It is clear that the British Government does not understand what the underlying problem is with the UK economy yet the World's politicians are desperate to reassure the public that the current problems can be resolved quickly and that they do not have to worry. There is no doubt that this approach has worked for Gordon Brown in the last few months as he has been hailed as having solved the financial problems of the UK and shown the rest of the world the way forward! It is also quite apparent that none of the world's leading economists have worked out what caused the problem or are not admitting to it. It is unlikely that anyone will ever solve the problem unless they first work out how the problem came about. In this half of the site we will explain how the recession came about and what this means for the future.
It might appear at first sight that there is a single worldwide financial problem. In fact, there are at least three different scenarios at work. The first is the problem of the Western Nations that have over-borrowed to support their life style and the demands placed on their governments by an increasingly large and unproductive population. The second are those countries that were tooling up to provide goods and services for these countries and who were reliant on money from these countries to fund their development. Then there is the third group of counties that were reliant upon the two main groups to keep them going. These are third world countries who are never going to go anywhere and whose trade volumes are small. However as the World economy slows they will be badly hurt except for those that export raw materials, such as oil, that are still needed by the other two blocks. These developing nations are of little importance to the World economy. Many of them will default on their debts as the World economy continues to slide backwards. If the governments of these countries do not have sufficient funds then the IMF will have to assist them. If the IMF is unable to assist then they will default on their debts and the losses will then be transferred to the Western Nations who have extended loans to them. Even if the IMF does get involved then it will probably insist on an increase in their interest rates which will increase the chances of them defaulting on their debts or at least force down the living standards of their people.
Almost without exception Western Governments and economists follow the teaching of Keynes. Certainly Gordon Brown has stated his adherence to Keynesian economic theory on several occasions. Keynesian economics assumes that the State will interfere in the financial activities of the nation. Where possible the Government should stimulate consumption as it means that society can spend itself to riches. It assumes that consumption is encouraged by creating jobs so any capital investment is 'good' and that this can be helped by the State setting artificially low interest rates. Finally, the State should spend more than it taxes in order to stimulate investment and consumption. Keynesian economics is all about government management of the economy, full employment, low interest rates and cheap money, deliberate government deficits, and stimulating largely unproductive growth. In a nutshell, the Keynesian economics that Gordon Brown proclaims to believe in, is based on simple monetary inflation. Without monetary inflation Government deficits would cause higher interest rates and deflation. Government deficits are only possible when there is monetary expansion.
According to Keynesian economics, holders of money wealth are sheep to be shorn particularly in an inflationary period. Governments, businesses and people who borrow money all benefit from inflation. The losers are those that save. Pension plans, savings deposits, and life insurance companies are what less wealthy savers invest in. It is these people that the Government can go after most easily. The Government also carefully regulates these businesses so that they can be easily exploited as a source of revenue. Governments also have mechanisms for locking money into investment such as government debt in the form of gilts, as well as pension funds and investment markets. None of these has any great benefit for the economy other than to give the State a method for securing the finance that it needs.
It is the middle classes who are the savers and they are the ones who suffer during an inflation bubble. At the end of this current crisis it will be the middle classes who will be significantly worst off. Saving is a State sponsored swindle that takes as much as it can from those who are too innocent to evade it. By the continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens. By this method they not only confiscate, but they confiscate arbitrarily so it is a ubiquitous hidden tax. Lenin is supposed to have declared that the best way to destroy the capitalist system is to debauch the currency. Now the British Government is doing its best to carry out Lenin's wish. Significant inflation means that the State has lost its ability to defend its citizens in an impartial way. Anyone caught in an inflationary situation stands to be harmed and they only have one concern, and that is what they can do to protect themselves. No individual can do very much and finding shelter is the only option left open to them.
Most people in the UK have little interest in the stock market unlike the USA where many have their pensions invested in it. Most people believe that the stock market in some way reflects the commercial processes that are in train around the World. In reality, trading on the stock market is just gambling. Stock market speculation adds nothing to the wealth of any nation although it might improve the value of pension funds. Pensioners in the UK with private pensions and investments will suffer because of the current fall in the stock market but most people are oblivious to inflation providing that their incomes keep pace with the cost of living. For them the problem of inflation belongs to someone else. However, a rapidly increasing stock market is a good indicator of money inflation. Commodity speculation is also linked to inflation. This phenomena has also been very visible in the last few years.
The stock market is always well patronised during a period of inflation. When a government starts to use inflation in a time of low business activity the money has little to do and so goes into the stock market. A boom in the stock market is a form of price inflation with the stock market just acting as a pressure valve. As the economic cycle advances some of the money in the stock market is drawn into creating business prosperity but most of it stays in the market as it is seen to be a certain way to create even more wealth. The stock market will always stop rising when inflation stops or is checked. When inflation runs away the price of stocks collapses back to their real value. This can mean that the real value of the stocks are decreasing even though their monetary value is still rising because of inflation.
