SELDOM can there have been such a downbeat reaction to the news that interest rates have been slashed again to yet another historic low, just 1 per cent. It wasn't just that the cut was expected and so nobody got the party balloons out, it was the loud chorus of groans that it just would not do the much-needed business of stimulating the economy that was striking.
I share that view; indeed I think it is time that the Bank of England went much further into unorthodox territory and started expanding the money supply, or printing money as popular parlance has it.
This sounds like heresy and madness. We have af
ter all spent bitter, painful years learning that we have to keep the money supply under pretty tight control because if the government prints too much of the stuff, inflation takes hold and can indeed spiral uncontrollably into Zimbabwe-style hyper-inflation.
All this is true and I am not suggesting for one moment that Gordon Brown should start behaving like the crazed Robert Mugabe. But I do think that the case for some controlled expansion of the money supply in order to induce some inflation has become extremely strong.
Why? Because I think that the British economy now faces the risk of deflation, meaning a period of falling rather than rising prices. Inflation, measured by the Consumer Price Index, peaked at 5.2 per cent last September, fell to 4.5 per cent in October, slipped to 4.1 per cent in November, and then tumbled to 3.1 per cent in December, a near halving inside four months.
Continuing low petrol and food prices, plus reduced electricity and gas costs to come this spring and continued discounting by retailers will, I expect push inflation to zero and turn it negative at some point in 2009. Add in mortgage costs, as the Retail Price Index does, and inflation figures of -2 and even -3 per cent are a safe bet.
Wouldn't this be a good thing? It might look like it since we would all surely benefit from cheaper prices. But actually it would be a bad thing. A look at the property market tells you why.
We are now seeing a deflating market where prices of both new and second-hand homes are falling. Prices across Britain are now down about 20 per cent from their peak in mid-2007. Most people think they will carry on falling, perhaps by as much as 30-40 per cent from that peak.
The problem is not the availability of mortgage finance; though there is less available now than there used to be, banks and building societies still have a lot more to lend than is currently being taken up. The problem is that people who would like to buy a house expect prices to carry on falling and so would rather wait until the market has bottomed out.
These deflationary expectations have caused the house-building business to crash into the buffers, throwing a lot of people out of work. Lawyers and estate agents are also joining the dole queues.
This might be less painful if wages were stable. But they are not. They are being driven down, not just by rising unemployment, but by companies trying to survive and keep their workforces by putting employees onto a four-day week or by the kind of enforced holidays that we are now seeing in the car industry. Deflating prices make this worse; look for example at the cries of woe coming from dairy farmers, many of whom are reported to be thinking of getting out of the industry because of price cuts imposed by the wholesale milk purchasers.
The dangers of deflation are dreadfully illustrated by Japan's experience. In the mid-1990s, a property and land price bubble burst. Over the next five years, house and commercial property prices fell by 70-80 per cent. This hit Japan's banks, which had vastly increased their property-based loans during the boom years, much as our banks did. As the value of the assets on which they had loaned money deflated, they had to curb their lending to the rest of the economy. The result was ten years of stagnation – next-to-no growth in the economy and reductions in wages, a period now known to the Japanese as the "lost decade".
That's the danger we now face. In fact, I think it is already upon us. Although the official statistics say that we are still living in an inflating economy, people are now behaving as though it is deflating. It is quite understandable. Anybody walking down the high street sees nothing but signs advertising deep discounts. I saw one in a Glasgow bed shop recently claiming it was offering 70 per cent reductions. Why buy anything today, when it looks like it will be cheaper tomorrow? Thinking like that will only make the recession deeper and the dole queues longer.
What can be done? Cutting interest rates aggressively is one part of the answer. The failure of the Japanese government to do that in the first few years of its property price crash is now generally reckoned to be have been a big mistake. But when you get to zero, as eventually happened in Japan and is now nearly the case in America, no more can be done. The other part is to print more money, now known in economist-speak as quantitative easing, just enough cash indeed to stop low inflation turning into deflation.
To do this, the government does not tell the Royal Mint to churn out more banknotes. It can do two things. One way is for the Bank of England to buy corporate bonds and other assets from the high street banks, giving them more money to lend. The other way is for the government to borrow more money and give it to us via tax cuts.
I suspect the latter option is more likely since lack of confidence to borrow and spend appears to be more of a problem than lack of willingness to lend. One very strong candidate for tax cuts is on the income earned from savings as people who have prudently put something aside for a rainy day are now being viciously and quite unfairly penalised by low interest rates.
It will add even more to the huge mountain of national debt, which, with the existing splurge of borrowing and the addition this year of private finance initiative liabilities, will be edging towards 100 per cent of GDP by 2011. National bankruptcy?
No. By mishandling deflation Japan was left with a whopping debt that the current recession is now swelling further towards 200 per cent of GDP. Printing money will cause a headache, but not doing so will leave us with a severe migraine.
• Comments and criticisms welcomed at:
pjones@ednet.co.uk.
The full article contains 1163 words and appears in The Scotsman newspaper.
