April 15, 2013
It is often the case that we fail to recognise the significance of events when we witness them and it is only years afterwards that we realise that this or that moment was a major turning point. In September 1988, I sat in a medieval hall in Bruges and listened to Margaret Thatcher giving the now famous Bruges speech. The speech was delivered at the opening of the academic year of the College of Europe.
In case there were any doubts before, the Bruges speech served to place the issue of Europe right at the heart of the Conservative party in Britain and by extension British politics in general. It is no overstatement to say that Europe, and British relations with Europe, is still central to the British Tory party, so much so that the present boss, David Cameron, has pledged a referendum on the subject, something that not even Thatcher would have dared.
However, listening to the Bruges speech, I realised the enormity of what Thatcher was starting had evaded me. She was putting the re-establishment of national sovereignty front and centre, and was goading the assembled Europhiles to respond. The other point she made was the one about rolling back the state; and this, it seems to me, was of equal enormity – in a speech that is remembered for Europe and little else.
What if the death of Margaret Thatcher comes at a time of another significant moment, which we might not recognise now, but might yet look back on as a turning point?
I am talking here about the re-emergence of inflation. When we consider the broad sweep of recent economic history, we can see that Thatcher and Reagan in the US set out on a crusade to eliminate inflation from both countries. This crusade, deploying both fiscal policy in Britain and monetary policy in the US, led to a sustained era of low inflation or very low inflation in the English-speaking world. Bond yields declined over the period as interest rates fell in line with prices.
We also witnessed during this low-inflation era a huge surge in the power and prestige of central banks and the elevation of central bank bosses such as Alan Greenspan to almost deity status, for a while at least. And, as is the case with any prolonged period of reasonably low inflation, it greatly enhances the power of creditors over borrowers. In addition, as wages are pushed down, the return to workers falls and to capitalists rises.
This has now reached extreme proportions in the US where wages for the average worker have dropped consistently over the past 30 years. The money that used to go to workers has gone to corporations in higher profits. And as you would expect, this has led to the emergence of mega-corporations that serve to reinforce this trend.
For example, a 2012 study showed Wal-Mart alone was responsible for driving down wages in retail by 2 per cent across America. In rural areas, the impact was more pronounced.
While the average guy struggles in the US, the rich guy just gets richer and richer.
One final effect of the Thatcher/Reagan era of deregulation and low inflation has been a huge increase in financial instability. Indeed the flip side of this price stability is financial instability, boom-bust and banking and credit crises. The central banks of the world have become fixated with low price inflation. As long as inflation remained low, according to the new mantra, credit could expand and expand, which it did and bank lending likewise.
All this money sloshing around is not going into wages, so it has to go somewhere and it goes into assets. This caused assets such as houses to soar in value. We see something similar in stocks, and each rise in the underlying value makes legitimate more lending against that collateral. In time, the markets peak and crash, leaving the central banks to clean up the mess that they largely helped cause by overlooking asset price rises.
The subsequent fragility of the post-crash financial system has led to an unhealthy fusion of the interest of the banks and the financial markets and the policy of the central banks.
It is like a hostage situation – the banks and financial markets are the hostage takers, the economy is the hostage and central banks pay the ransom. The global financial markets scream at the central banker: “If you don’t print more and more money, we will have to shoot the economy and your political masters, the governments, would not like that.”
So the central banks are in a corner. They have no option but to accept all sorts of collateral from the banks in return for cash. In the US, the Fed is making $85 billion a month available to the banks to lend. This is a phenomenal figure and it is leading to a strange situation whereby no matter what happens in the real economy, the financial markets rally.
Last month, the US produced fewer jobs than expected and the markets rallied on the certainty that the Fed would print more money. The month before, the US economy produced more jobs than expected and the markets rallied on the expectation of better profits. So it’s a case of ‘heads I win, tails you lose’. Why? Because the Federal Reserve is eliminating risk by printing as much money as practically possible.
But what if the US economy is changing gradually? Could we go from low inflation to stagflation (inflation and low growth) to hyperinflation without the nice bits in the middle, which are strong growth and a healthy increase in wages?
American household borrowing is rising again, which suggests that the long period of deleveraging is over. With interest rates at close to zero, and billions available to the banks to lend, it is not hard to see what could happen next. The US has 40 million teenagers and 40 million twentysomethings. They are surely not going to accept lower and lower wages in the face of higher and higher profits.
When the pendulum swings, who will notice it?
What if the Fed is overstaying its welcome at the bar of easy money? What if it is still looking over its shoulder at the deleveraging cycle, just as a new inflationary one is emerging? The last time the US Federal Reserve kept interest rates so low for so long was in the early 1970s under the stewardship of Arthur Burns.
This was followed by a long period of stagflation and ultimately double-digit inflation, setting the scene for the arrival on the stage of Thatcher et al.
History suggests that all eras come to an end and are superseded by something totally different. Maybe we are going into an inflationary world and we just don’t realise it yet. Indeed the death of Margaret Thatcher last week may not just be the end of a person, but could be the end of the era she engineered. Watch US economic data closely over the coming months for signs of the big switch.
Just like the Bruges speech, which signalled the beginning of a 20-year war in British politics that will end with Cameron’s referendum, the recent developments in the US economy could also be a major turning point, one that could usher in a new era of higher inflation all over the globe.