The World's economy is now based on borrowing and the governments of the World have to get borrowing going again. Not just short term borrowing to help people through their immediate daily problems but long term borrowing. The reasons for this are twofold. Firstly, it postpones paying for today's expenditure until tomorrow. Secondly, a fundamental presumption of Keynesian economics is that inflation is an essential feature of a modern economic society and those who are stupid enough to save cash should watch their money being misappropriated by the State so that it can undertake its good works. No modern State could survive if the value of its currency was not being constantly devalued. Today inflation is a vital necessity and all governments declare misleading rates for inflation to disguise what is happening to their currency. The simple truth is that the State benefits directly from printing money and driving down the real value of its currency. The State cannot continue to be responsible for an ever increasing proportion of societies expenditure without inflation. With taxation at an all time high the only new source of income for the British Government will come from dismantling the wealth that has been accumulated by previous generations and the easiest way to do this is by inflation.
What is clear is that the British Government is desperate to get borrowing going again. Given the chance, it would like to recreate the same conditions that caused the current financial crisis in the first place. To a bystander this is insane logic but not for the British Government. Only with a high level of borrowing can the UK economy flourish and house prices recover. There has been no real growth in the last ten to fifteen years, just ever increasing borrowing made possible because of a high level of monetary inflation. That is why house prices rose so rapidly and why the stock market was able to rise so fast. That is why Government expenditure was able to rise as fast as it did. Now reality will return and the first way that this will manifest itself is that values will fall back to the level that existed before the start of this inflationary cycle. House prices in the UK will drop to something which is close to half of what they were in 2007. The price of stocks will fall back to the same levels as the mid 1990s. The last decade of money inflation has hollowed out the value of all the major currencies so adjustments have to be made for that when assessing the above generalisations i.e. things are much worse than they seem as the value of the currency has fallen over this period. Disposable income will drop back fast as will the general standard of living over the next five years. This will hit people's quality of life in the West but also those people who live in manufacturing countries like China that were using the accumulated wealth of the West to recreate themselves.
From the Governments point of view, the best arrangement was to get people to place as much money as they could into property as a way of hiding monetary inflation, and to tax people in the process so that it had a win-win situation. This is what the British Government was doing for the last decade. The trouble with using inflation in this way comes when the Government loses control and lets inflation run unchecked for too long. The last ten years have seen a massive growth in the quantity of money in circulation which can be seen by the increase in the value of homes, stocks and bonds, and personal debt. If there had not been a massive level of inflation over the last ten years then business turnover would never have grown to the extent that it did, if at all. This in turn would have meant lower tax receipts. Similarly, GDP would not have grown at all. Creating the illusion of progress and an improvement in the economy is vital for any Government. However, there comes a point where so much money has been printed that there is nowhere else to dispose of it. At that point the end is inevitable as the State cannot continue to play the inflation and growth card and then there has to be a recession.
It is often said that inflation has been low for the last ten years. Well that depends upon what data is used and what type of inflation is being described. If it is the British Government's official data then cost inflation has been very low. Few people now have faith in the official statements on inflation. One giveaway is the price of property. That increased roughly threefold in the ten years that Labour has been in office. The question then is where did this additional money come from? The Government strenuously omits anything to do with the cost of accommodation from its official inflation calculations even though the buying and selling of property is a cash transaction. If the housing market was inflating then some of that inflation had to transfer into the wider economy. After all many people were taking on debt and others were realising the increased value of their property to buy goods and services. Construction companies were producing property and continuously inflating their prices in a seller's market.
Between 1900 and 1999 retail prices rose at an average annual rate of some 4.3% per annum. However, there was a marked contrast between the two halves of the Century. Between 1900 and 1949 the average rate was 2.6%. For much of the 1920s and 1930s prices were actually falling. Between 1949 and 1998, prices rose some 19 fold at an average rate of 5.9% per annum. It should be noted that the British Government has, on average, increased the supply of money by 4.75% per annum ever since the 1950s up to the late 1990s. The speed at which prices were rising more recently can be seen by the way that the price of a pint of bitter doubled between 1979 to 1997. This gives an annual inflation rate of 5.5%. In the last decade the rate at which the stock market, house prices, and personal borrowing increased was more than 10% per annum. In other words since 1998 the British Government has been increasing the supply of money at double its historical rate. This is the cause of the current financial difficulties and shows how much unwinding has to take place.
Only a year ago the British Government was insisting that the combined inflation and growth rate was increasing by about 3 to 4% per annum. This meant that GDP had to rise by this amount for the economy to stand still. No one, other than the British Government, could have ever believed that price inflation was as low as 2% in the last decade. If the price inflation rate alone had been acknowledged as being around 6% then GDP would had to have risen by more than 7% per annum for the data to look acceptable. In the last decade GDP was routinely claimed to have risen by about 3 to 4% per annum but if real price inflation was over 6%, then the economy was in reality sliding backwards. In 2007 price inflation was clearly well over 10% so GDP should have been rising at a rate of more than 11% or more for growth to have been taking place. In the case of the UK, or for that matter any of the other western nations, GDP has not been rising by anything like this amount in the last decade. Only the Chinese have been enjoying this sort of rise in GDP.
