jean.

        • jean baker
          Posted June 23, 2009 at 7:35 pm | Permalink

          Thank you – truth is always straightforward ……

          ‘Those who play the game do not see as clearly as those who watch …. ‘

          Old Chinese Proverb

          PS I recently read the Chinese hold the US purse strings (?)

      • Adrian Peirson
        Posted June 24, 2009 at 4:47 am | Permalink

        Problem Reaction Solution, first create the Problem, wait for every one to react, demanding a solution then, impose the solution you always wanted.
        A worldwide banking system, a new world order.

        Of course it could all have been easily solved and still could, we could be out of this mess within one year.

        http://www.moneyreformparty.org.uk/download/leaflets/mrp14pol.pdf

        • jean baker
          Posted June 24, 2009 at 8:02 am | Permalink

          Commonly called ‘spin and manipulation’. In Britain’s case, Brussels based EU financial centralization. Bliar’s reward (reportedly) the next presidency. To kill time he’s on a (reportedly) taxpayer funded ‘mission of peacekeeping’ – frontline confirmation he’s as ‘useful as a chocolate fireguard’.

        • jean baker
          Posted June 24, 2009 at 8:05 am | Permalink

          PS – I recently read a ‘German group’ formed the EU to succeed where Hitler failed.

        • Adrian Peirson
          Posted June 25, 2009 at 6:24 pm | Permalink

          52 Reasons to get out of the EU.

          Threy are taking us to a totalitarian Command Economy, where every move, every action is state sanctioned.
          Look around you and tell me I’m wrong.

          http://www.youtube.com/watch?v=_NtSd0EOF3w

          Now would be a real good time your Majesty.

  7. Michael Lewis
    Posted June 23, 2009 at 11:03 am | Permalink

    This reminds me of an article written by Anthony Hilton in the ‘Evening Standard’. In it, he complained that “speculators” would ruin any recovery by bidding up the price of Oil.

    Requesting comments, I pointed out that “speculators” these days are just ordinary familties worried about the current government debasing their savings. ETFs are a wonderful thing! Now, rather than watch Gordon Brown destroy my savings, I can simply buy some Oil, or Copper, or Gold (though when you see adverts asking for Gold on TV, its time to take some money off the table) , Sugar, Coffee, any store of value.

    I don’t think Gordon Brown will start drilling for Oil, mining for iron ore, fundamentally altering their demand-supply balance overnight. Thus, they are a much better store of value than Sterling. The printing presses are on full speed.

    The Bank of England, The FED, they can debase Sterling and the Dollar, any idiot can see that they are devaluing because they are in too much debt.

    What is worse, they are digging us all in further.

    Eddie George did one really great thing: letting Barings go bust.

    It the FED had followed his example over LTCM, maybe we wouldn’t be in this situation now.

    However: failed banks should fail. RBS, HBOS, Northern Rock shouldn’t exist anymore (retail depositors can still be protected to a degree).

    Allowing failing organisations to fail , we’d be in less debt, and capital would flow to those that deserve it. We’d be out of recession quicker.

    • Tim Coates
      Posted June 23, 2009 at 2:53 pm | Permalink

      Indeed ordinary people are speculators, often without knowing it for example via their pension funds. Though this is nothing compared to the speculation that has been undertaken in land. JR please take note.

      And it isn’t just people speculating on acheiving an inordinate capital gain through their own house (well the land it is built on) but commerical enterprises doing it too including the banks. Banks after all speculated on derivatives made up from sub-prime and other loan based product sets. These loans were made originally on the belief that the underlying asset would appreciate faster than the need to repay a loan. It was always going to be unsustainable

      If you want a solution, tax the land, not the person. Replace taxes on production (so income, cgt etc) with those on speculation and pollution (land, carbon).

      • jean baker
        Posted June 23, 2009 at 7:42 pm | Permalink

        Surely, paying into a pension fund in the full expectation of proper management and a good return isn’t ‘speculative’ ?

        It was a national scandal – a total outrage – when Robert Maxwell (reportedly) ‘dipped into others’ pensions’. It (reportedly) led to his demise.

        Nulabor has no such scruples where other peoples’ money is considered – they’re rotten to the core !

