Inflation is too much money chasing too few goods. Today inflation in the UK and the US is being driven higher by increases in the prices of energy, raw materials and basic foodstuffs, and in the UK by the costs of government. Much of the international inflation comes from excess liquidity in the oil exporting economies and from the demands of Asian economies which have built up large surpluses through successful exporting. The US and UK economies have bigger problems from the way credit has dried up, leading to job losses in the US and a sharp slowdown in the UK economic forecasts.
This makes high interest rates in the US and UK economies an inappropriate response to the inflation â€“ something the US authorities have understood. There is clearly no excess liquidity in the US or UK private sectors. Asset prices on both sides of the Atlantic are falling. US house prices, shares and commercial property are either in freefall or are showing signs of distress. UK commercial property has fallen sharply, UK shares are down and most residential property prices are now static at best.If we had too much domestic liquidity you would expect some or all of these values to be rising, not falling.
Energy prices have risen partly because the emerging economies have need more and more of the limited supply, partly because the dollar and the pound have been weak currencies, and partly because despite global warming theory it has been a very cold winter in many parts of the northern hemisphere where much of the effective demand for energy resides. Food prices, especially grains, have soared. This is partly because the Asian customers want more and better food, but partly because the weather has been so bad affecting crop yields and partly because some global warming theorists have favoured using grains for fuel, diverting them from food.
The big pools of liquidity built up in Asia, Russia and the other commodity producing areas have helped power the prices of precious metals and other commodities, both to fuel demand for industrial products, and to satisfy new holders and hoarders of them.
The UKâ€™s inflation rate has been increased by the inefficiency of the public sector, and the liberal use of higher charges and taxes to tackle what is more truly a problem of spending badly.
The correct response to the commodity price inflation in the west should be to ignore it, all the time there is no transmission from the higher metals, energy and food prices to wages and asset prices. So far there is some sign that some of the extra costs are being passed on by business, but no sign that either the US or the UK is about to have a worrying round of wage inflation. Passing the price increases on just shifts more of the pain from companies to the individuals who buy the products. It looks as if this inflation is going to lead to a reduction in the spending power of consumers in the UK, as neither the government nor the business sector are willing to take the hit. Indeed, the government is keen to divert attention from its own role in the inflation, by calling in parts of the private business world for punishment talks when their prices have gone up, as it is currently doing with the energy suppliers.
In the UK everything points to the need to cut the costs of government, not by doing less in the services that matter but by doing things better where they need doing. I set out in yesterday’s blog the need to cut UK government borrowing as part of our response to the present economic crisis. Today the message is reinforced by the inflation figures. The government has done the right thing in at last telling the public sector â€“ including MPs â€“ that this yearâ€™s pay rise has to be below inflation. It needs to do much more to get value for all the spending it is committing.
Todayâ€™s gales may be the last fling of an unpredictable winter in the UK. The parallel squalls on the markets need the authorities to realise they have a serious problem and get to grips with it if they wish to create calmer conditions.