The Government had to ignore the true level of inflation when it reported GDP over the last 10 years otherwise it would not have been possible to claim that growth had taken place. Expressed in a more basic way all the growth in GDP in the last decade came from the Government printing 4% to 5% more money every year. Another 5% or more was printed and quickly used to inflate house prices, to inflate the stock market and to increase personal debt. If this proposition is checked against reality then everything makes sense and the numbers balance out exactly. This shows the extent to which the British Government has been manipulating the official data to show an 'improvement' in the UK economy over the last decade.
If the Government was being completely honest it would disregard the contribution that State expenditure makes to GDP as this is purely consumption rather than anything useful in the productive sense of the word. It certainly does not contribute anything to growth in the economic sense of the word. This is another good reason why the UK Government can never declare the true rate of inflation. This blatant misrepresentation of the financial data about the UK economy is one of the main reasons for the current financial problems. If only factually honest data had been used by the British Government or for that matter other western governments then none of the current problems would have arisen. If interest rates had never fallen below 10% in the last ten years then borrowing would not have got out of control. It is true that there would not have been any 'growth' and there would not have been the 'success' that was being attributed to Gordon Brown's management of the economy. Voters would not have been so enamoured with the Government but at least the country's financial systems would have been intact, millions of people would not have the threat of negative equity looming over them and millions of people would have been able to look forward to a comfortable old age.
The British economy is now clearly managed by people who are economically illiterate. Not only do the Chancellor and the Prime Minister not understand what basic economic terms mean, but it would now appear that the Governor of the Bank of England has also forgotten even the most basic principles of economics. It would now appear that the measure of the success of the British economy is its Gross Domestic Product. GDP is the total amount of completed goods and services in the economy over a year and says nothing about whether or not the activity was useful. It also includes inflation and taxation. Therefore, GDP is a worthless index but providing that it keeps going up most people, including economists, believe that all is well.
Growth is another abused word that has a very specific meaning in economics. It means that one man does the same amount of work as two were previously doing. It means that there is a factory producing something useful where once there was a field. However, in modern Government speak the word 'growth' means that GDP is increasing. This is an utterly meaningless definition but again it is the right story to give the public. If they were told that GDP was falling they would get worried. Tell them that 'growth' is taking place and they are happy. As long as the financial markets also believe what the Government says, then things will carry on for a bit longer but credibility is already stretched close to breaking point.
It is interesting how the Bank of England Governor, Mervyn King, was able to forecast six months in advance what the rate of inflation will be in 2009. This is the same thing that happened when Tony Blair said that immigration would be halved within one year of his announcement and sure enough it was. Not because there were less people entering the UK from abroad but because a large number of migrant workers were reclassified as coming from the EU when the EU expanded eastwards. It was simple political misinformation but it was good from the media. How can the Governor of the Bank of England know that inflation will be just one percent in mid 2009 when the pound has lost a third of its value, and the British Government is borrowing money at an alarming rate and the whole worlds commercial markets are in turmoil? The answer is that it just depends upon what is put into the equation, but it shows the utter contempt that all levels of the executive have for accurate reporting. The fact that all the official statistics have been abused for years is one of the main reasons why there is so much difficulty today. It was inevitable that even the best Civil Servants, when given the task of manipulating the official data, would eventually lose control when they tried to adjust all of the variables in a complex web of interacting statistics. That is why the Bank of England was caught out by the current recession. They made the classic mistake of believing their own propaganda.
A major problem with understanding the behaviour of the UK economy is that 'growth' and 'inflation' are in reality the same thing. It just depends upon where the Government cares to draw the line. For maximum effect, they are measured against GDP or the total amount of completed goods and services in the economy over a year. In a society where the State is responsible for half the countries expenditure this is a meaningless system of measure. If the Government increases taxation or employs more civil servants GDP will go up. GDP has nothing to do with productive output. It just gives a very incomplete measure of national turnover. It is meaningless when trying to determine the health of the economy. Gross Domestic Product is not even a measure of the entire supply of real value for money purchases. To assume this is to forget all the existing capital wealth of the country. In the UK at least one fifth of the national wealth is land whose quantity is fixed and whose real value is hard to increase. Another large part of national wealth consists of buildings and durable goods. Another part is natural resources. Normally only a small part of the nation's wealth is for sale at any one time. In a period of rapid inflation the turnover of capital assets increases. However, GDP is a useful indicator of a lack of progress if it is expressed against real inflation levels. This shows that the UK economy has been contracting for years.
If too much money causes inflation, then inflationary prosperity causes too much prosperity. If the prosperity is not based on anything tangible then it is so much waste. When inflation reaches its terminal stage there is always failing prosperity, shortness of money, collapse of the stock market, rising taxes, larger Government deficits and yet still more money expansion except that it will be accompanied by soaring prices. None of the traditional remedies are ever effective. Everyone finishes up paying and no one benefits. This will be the outcome of the current recession.
Published: January 2009