        • Tim Coates
          Posted June 24, 2009 at 3:51 pm | Permalink

          It is speculative because those pension managers, like all fund and investment managers will speculate with the investment. You may not intend it to be, but it will be. So it isn’t just Gordon Brown who is an outrageous manager of other people’s money, and the ruiner of pensions – the industry itself, which totally believed Brown’s no more bust rhetoric (lies), has itself to blame.

          The only reason to have a pension is the employer contribution and that is clearly going to fall…

    • Sally C.
      Posted June 23, 2009 at 4:58 pm | Permalink

      Correct!

      • Michael Lewis
        Posted June 23, 2009 at 10:36 pm | Permalink

        The great thing about the internet and cheap on-line brokers, is that its turned average joes into the equivalent of a “bond vigilante”. We can punish (in our own small way) the government by selling sterling, selling gilts and just moving our savings elsewhere… Fantastic. The Debt Management Office can say their fixed auctions are going swimmingly , of course its the BofE printing press thats bidding. Sooner or later, inflation will be back…

      • Lola
        Posted June 25, 2009 at 9:30 am | Permalink

        No, not entirely correct. A speculator is a person who taks the slack out of a market. He is a buyer of risk. An insurer if you like. This is entirely different to an investor or a true investment manager, who does not speculate.

        There are tens of thousands of collective investment schemes including pension funds availabe to the UK retail investor. In this universe there are very speculative funds – Japanese Warrants say – and very unspeculative funds – most index trackers and passively managed funds.

        An between these there are many other funds run under various philosophies – ‘value’ for example – where the manager does not set out to speculate but to make a decision about the absolute or relative value of a security and its propsects. He runs a fund as he knows that his analysis will not always succeed and that diversification reduces risk.

        So it is entirely incorrect to lump all collectives managers as speculators. They are not.

        This brings us to tax. You do not tax speculation. It just puts up the price of the risk insurance provided by the speculator and impoverishes us all. This applies to those that try and foresee the future course of oil prices and other commodities. What these ‘speculators’ actually achieve is the stabilisation of prices. It is Government interference and the actions of cartels like OPEC that cause price rises, not the speculators.

        In fact you are only attacking a symptom not the cause. The excess of ‘speculation’ which you indentify, house prices, was driven entirely by excess liquidity, too much money at too low a price. To control house price ‘speculation’, make the government run sound money and ensure banks run sound capital and solvency ratios, both of which were undermined by Browns policies.

        As to the taxation of land, I entirely agree. Introduce land value tax to replace private and business rates, CGT, VAT IHT etc etc. And that would go a long way, with sound money, to stopping stupid house price bubbles.

  8. sm
    Posted June 23, 2009 at 3:42 pm | Permalink

    Inflations only matters if you have fixed non inflation linked income, low, or no income ,including those who receive no state help. (That will in future contract private demand)

    The market is being massively manipulated in order to delay events, until post the election, unless events force it sooner.

    QE cant continue, im not sure how it will be possible to reverse? without a Paul Volcker, so its probably inflation instead of taxation.
    or maybe stagflation.

    http://en.wikipedia.org/wiki/Paul_Volcker

  9. Mike Stallard
    Posted June 23, 2009 at 4:16 pm | Permalink

    Down here in the Fens, strange things are happening too. We have had our new College axed. We have had, however, £58,000,000 offered to our two Comprehensive schools (admittedly over the next decade or so). Hazel Blears (remember her?) promised £5,000,000 for urban renewal of shops. This has gone down now to £3,000,000. So there really do seem to be some cuts in the ghastly over expenditure of the state.
    Why didn’t you mention the Public Sector unions?
    The French, who are expert at arranging strikes, have already organised a pretty good one over power supplies.
    When the Public Sector, whose Unions support the Labour Party now it has lost Lord Levy’s tennis parties, gets its p45s, surely there will be a winter of discontent and resultant inflation then, just before the election?

    • jean baker
      Posted June 23, 2009 at 7:45 pm | Permalink

      That which Labour says and what it actually intends, are two very different things – spinners and conners.

      • Mike Stallard
        Posted June 24, 2009 at 4:07 pm | Permalink

        Are you, by any chance, the same person whom I meet twice a week in the gym at Wisbech? If so, allow me to say how much your advice there has helped me along through these difficult times.

