A tax by any other name

People are always telling me I shouldn’t be obsessed by inflation, but I’m sorry to say that as an Economist it’s one of the parameters of our world. Taxes take money and wealth from the public and give it to the government, which usually makes a mess of spending it. Inflation does exactly the same, removing wealth from the individual all the time and not even giving some of it back as spending. And nobody really notices.

So today I’m going to give you all some home truths about what inflation really means, and why we are completely wrong to think it is benign.

Let’s start with the year 1938. Why you may ask? Well that’s 87 years ago and so roughly the lifespan of the average person nowadays in the UK (give or take). So there will still be people alive who will remember that the average weekly wage then was £3.45, or just under £180 a year. That’s not even a cup of coffee per week nowadays. Even when I started work in 1969, that was  £24 a week or £1248 per annum. Not that long before that (maybe 5 years) I remember being told that it should be every young man’s ambition to earn £1000 pa. As of today that annual figure is just over £40,000 pa.

Now unless you are really bad at maths, you will notice that something in say 1964 which cost £1 then would now be £40. In reality, better manufacturing, cost savings etc etc probably mean it isn’t quite that bad but I’m sure you can see the point. And they’ve probably reduced the size as well.

Most interestingly, over those 87 years the UK has suffered inflation on average of 5.25%. Even more interestingly, the USA has only suffered a mere 3% or so and as a result has enjoyed lots of advantages over the timespan. In 1938 UK inflation was 1.2%. Ignoring extreme ups and downs, as of today that figure is 3.8%. To put that in context, in 10 years time, what £1 will buy today will take over £1.45.  20 years out it becomes more than £2 which means you have lost half the value of what you had.

Now you can see why governments love inflation. Borrow £100 today. In 20 years time you don’t have to pay back £200, you only have to pay back….£100! Unfortunately, it’s one of the reasons the UK Treasury is in trouble over its borrowings. First issued in 1981, inflation-adjusted gilts  (linkers) were restricted to pension funds and life assurance companies, which was an excellent idea. Unfortunately, it became obvious in the early days that this was cheap money because the payback was years away and the coupon ( ie interest paid) was tiny compared to traditional gilts. The trouble is, inflation has remained stubbornly high ( as high as 11% only a couple of years ago, which means that in only 7 years  - seven years – we get to the same doubling as after 20 years at 3.8%). And by the way, that figure is almost certainly too low, because Gordon Brown removed housing from the CPI figures over 10 years ago, to try to bribe the electorate in 2015. At the time there was more than 0.5% of a difference to the index, so its probably not much different today. As a result the true rate of inflation is  4.3% as opposed to 3.8%. The UK has the highest percentage of linkers to ordinary gilts of any country in the world at around one third. This alone is crucifying the current monetary aggregates as more and more has to be diverted to pay interest on the debt. It simply cannot continue. Public spending is itself inflationary. As Inflation rises, the markets expect the authorities to raise interest rates. Not in the UK. The Bank of England just lowered them. That signposts even less credibility in monetary management to the vultures that are just hovering waiting for another killing a la 1992. In fact we are about to come to the anniversary of that day on 16^th September. Financial crises always erupt once the harvest is in. And in case you don’t know the 30 year gilt interest rate has just gone over 5.7%. And the BofE together with its outstanding Governor just reduced interest rates to 4%. Unbelievable. The only government debt disaster that ranks alongside this  is was the French idea of a loan linked to gold in the 1970s – the infamous “Giscard loans” which originally raised around 6.5 Billion French Francs. If I tell you that it cost 90 billion FF to repay them 15 years later I think you can see this was not the smartest move anyone ever made. The repayment added 4% at a stroke to France’s conventional debt pile. More importantly still, even with inflation at 4.3%, the UK is actually ADDING costs on costs of interest payments. Total insanity. Interest rates should – in general - be between 1 and 2 % above inflation to hold inflation steady. We are already running headlong towards higher inflation and they pour oil on the flames.

Politicians have “weaponised” the cost of living crisis which is such a hypocritical stance that it defines what they are. It is almost entirely created by the same politicians fiddling with the economy. If you take the 5+% overall long term inflation rate, to keep pace with the cost of living you have to increase your earnings by the same amount. In other words if you earn £1 this year you need to earn £1.05+ next year to buy the same things. The cost of living crisis is created because in general you will not get more than the rate of inflation as a pay increase. The problem of course is that unless the economy as a whole is increasing by more than this figure then there simply isn’t enough in the national coffers to help. Growth is what makes everything work. As Ronald Reagan said “ We cannot reduce the deficit by raising taxes.” The only way to do that is to collect more taxes  or reduce spending and sadly politicians generally opt for the former which curtails growth, as opposed to the latter which would get them slung out of office.

As a gentleman of impeccable economic credentials has said, Britain is not where it was in 1976 when the IMF imposed cuts. Of course, again, it suited our politicians to call them in as it gave them someone else to blame. But we did have the beginnings of North Sea Oil and several other plus points. As of now we are in a much worse position than 1976. Just to take an analogous point, we aren’t even LOOKING for North Sea Oil, we are actively cutting it with all that that means for employment, the economy and future prosperity. 

What has been arguably the best economic management since the end of WW2? Answer – Germany in the 1960s. They had what has been called the Wirtschaftswunder, or roughly translated as “the economic miracle”. And why was that? Very simply put the authorities held everything pretty much unmoving for more than 10 years. Monetary growth was held to 2% - not more and not less, whatever the conditions. This led to certainty in the business community, as did the fact that taxes were held as well. More certainty. What did that lead to? A strong DeutschMark. Which held down inflation. Which led to a growing economy that was growing so fast that the authorities had to raise the exchange rate to stop it overheating. And inflation? The only words I can think of are stable and quiescent. It really isn’t rocket science but I regret to say people want to tinker so they are seen to be doing something. Sadly, practically everything they actually do is a retrograde step.

So the next time someone says inflation is only x% think about how that will affect your earnings and wealth in 5 or 10 years time. It does not make pretty thoughts.

‍