It's time to admit inflation is going to be a major problem

It's time to admit inflation is going to be a major problem
I don't wish to be smug. But can we now agree that, despite repeated warnings from ministers and the City, the UK won't get caught in a "deflationary spiral" and inflation is a much greater danger?

By Liam Halligan
Last Updated: 5:11AM BST 29 Mar 2009

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For months, this column has argued that the spectre of deflation has been conjured up by those whose hubris and incompetence caused this crisis.

It's given Gordon Brown an excuse to indulge the Keynesian wet-dreams of his political adolescence, spending our money willy-nilly, with absolutely no regard for the impact on future generations.

Our economy is being held to ransom by deflation fear

Even before this sub-prime debacle, his borrowing was far too high.

But having failed to put the UK's fiscal house in order during the good years, Brown has now set fire to the whole shebang.

The reason, we're told, is that because deflation is imminent, "the danger of doing too little is greater than the danger of doing too much".

"Deflation is coming" has been the mantra of the City economists too.

Could their views be influenced by the institutions employing them?

Hyped-up deflationary fears have certainly led to an awful lot of taxpayer-funded "soft credits" being chucked towards the Square Mile.

Meanwhile, the supposed cure, "quantitative easing" (sic), is allowing banks that should fail, that need to fail, to rebuild balance sheets they themselves destroyed by years of wild risk-taking. So, if you're a washed-up, spendthrift Prime Minister, or a banking executive desperate to cover up past mistakes, "look out, deflation" is a useful message to get into the mind of the public.

Barely pausing to look at the evidence or question WHY our so-called leaders are saying this, the press has too easily obliged.

The UK economy contracted 1.6pc during the final three months of 2008 and 0.7pc the quarter before.

This is now a deep downturn – the worst since the early 1980s and counting. Retail sales growth was a perky 3.8pc in January, but slumped to 0.4pc last month.

Despite that slowdown, and the "deflation is nigh" warnings, CPI inflation ROSE in February – to 3.2pc, up from 3pc the month before.

So grave is the deflationary danger that the Bank of England has just written a letter to the Treasury explaining why inflation remains ABOVE its 2pc target – as it has been for 17 months.

RPI inflation fell marginally last month, to 0.0pc. But that measure stresses house prices – which, of course, have dropped sharply.

Desperate to drum up more free taxpayers' cash, City economists were only last week forecasting the February RPI number would be minus 0.7pc. How wrong can you be?

The RPIX – similar to RPI, but excluding housing costs – also rose last month and, while the deflationists tried to attribute February's CPI number to rising food prices, "core inflation" – which excludes items with volatile prices such as food – shot up too.

Why? Because, weighed down by lax fiscal and monetary policy, the pound has lost a third of its value in just over a year.

That pushes up import prices and overseas goods account for a very high share of UK household spending.

In my view, inflation will get much worse in the medium term.

By the time "quantitative easing" is over, the UK will have more than doubled its monetary base.

Deflationists say low lending offsets that but M4 – the broadest monetary measure, which includes bank lending – is still growing by 16pc a year.

Lending to households is 5pc down on last year. Lending to firms is still expanding but only by 4pc, compared with 15pc average annual corporate credit growth since 2005.

But credit to OFIs – other financial institutions – is now growing at a colossal 45pc annual rate, so banks are "still lending", as they say, but mostly to their own off-balance sheet vehicles
which they set up in previous years to take crazy risks.

That lending will find its way into the economy and is still inflationary – even if ordinary punters are "credit crunched".

So, both base and broad money are now expanding rapidly – storing up huge future inflation, despite the slowdown.

I accept that, during the early summer, the RPI may go negative for a month or two. Oil prices were up above $140 in May and June last year, and will this year be much lower – weighing heavily on the index. But such "base effects" will be short-lived and very quickly reversed.

Oil was $40 a barrel in December 2008 and, as explained below, could easily be at $60 by the end of this year – 50pc higher.

That will send the inflation indices into orbit, just as the vast monetary expansion starts feeding through.

So, please, let's stop pretending deflation is a problem.

We need an honest, robust debate about fiscal meltdown, bank balance sheets and future inflation – the genuine problems we face.

West set for a crude awakening

AS THE G20 denizens battle to save the global economy, one positive they can point to is the price of oil. Since soaring last summer, the cost of crude has collapsed.

That lowers fuel bills and helps Western oil importers cut their (often gaping) trade deficits. How bad would things be if, as well as financial meltdown, we had high oil prices too?

Well, that could easily happen. Oil prices moved firmly above $50 last week – almost 40pc up from their February low. Until now, most economists have accepted the "demand destruction" story – assuming a slowing world economy would use less oil, keeping a lid on prices.

But crude has recently rocketed, despite the prospects for global growth being worse than at any time during this crisis. Across the Western world, GDP growth forecasts are being scythed. The US, the world's biggest oil importer, is now contracting at its fastest rate for three decades. In Japan, the world's second largest economy, oil imports are at a 20-year low.

So why is oil going up? Well, "demand destruction" was never as big a deal as economists in oil-importing countries wanted to believe.

The big emerging markets now account for a large share of world-wide oil use. Their population growth, and on-going economic expansion, is keeping global oil demand firm.

At the same time, recent low crude prices have caused production cutbacks. In the past six months, the number of active oil rigs in the US – still a major crude producer – has dropped nearly 50pc.

Even worse, high credit costs have led to much lower spending on future production capacity.

In Saudi, UAE, Russia and other leading producers, numerous oil infrastructure projects have lately been mothballed or axed.

That's one reason why oil markets are showing such a steep "contango" – with futures contracts way above today's "spot" price. Oil for delivery in December 2009 is now more than $60 a barrel, rising beyond $70 a year later.

Something else is going on too. Across the world, many sophisticated investors and money-managers have never believed the self-serving "deflation is coming" mantra being pumped-out of London and Washington. And as Western governments lose control and central bank printing presses crank-up, the "inflation not deflation" crowd is growing.

That's why oil prices are rising. As a tangible, scarce asset like gold, crude is increasingly being used as an easily tradable anti-inflation hedge.

http://www.telegraph.co.uk/finance/comment/liamhalligan/5066497/Its-time-to-admit-inflation-is-going-to-be-a-major-problem.html

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