"There is no means of avoiding a final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as a result of a voluntary abandonment of further credit expansion or later as a final and total catastrophe of the currency system involved."
- Ludwig von Mises

Wednesday, January 26, 2011

A Central Banker has a Moment of Clarity: Standard of Living to Plunge at Fastest Rate Since 1920s

Mervyn King, Bank of England's Chief, had some sobering words in a speech at Newcastle upon Tyne.  What I found interesting is his allusion to a central bank constraint, or "trap" as I see it between rates/inflation, and unemployment.  I hope Bernanke is watching the UK.
Mr King insisted that the Monetary Policy Committee could not have increased interest rates from their current record low level to tackle the rise in inflation. 
“If the MPC had raised the Bank Rate significantly, inflation might well have started to fall back this year, but only because the recovery would have been slower, unemployment higher and average earnings rising even more slowly than now,” he said. 
“The erosion of living standards would have been even greater. The idea that the MPC could have preserved living standards, by preventing the rise in inflation without also pushing down earnings growth further, is wishful thinking.” 
He added: “Monetary policy cannot be based on wishful thinking. So, unpleasant though it is, the Monetary Policy Committee neither can, nor should try to, prevent the squeeze in living standards, half of which is coming in the form of higher prices and half in earnings rising at a rate lower than normal.”
King also said:
“In 2011, real wages are likely to be no higher than they were in 2005,” he said. “One has to go back to the 1920s to find a time when real wages fell over a period of six years. 
“The squeeze on living standards is the inevitable price to pay for the financial crisis and subsequent rebalancing of the world and UK economies.” 

But do not fear.  The good George Osborne, British Chancellor of the Exchequer, blamed the UK's recent dip in gdp on... get this -  snowflakes and cold weather.  That should make every Briton feel confident and much better.

But the Telegraph reports otherwise:
Mr Balls accused him of making up “excuses about the weather”. Economists also raised doubts about the cuts.  Jonathan Loynes, of Capital Economics, said: “Although heavily affected by the weather, the UK’s shockingly bad fourth quarter GDP figures raise serious concerns over whether the economy is in a strong enough position to withstand the fiscal tightening.” Howard Archer, an economist at IHS Global Insight, added that the figures reinforced concern over the economy’s ability to grow “in the face of spending cuts and tax hikes”.

Spending cuts and tax hikes...  sounds like deflation to me.  Europe, meet your cousin, the UK.  Good luck to you both.  or you can take a page from your other cousins across the pond, the Americans: print away, spend away, and kill your currency to "save your economy!  Well, at least buy some time.

God save the Queen?  No!  God save us all!



Jim Slip said...

Deflation: your cash (if you have any) is worth more, but your property is worth less.

Inflation: your cash is worth less, but your property is worth more.

Are they really that different?

Btw, Martin Wolf writes in his latest column in the FT:

"If China wants to escape from the tyranny of that dreadful dollar, stop buying. Please."

Sounds right to me. Until then, the US can print as much as they like.

Misthos said...

I agree with your summary of the effects of inflation and deflation. But there are different employment consequences to each. I would say that employment suffers more in deflation. Also, deflation could get out of control in a highly leveraged economy. The risk of deflationary collapse rises with the amount of total debt in a system. Less money in the economy = less money to pay off debts and interest = increased defaults, which can become a vicious spiral.

In the US, much of the economy is based on asset valuations, especially for the wealthy. No surprise there that the US chose dollar devaluation. But having the reserve currency also helps - you get to export a lot of that inflation to... China!

And so I agree that China is stuck, but I don't put it past them that they don't have a Plan A, or a Plan B, etc..

Jim Rickards recently summed up the US-China ongoing currency game well:

"The Chinese feel betrayed by the U. S.," Rickards says. "They feel that part of the deal for buying all those Treasurys was that the U.S. would maintain the value of the dollar. There's an old saying, 'if you're in a poker game and you don't know who the sucker is, then you're the sucker. The Chinese have just woken up to the fact that they're the sucker."