Liam Halligan: Bankers conjure deflation myth to justify their bailouts


Deflationary Myth Is Poor Excuse for Irresponsible Policy Excesses

By Liam Halligan
The Telegraph, London
Saturday, December 19, 2009

New figures show that UK inflation was 1.9 percent during the 12 months to the end of November, up from 1.5 percent the month before. That was "above consensus estimates."

Having said that, British inflation, to use investment bank parlance, has "surprised on the upside" pretty much every month for the past two years.

Ever since this crisis began, economists in the City of London have underestimated UK inflation and warned, instead, that "deflation" looms. As a result of this threat, policymakers have had "no choice" but to take "bold action."

Such action, as we've seen, has meant loading up the national balance sheet with even more public debt and printing money like crazy. The fact that these deeply irresponsible fiscal and monetary excesses have funded the "bailout" of the banks employing the economists who have spread this "deflationary myth" is, of course, a complete coincidence.

Isn't it obvious that "UK deflation" has been an intellectual conceit, conjured up by the banks to justify policies which have foisted their losses onto today's and tomorrow's taxpayers?

Is it undeniable that the "threat of deflation" has also been used by the prime minister, Gordon Brown, as an excuse to do what he does best, spending even more of other people's money, in a vain attempt to buy popularity before a general election that he must now call within six months?

Early next year, as Economic Agenda has warned for months, UK inflation will spike above 3 percent -– forcing the Bank of England to write yet another public letter explaining why CPI inflation is so far above the 2 percent target. So much for deflation -- the authorities will be trying to justify, again, why inflation is so high, despite the most serious UK slump since the 1930s.

Inflation is rising now, say the deflationists, only because this time last year oil and petrol prices were plummeting amid fears of global recession at the height of the financial crisis. I agree that firm crude markets will seriously aggravate price pressures going forward. The "adverse-base" effects will be brutal, feeding directly into the CPI.

Yet, the real story has been the pickup in "core" UK inflation -- excluding energy and food -- despite the slowdown and "deflation" siren calls. Core inflation also rose by 1.9 percent in November. And had VAT not been cut last December, core inflation would already be above 3 percent, with the CPI even higher.

The UK has endured the longest slump of any G7 nation and is the only major economy still in recession. Yet the UK has the highest rate of inflation.

The reasons aren't difficult to fathom. Sterling has fallen by around a third against the euro since this banking crisis began. Given that around 40p of every pound spent in Britain is spent on imports, a falling currency stokes prices.

British commerce has long been highly dependent on bank financing. The credit crunch, as a result, has destroyed vast swathes of productive capacity. The inflationary impact of that can be seen up and down the supply chain, as firms fold and those that remain are able to bid up prices. No wonder manufacturers' input price inflation surged to 4 percent last month.

The main reason UK inflation is rising, though, and is likely to go much higher, has been the Government's deranged anti-crisis measures -- namely sky-high borrowing and an near tripling of the UK's monetary base in the past nine months, under so-called "quantitative easing" (QE).

The UK borrowed a staggering L20.3 billion last month, by far the highest November figure on record. So far during this financial year, HM Treasury has put another L107 billion on tick, compared to less than L50 billion by the same stage in 2008/09. The grim reality is that Britain is on course to borrow the thick end of L200 billion a year for the next three years. The gilts market simply won't have it.

When I raise such concerns, otherwise intelligent people tell me I am mad. "We're managing to sell all our bonds," they say.

But just look at the numbers. The vast majority of gilts sold during 2009/10 will have been bought by the Bank of England using the proceeds of QE, rather than by real investors making judgements about the UK's financial prospects.

QE will end next year. It simply must, or sterling will go into freefall. And when it does end, even on the Government's ropy estimates of how much it will borrow during 2010/11, the number of UK gilts hitting the open market will be six or seven times more than we've managed to sell this year.

Oh -- and by the way -- most of the gilts the UK flogs are "ordinaries," not indexed for inflation. So when inflation starts rising, our gilts will become even harder to sell.

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