Fasten your seat-belts: things will get worse
First published in the Telegraph on 11 June 2008
It had to happen sooner or later. We have an economic disaster that cannot be blamed on Gordon Brown. No, not the collapse of Northern Rock, which the Prime Minister wrongly tried to attribute to problems in the American sub-prime market. Not the slump in house prices, rising unemployment or our stalling economic activity, which are all home-grown traumas.
No, this is 21st-century stagflation: a toxic brew of soaring inflation and slumping growth. Technically, Mr Brown could have done more to prevent the latter, although I’m willing to give him the benefit of the doubt. But the return of stagflation – or globeflation, or whatever peculiar name the wise men will give it – is an international phenomenon, with higher prices generated by China’s rising economy and the fear that we may be running out of oil/metals/food/water.
Its consequences will be keenly felt here on our sensitive, import-dependent island. While we won’t see inflation shoot up to 25 per cent as it did in the 1970s, the experience will be no less painful.
Experts, who had assumed that the Bank’s next move with interest rates would be down rather than up, are scrabbling to change their forecasts. They are now betting on the apocalyptic prospect that the Monetary Policy Committee will raise borrowing costs as we head into a housing crash. They are also wagering that inflation will remain above four per cent for the next half-century.
This is terrible news for Mr Brown, who was quietly hoping the Bank would come to his rescue and slash rates to generate a bounce in time for the next election. While he may have looked across the Atlantic for his scapegoat last time, this time the culprit – or at least the catalyst – for the chaos is closer: in Frankfurt. For it was there, last week, that the president of the European Central Bank, Jean-Claude Trichet, threw a massive spanner in the works by warning that inflation is such a concern that he is likely to raise euro rates next month.
Having weathered the financial markets crisis (give or take the nationalisation of a high street bank), we are now facing something quite different: a widespread economic crunch that will affect us all. And if this weren’t enough doom and gloom, it is worth remembering that the behaviour by central banks in Europe and America is uncannily reminiscent of the spat in October 1987 that helped spark the worst-ever falls in the stock market (though, admittedly, share prices have fallen far enough to make a repeat of Black Monday a near-impossibility).
Either way, life is about to become even more painful – not just for homeowners, who are already having to contend with a fall in the value of their property, but for anyone with a job. Unemployment, already rising, will escalate, and companies will become increasingly reluctant to raise their wages. The standard of living for the average Briton will fall as the cost of living outpaces our earnings. The financial markets are starting to face up to this prospect. It will be some time before the full reality dawns on the wider public, but when it does it will be difficult to stomach.
Whether the Bank raises rates or not, the cost of borrowing for households and companies is already rising; this will accelerate over the next few weeks. With money market borrowing rates almost half a percentage point higher than last week, banks and building societies will soon pass this extra cost on to homeowners in the shape of higher fixed-rate mortgages and higher fees.
If the housing market were in good shape, this would be worrying enough, but coming as it does when prices are falling at the fastest rate since the last crash – by some measures even faster – it is a cause for concern. For all the damage done by higher taxes and regulations over the past decade, the economy is still a better-adjusted animal than it was in the early 1990s – albeit more debt-ridden.
But with mortgage rates spiralling just at the moment when consumers are at their least optimistic, there is no telling how severe the downturn could get. Mr Brown’s personal poll ratings may have further depths to plumb as a result – even accounting for the traditional British affection for the underdog.
I used to believe that in economics and politics you make your own luck, and this dictum has applied pretty well for most of Brown’s premiership. Having spent and borrowed too much when he should have been putting away cash for rainy days, he is now being punished for it. Unlike George Bush, he has nothing left in the can for major tax cuts, and would have to borrow in order to lower taxes.
This would be unwise. First of all, Alistair Darling has already cut taxes by pounds 2.7 billion for those affected by the 10p tax fiasco; I doubt an extra few billion would make much meaningful difference.
Second, and most important, it would threaten to undermine the economy in more deep-seated ways than one can easily imagine. The two borrowing rules Brown laid down as Chancellor (that the Government must borrow only to invest; and that total government debt should not exceed 40 per cent of GDP) are among the few threads helping us avoid those double-digit inflation rates we saw in the 1970s. The minute anyone sensed that Labour really was preparing to borrow its way out of this, we would be punished by the international capital markets with an even weaker pound and far bigger price rises as a consequence.
The most sensible thing would be to batten down the hatches, keep cutting spending and to borrow as little extra as possible. We will have high inflation for the next year or so, but as the world economy slows, so will the price rises. Although the markets have become overexcited about high inflation, I still suspect the next move in Bank rates will be down – not up. Labour could put this at risk if it went for unfunded tax cuts.
Of course, an eventual upturn won’t save Brown from what seems his inevitable fate – any more than it did John Major. However, it may prevent him from going down in history as the man who wrecked the British economy for the first quarter of the 21st century.