Inflation coming spells big trouble
How to spot the next crisis? Not every twinge, or every ominous feeling, turns out to be a reliable omen of imminent economic turmoil. Often, policymakers just get lucky. Or the underlying trends and animal spirits propelling the economy are strong enough that a problem does not turn into a disaster.
There are moments of premonition, though, that turn out right. Many of us working in political, economics and business journalism felt it at various points in 2007 and 2008 as the financial crisis built. Initially it was a downpage story, a business section curiosity, and many bank boards and executives carried on as though it was indeed a blip. It wasn’t. When a realisation spreads rapidly and sinks in – usually quite suddenly over a day or two – then it gets frightening. A crisis has a momentum of its own as people, companies and governments respond in a hurry, make mistakes, metaphorically bumping into each, as they try to save themselves, their firms and the economy.
The best dramatic representation of the rarefied moment of early, privileged realisation, when everyone else out there is unaware of what is about to hit, and most market participants carry on as though the music is not about to stop, is in Margin Call. That’s the single best film on the financial crisis of 2008. A junior has run the numbers – “the kid killed it” in the words of his risk manager superior – and the numbers on which everything was built no longer add up. The model is bust and the firm will be too if it doesn’t sell, sell, sell, the junk the next morning before all their rivals realise.
We’ll know in the next six months or so whether this is just such a moment of realisation, on overheating and surging inflation. Right now, it looks like it and it feels like it to me. Partly because almost everyone is carrying on as though it isn’t about to happen, and the signs are there that it is.
The economy in the UK is powering out of the crisis in a spectacular fashion. There’s a boom building, with mania in the housing market and cheap money mortgages flying off the shelves. The Bank of England will say on Thursday that the bounce back is stronger than it expected just a few months ago.
It will be interesting to see what the BoE leadership says when asked about potential rate rises. It’s an election day tomorrow in Britain. They may choose to be circumspect.
In the US, the situation is more ominous. The economy is recovering well, but President Biden is pouring petrol on a fire that is already going. The $6trillion of stimulus ordered by Biden’s team on top of a recovery that is happening anyway thanks to the private sector and existing government spending. Government policy risks overheating and an explosion. The US Treasury Secretary Janet Yellen hinted earlier this week that rate rises might be necessary, and then modified her position to say they are not coming, perhaps after political pressure.
Alarm bells are ringing in areas such as construction. Lumber prices have soared, reports Fortune. “The lumber shortage is getting worse. On Tuesday, the price per thousand board feet of lumber soared to an all-time high of $1,359, according to Random Lengths. Since the onset of the pandemic, the price of lumber has skyrocketed 280%.”
James Mackintosh on the Wall Street Journal says that we could – could – be heading for one of those generational changes in global economics.
Read his persuasive assessment – Everything Screams Inflation – here.
There is an obvious argument that a burst of inflation is necessary and positive because it will eat away at the debt, eroding the mountain while calming consumer excess. If the poorest paid get some leverage to demand pay raises that’s positive too.
The problem is that it is difficult to get inflation right once it starts, to pinpoint just what is the sweet spot, neither too hot nor too cold.
And then rate rises are needed, bigger than would initially have sufficed if the authorities dither and wait too long. Great, rate rises restore some power to savers and calm borrowing excesses, but they also stress businesses and individuals who borrowed too much on the assumption that money would stay cheap – virtually free – for ever. Just a rise from 0.1% to 3% in stages would be very difficult for many borrowers to handle.
Fear of inflation, and a dislike of booms being followed by busts in which people get hurt, explains why policymakers rightly looked several decades ago for ways to control inflation and create a permanent low inflation environment. This obsession led in time to the use of QE – known sometimes as money-printing – and endless cheap rates whenever trouble appeared and even once it had faded away. This has boosted asset prices, punished the young without houses and distorted the basic workings of capitalism.
The economy and government policy on both sides of the Atlantic is predicated on this – low inflation – and cheap borrowing carrying on. If inflation is coming and rates have to rise, get ready for political trouble. Boris Johnson, unlike Gordon Brown or Margaret Thatcher, is not much interested in the subject of economics. The current Prime Minister might have to start learning soon.