  10. jon
    Posted June 23, 2009 at 7:02 pm | Permalink

    Well I’m looking to switch back to a fixed rate mortgage. I’m sure the rates will creap up before the BoE moves in a few months. In a recovery smaller companies tend to mover first, don’t see the signs in the 250 and 350 not that we would expect that, inflation will come from elsewhere.

    As mentioned China re stocking, the CEO of Quantas said a couple of weeks ago that they saw a rise in air freight with China. OPEC needs about 65 dollars a barrell to make a profit, who’s complaining at 70 dollars other than high taxed countries. I don’t think OPEC would want a huge price increase themselves.

    I think we have a false dawn or two to get over but we will have the green shoot brigade coming out at every opportunity like a virulent weed.

    • Mark
      Posted June 24, 2009 at 8:31 am | Permalink

      Just 10 years ago OPEC was pumping at full rate with prices under $10, engaged in a full scale market share war. They certainly don’t need $65 to make a profit on anything other than some minor project sponsored by a foreign oil company in return for a supply contract. The judgement for them is the price track that will maximise their return from their resource. Too high a price, and competing supply erodes current volume and income, and potentially extends the resource life to a period when a real substitute cuts energy cost (e.g. say fusion at some point). Too low a price, and revenue is reduced on that account – something that matters greatly to those whose resource is nearing exhaustion. Differing reserve life expectations ultimately divide OPEC. Actions are driven by social pressures in Venezuela, Iran, (and maybe soon Iraq again), Saudi and Nigeria: the others are also-rans.

      • jon
        Posted June 24, 2009 at 12:31 pm | Permalink

        I appreciate my comment was a generalisation and supply management is a big issue here. However there are costly projects to pay for which are getting more expensive and a number of commentators over the years have put that as a price that they don’t really wish to go below for too long. OPEC did try to include the likes of Nigeria recently though I can’t see that happening.

  11. figurewizard
    Posted June 23, 2009 at 8:10 pm | Permalink

    The unique feature of this recession so far is that many employees in the private sector have actually accepted wage cuts in the best interests of both the long term future of the company and their jobs. Honda’s decision to temporarily stop production from the beginning of the year is a case in point.

    At the beginning of this year Honda announced that the business needed to stop production temporarily in order to clear their backlog of stock. Although employess continued to be paid. they were receiving less income than before; a pay cut in other words. Now, because Honda’s plan has worked the company has restarted production and the staff are going back to work.

    This is a shining example of how the staff of a private sector employer were to go along with the management’s plan to guarantee both the long term future of the business and their jobs with it. What a contrast this is with the public sector however! Gordon Brown boasts in the House that he is dead set on increasing spending on it, despite this being responsible in part at least for the dire financial straits that the country faces. Nor is there a word on the bomb proof (and unaffordable) pensions that the public sector enjoys as opposed to the collapse of final salary schemes elsewhere.

    If anything shines a light on Brown’s misguided approach to running an economy on the back of clapped out and discredited social engineering theories, it is the success of Honda’s plan in preserving both their financial health and job prospects in Swindon at a time of crisis.

  12. Denis Cooper
    Posted June 24, 2009 at 9:28 am | Permalink

    For the record, last week the Bank of England created another £6.5 billion and used it to buy up existing gilts, while the Treasury borrowed £6.8 billion by issuing new gilts.

    As of June 18th, the “Quantity of assets purchased by the creation of central bank reserves” was £92.72 billion:

    http://www.bankofengland.co.uk/markets/apf/results.htm

    broken down as follows:

    Commercial Paper £2.10 billion
    Corporate Bonds £0.75 billion
    Gilts £89.87 billion

    ie 97% of the “quantitative easing” has been used to ensure that the government can continue to borrow in order to cover its budget deficit, which is now running at about a quarter of its expenditure.

    The question is whether the Bank will agree to continue to help the government out for long enough – ie, until it can go into an election next spring claiming to have seen us through the recession – or the MPC will decide this autumn that there’s no longer any plausible justification for more “quantitative easing” of its financial difficulties.

    My guess is that the MPC will look at the potential economic consequences of suddenly cutting off the supply of new money, and will decide to tail it off very gradually during 2010.

    And on that basis, I’d say that Gordon Brown still has a fighting chance of winning the next 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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