We live in interesting times right now. September and October are traditionally the most volatile months of the year.
All the problems with the credit crunch are working themselves through, but slowly and still more opaquely than the governments and central banks would like.
The Bank of England today decided to hold interest rates at 5.75%, reversing what had been expected to be a rise to 6% just a few weeks ago. However, the price of crude oil also was steeply up this week, at $76.41. Add to this all the money printed to help the banks through their difficulties and we have some major long-term inflationary pressures.
Yet market sentiment demanded that interest rates be kept at the rate they are. It is very hard to call what will happen next. On the horizon for the past few years have been the following issues:
- High house price inflation leading to highly leveraged personal borrowing
- Low credit card rates leading to large unsecured indebtedness
- High government spending pushing up inflation in public services and also a deteriorating government debt position
- Globalisation pushing down the cost of manufactured items
- Globalisation increasing the price of raw materials, oil and food
It is hard to predict which of these is going to unwind first and which will cause the most difficulty. However, at least one of them will as they are all linked in one way or another.
My guess is that at last house price inflation is going to come home to roost and that in turn will slow the economy, even if we don't have a huge recession. The kicker is that the other issues are likely to support inflation; meaning we are in for a bout of stagflation at best.
18 comments:
I would have imagined our economy was more volatile after Christmas with families paying off their credit cards. As you say, let's wait and see what happens next.
They need to have more inflation to mask the inevitable fall in house prices.
E.g. between 1990 and 1995, house prices as a multiple of earnings fell from 5 to 3 (i.e. by 40%), but nominal house prices only went down 15% because inflation averaged 5% p.a.
Consumer spending has been fuelled by remortgaging on the back of higher house prices, and so the unwinding will have the equal and opposite effect.
Seeing as house prices to earnings ratio is now 6 and might well fall as low as 3 again, they are going to need a fair bit of inflation to cover this up.
Ellee - This has more to do with contracts that are renewed in the financial markets, notbaly for pension funds
Mark - you are quite right, as usual.
Perhaps all the excessive money supply has been allowed with this very effect in mind?
I still think the housing market will start the crash as it is and was unsustainable...but has proved that sentiment wrong, but how can it have done?
Still very troubled times ahead.
CU, that is the mystery in of all this, asset price bubbles contain within them the seeds of their own destruction, and ten or twenty years later we are back to square one.
Sure, some people earn a few bob on the way up (incl. yours truly), and the Goblin King says 'if house prices go up = vote of confidence in my handling of economy', and on the way down it all gets very nasty, and ten or twenty years later we do it all over again.
Hmmm.
"the price of crude oil also was steeply up this week, at $76.41". Or put the other way, the value of the USD fell against the world's currency, crude oil.
Where's your top destination if the party here's ending?
MW - Asset bubbles are hard to manage and no one has found a way yet. Having money supply and interest rates as the only tools of economic market management (bar taxes) seems to encourage bubbles.
Dearime - Quite true but he pund has fallen a few cents against the dollar recently too; so still will be an inflationary effect for us.
Winchester - If you look back to my posts last month I asked my readers; they decided on Peru!
I've been thinking about what Mark said recently too. Have you noticed that inflation has doubled recently? The target used to be 2.5% on RPIX and that is now sitting at just under 5%.
Money is still basically free, with interest rates and inflation pretty close, and house prices rising at about the same rate.
The recent growth has been an illusion and I suspect that real incomes have actually been falling.
Ed, I did read somewhere recently that overall wage growth was 3.5% and RPI was 4.5% (rough figures only). Assuming that means NOMINAL wage growth of 3.5%, your assumption is correct.
RPIX = 4.5%, salaries rising by 3% (purported, although its been a long time since I had an increase in excess of 2%!, must be these city slickers pushing up salary figures CU!). Consumer price index (the governments preferred figure) is rising at about 2% but that excludes the cost of mortgages (how convenient). Thus the British public are actually getting poorer, thanks to bad government and house price inflation. Of course, you have to wonder why the Unions are keeping so quiet....
I think the only reason that people have been quiet so far is that the cost of things like iPods, flat screen tellies and clothes have been falling. Once that effect unwinds we are going to have serious inflation on our hands.
It's also amazing how loose the public finances have been during our "boom", we have been running a huge deficit for years.
Seriously bad management.
Wage growth is a moot point for 8 million self employed people in the UK, and sole traders.
Ask them what their wage growth is and you might be surprised that it is virtually non-existent, and has been for some years.
That is yet to filter through as they absorb most of the RPI rise, but it is becoming very tough out there for many millions...not me of course because I have a rich market, but most others don't.
Watch out for the defaults and failures of small business (I know it has started)in the very near future because when that starts to rise there are bad times ahead.
Well you all make some valid points here. I think the overall trend re wage growth and inflation is fairly standard though...if wage growth gets ahead after all the bank raises interest rates.
However, public sector wage growth has until this year been at over 5%; so some people have been doing well out of the Brown economy unsurprisingly.
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