All good things have to come to an end. The benign environment where China and India delivered an ever more stunning array of goods at fabulous prices is changing into an era when Chinese and Indian demand puts substantial upward pressure on raw materials. At the same time the West’s insatiable appetite for these goods based on leveraged credit has been hit by the Credit Crunch.
During an era of transition – from rapid credit led growth to slower growth, and from low inflation to higher inflation – there are always conflicting signals for policy makers. Some look resolutely back, seeing the build up of inflation that has come from past monetary excess: they demand the donning of a tougher hair shirt in the forms of high interest rates and more intense regulation. Others look forwards to the slow down, seeing that the credit crunch itself will in due course reduce inflationary pressures and slash asset prices, which in turn depresses demand more.
The latest inflation figures for the UK are poor, with RPI inflation running above 4% compared to the old government target of 2.5%, but they should have come as no surprise. The next couple of months will see further energy and food inflation flowing through. No one believes the 2.2% increase in the CPI reflects family experience of their daily budgets, and adds to the feeling that the government and the monetary authorities are out of touch.
Tne government itself is under pressure on the Non doms issue. Many in business now believe the government’s addition of more scrutiny and detailed rules on savings income to the idea of a flat fee will scare people away. If the government persists they will discover the hard way that there is one thing worse than having rich people here not paying full amounts of UK tax, and that is not having the rich people here paying any tax at all. The government needs more revenue to get closer to matching its bloated pattern of expenditure. It is not a good time to pick a fight with people who are making some contribution to the tax collected and to London’s successful economy. Sometime reality needs to take precedence over ideology or senses of fairness.
The government also eneds to tackle the obstinate problem of little or no growth in public sector productivitiy. Now we have such a large public sector it is more important than ever that its productivity should start to rise by at least the average growth rate for the economy as a whole. Manufacturers needs to raise their productivity considerably faster than 2.5% a year to stay in business in a very competitive world. It is high time the government found ways to use the new technology and better management techniques used widely in the private sector to deliver more public service for less.
The pound has been falling for some time against the Euro, and is now also falling against the dollar. Whilst this helps exporters to set more competitive prices, it means more imported inflation. The Gordon Brown devaluation is now shaping up to be bigger than the devaluation after the damaging Exchange Rate Mechanism experiment in European monetary co-operation, recommended by all three poltical parties and foolishly adopted by a previous Conservative government. The Bank of England will have to take into account this drop in the pound when it makes its interest rate decisions, as a falling currency does loosen monetary policy and relaxes inflationary disciplines.
The UK is going to have to pay a substantial premium in the form of higher interest rates than the USA, Japan, and Euroland for some time to come. That is the price of too large a government deficit, too much wasteful public spending, and a failure to raise productivity in the public realm. The UK is less well placed to offset the Credit Crunch than our main competitors because the government divorced Prudence many years ago. The government’s newer Valentine is its very own flexible friend, the Borrowing Requirement, as it continues to spend money it does not collect in taxes. Government borrowing is deferred taxation. We will all be paying the bills for years to come.