Time for governments to take the inflation threat seriously

Practitioners of notaphily (they can’t touch you for it) may have purchased for their collections an example of the $50m banknote issued by the Reserve Bank of Zimbabwe under the benevolent rule of Robert Mugabe; if so, it will have been the sole transaction in which that worthless piece of paper acquired any value. We may have had our troubles with the global downturn in 2008, but in that year the inflation rate in Zimbabwe passed 100,000 per cent.

Of course, people might say, that happened in an undeveloped economy governed by an extreme nationalist dictator, on a different continent. Very true; but on our own continent, under a democratic government in Weimar Germany, people ended up being paid twice daily, to keep pace with hyperinflation, had to take a wheelbarrow full of currency to the pub even if they had no intention of standing a round, and ended up burning banknotes to keep themselves warm.

Both those catastrophes occurred under the pressure of extreme events, but that should not be allowed to obscure the lesson they teach us: hyperinflation can happen anywhere, if circumstances become sufficiently adverse and, more importantly, even a much lower, but significant, rise in inflation can have drastic consequences. We are currently emerging from a pandemic crisis that has been both global and economically devastating. That does not mean we should be contemplating buying wheelbarrows, but it does mean we need to be extremely wary of an inflationary spiral.

Not so long ago, articulating that concern was likely to provoke derision: such pessimism was for old women, of both sexes. Now, however, as the economic statistics begin to convey a warning, the mood music is changing. Back in May, the Bank of England governor Andrew Bailey assured MPs there were no signs that inflation expectations or price rises were becoming entrenched; he believed price rises were temporary. That followed on the revelation that UK inflation had more than doubled in April to 1.5 per cent.

Even at that stage, however, the Bank’s outgoing chief economist Andy Haldane cast a lone vote at the Bank of England’s monetary policy committee (MPC) to reduce its bond buying programme. Then, with inflation having risen further to 2.1 per cent in May, the MPC minutes for the next meeting insisted: “Financial market measure of inflation expectations suggest that the near-term strength in inflation is expected to be transitory.” But Haldane, attending his final MPC meeting, again voted against the other eight members’ decision to maintain asset purchases at the current level of £895bn.

Earlier in the month, Haldane returned to his theme of warning against what he had previously called the “tiger of inflation”, in an article in the New Statesman: “In my view this is the most dangerous moment for monetary policy since inflation-targeting was first introduced into the UK in 1992 after the European Exchange Rate Mechanism debacle.” He cautioned about the danger of returning to the kind of wage-price spiral experienced in the 1970s and 1980s, though he conceded that inflation would not return on that scale.

The reality is that neither Haldane nor the more doveish members of the MPC know with any degree of certainty what the prospects for inflation are. The Covid crisis is not an economic downturn on traditional lines, like 2008, but a unique situation that has skewed the economy by disrupting it asymmetrically. In some areas reliable data are hard to acquire and to read; the ONS has been unable to collate prices for such consumer items as airfares and cinema tickets. Research by the London School of Economics shows that prices have been more volatile in the past year than over the previous two decades.

There is now widespread acceptance that inflation is going to spike over the remainder of this year, but also a consensus view that it will be temporary. Certainly there is nothing on the radar at present to suggest otherwise: it is a respectable thesis, not in conflict with the presently available economic data. But the same might be said of a more pessimistic interpretation: the trend is upwards and the economic checks and balances that kick in during a normal downturn may not function predictably in an unprecedented situation.

Optimists routinely take comfort in the experience of 2008, when inflation returned to normal levels; but there is no economic law which dictates that, in the unique circumstances of the post-pandemic crisis, any valid precedent exists. In particular, across the entire market, there are supply-chain vulnerabilities that could prove unexpectedly intractable, with a consequent effect on price rises over a prolonged period.

Worst of all, long before Covid appeared, there were grounds for serious concern about the prodigality of government spending in various parts of the globe. The pandemic has given enormous impetus to that already worrying trend, as testified by President Biden’s $1.9 trillion stimulus package. Boris Johnson’s spending, in the context of Britain’s smaller economy, is proportionately alarming. That would be less alarming if Boris showed any signs of reining in this prodigality; unfortunately, it increasingly seems he has become addicted.

There is absolutely no excuse for throwing more than £100bn at a white elephant such as HS2, which is less a serious infrastructure investment than a vanity project – the Millennium Dome on rails. But when compared with America, Boris appears frugal, even parsimonious. The US federal government is haemorrhaging money. Lavish welfare has put many citizens in the position – familiar in pre-Thatcher Britain – where they cannot afford to take a job, in turn provoking a shortage of labour and resultant wage inflation.

The 2008 global crisis was precipitated by the American sub-prime mortgage market, in which the Clinton administration had intervened by legally requiring lenders to supply mortgages to members of minorities and disadvantaged people, leading to such absurdities as a $500,000 mortgage being granted on the security of a welfare cheque. It was Democratic virtue signalling, woke before the term gained currency, with the mortgage market incongruously being controlled by the Department of Justice. The consequences were dire; some commentators believe we came closer to global financial meltdown than was generally admitted.

Now the Biden infrastructure package – which stretches the meaning of that term beyond reason – is repeating the same mistake on a much larger scale. For the 12 months ended in May, the US inflation rate was 5 per cent, the highest since August 2008 when it hit 5.4 per cent. A snapshot of US inflation rates was provided this month by a survey by the Federal Reserve Bank of Dallas which showed 81.5 per cent of manufacturers reporting higher prices for raw materials, higher prices for finished goods reported by 44.6 per cent and the wage index up 9.1 points from May.

Probably more significantly, 61 per cent of Texas businesses said they were suffering supply chain disruptions, up by 35.5 per cent since February. Of those reporting supply chain problems, 41 per cent said they had grown worse in the past month and 18.8 per cent reported they were significantly worse. That, unfortunately, makes sense: as the economy reopens, supply-chain disruption becomes more evident and is likely to worsen. Therein, not just in Texas but globally, lurks a potential for aggravated and long-term inflation.

The deadliest feature of inflation is that it has a tipping point, beyond which it roars out of control, beyond the ability even of governments to curb it without resorting to extreme measures in which the cure may be as bad as the disease. There is no reason, at the moment, to believe we are heading down that road; most economists think it unlikely. But, when dealing with the economic equivalent of Covid, we must take the threat of inflation seriously and prepare to defuse it.

At the moment, there is little evidence that governments on either side of the Atlantic are sufficiently focused on this potential menace, or geared up to counter the threat. That is extremely unwise: if the precautionary principle is regarded as justification for extravagant measures to counter climate change, the same principle should apply to the threat of rising inflation.