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A year ago, the governor of the Bank of England tried to downplay growing fears of inflation. Any increase, Andrew Bailey assured us, was understandable given the “bumpy” economic recovery after the pandemic, and he expected “it to come back on target”. It was a view shared by many of the world’s leading economists, including Nobel Prize-winner Paul Krugman. But that didn’t stop it from being wrong: last week, Bailey raised the BoE’s base rate of interest from 1.25% to 1.75% — the biggest rate rise Britain has seen in 27 years.
Why were their crystal balls so inaccurate? Was today’s inflation simply unforeseeable? The straightforward answer is: no. The initial inflation was caused by the disruptions brought on by the lockdowns and was perfectly foreseeable using basic macroeconomic models taught in undergraduate classes. Yet most economists seem to have missed this — largely because, starting in March 2020, they stopped focusing on economic problems and became armchair epidemiologists, offering opinions on how the virus spread and what might stop it.
There was no meaningful economic discussion during the pandemic; normal repairs and maintenance appear to have been neglected, leading to serious problems with supply chains. In 2021, for example, there were 1,946 factory fires — the most ever recorded in a single year and an increase of 129% over the previous year. And these problems have been supercharged by recent geopolitical developments, the most obvious being the war in Ukraine.
As with the lockdowns, economists and policymakers repeatedly misjudged the effect of imposing sanctions on Russia. Most commentators thought they would lead to a collapse in the rouble and the disintegration of the Russian economy. The sanctions would “reduce the rouble to rubble”, predicted Joe Biden. This has not happened. The rouble is currently 30% higher than it was pre-war and while Russia is facing down a recession, the Bank of Russia is slashing interest rates rapidly, signalling that the worst is over.
While the sanctions have not impacted Russia as many assumed they would, they have crippled the Western economies. Before the war, it was fashionable to say that Russia only had an economy the size of Italy’s. This was always misleading. When properly adjusted for relative prices, Russia has an economy substantially larger than the United Kingdom. And it is not simply the size of the Russian economy that was underestimated, but also its importance in the markets for core goods.
For example, Russia produces large amounts of the world’s fertiliser. It accounts for 19%, 15% and 14% of the world’s potassium, nitrogen, and phosphorus exports respectively. Fertiliser is obviously key to growing foods, so disruptions to these markets tend to increase food inflation. Russia produces large amounts of basic foodstuffs too, and is the largest wheat exporter in the world. Put simply, the Russians punch above their weight in the production of the necessities for life. While they may not, say, have a world-leading social media industry, they produce a great deal of the goods that we simply cannot do without.
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SubscribeWhat do I know ? I did say in March 2020 that the policy of lockdown would prove to be disastrous. Not on here but wherever I could. The economy is our ecosystem . Just watch any living creatures and they have a routine and a way of living that enables their survival and enables the continuation of the species. We smashed that to bits.
Why would anybody think we humans are any different ? Clearly the economists and the politicians and the tame but hysterical media did and now we live with the result.
It was a displacement event on a grand scale and as is always evident when this happens it takes around 2 plus years for the results to become clear. We are seeing this now. In addition the people involved at the start always either get removed or fail to stay in effective power. This we see too.
The Brics countries are seizing the chance they have long waited for and are going to go for us in a major way. I expect the next step will be a new reserve currency based on commodities and production. We have little production and refuse to use the resources we have in case we get a nasty twitter storm about killing the planet. No such stupidity in China or India or Russia. I worry that the USA will go to war in a big way rather than lose reserve status for the dollar. As for the Ukraine sanctions there is nothing the powers in charge say that makes sense. It is going to be hard going and I doubt the West will face up to the challenge. Empires come and go.
There were quite a few of saying this. Apparently it was a conspiracy theory.
There is plenty of stupidity in China, India and Russia. And if you don’t think that China and Russia are continental empires, I suggest reading more history.
Tke key advantage of the West is that we are able to get rid of stupid and incompetent leaders. We don’t suffer over 20 years of a Stalin or Mao.
If you want displacement activity for governments trying to divert attention away from domestic problems, I suggest you look no further than Russia/Ukraine and China/Taiwan.
The USA (and the West) will be far more resilient than today’s fashionable pessimists suppose. It is the Russian and Chinese empires that are in danger. Check the massive amounts of bad debts surfacing in China at the moment and pause to consider how much of China’s economic growth has been faked.
I don’t completely follow your point about lockdown. Lockdowns were enforced all over the world. So why do you argue that only the West will suffer the consequences. This makes no sense.
There will be no meaningful (not one that makes any difference) BRICS reserve currency. This is just a fantasy. Look at what’s actually happening right now and where the smart money is going. Over 10,000 Russians and Chinese ultra-rich trying to leave to get to the West.
Huuuum! “It is the Russian and Chinese empires that are in danger. Check the massive amounts of bad debts surfacing in China at the moment and pause to consider how much of China’s economic growth has been faked”.
Methinks you should check where almost everything you buy on eBay or Amazon is made!
Noise. Irrelevant to the points I made. Please try to respond to the actual comments.
The fact that China makes all of our stuff shouldn’t give it the power you think. China still needs us to buy all their stuff. Faced with wolf warriors screaming at us unless we do we can shift manufacturing elsewhere . Granted, it’ll be more expensive, but then the collective power of free market capitalism is more inventive than autocracies. Someone will invent solutions -wheter its onshore 3D-printed manufacturing thats cheaper than importing from China, or whatever. If you provide the opportunity capitalism will figure out an answer.
Exactly. They just don’t get economics. It may even work out cheaper in the long run once it’s better automated and labour costs continue to rise.
Observe that the Chinese workers are on near slave labor salaries. A few workers are promoted out into the middle class. But demographics are now causing issues along with an excess of spending on empty buildings. They watch as production is being moved and fear India. China has a host of issues we are not informed about.
A sane response, Peter B
This is well said. I have seen many commentaries similar to the one published here by Mr. Pilkington. Essentially, they argue that western sanctions have substantially failed to damage the Russian economy, that actually the Russian economy is stronger now (stronger Rouble, and greater current account suplus and stronger balance of trade) and western economies have been significantly weakened. This line of argument lacks nuance and is myopic — too focused on what is happening right now. Like Peter Zeihan and other say, such an argument ignores that Russian industry largely relied on western technology, parts, equipment, human capital. That is all gone now and will likely not return for some time. Sure, the Russian will try to substitute to Chinese products, materials, technology etc. but there are two problems. First, as a matter of fact, China has not actually begun to increase its exports to Russia; one reason is because China appears reluctant to risk being subjected to western sanctions too, or at least, threatening its own economic and trade interests arising out of its relations with the West. Second, China currently does not have the economic and technological capacity to be a viable substitute supply chain for Russia. Russia is already beginning to strip domestic airplanes and washing machines for parts and semi-conductor chips to feed its war machine. This issue will grow worse over time as repairs and maintenance of its industrial capacity becomes impossible. For Western Europe the crisis is real, acute and happening now, but it is an energy crisis foremost. Over some time, Europe will be able to find energy substitutes (though it is likely this coming Winter will be very difficult). For Russia, they have all the energy and food they could ever want, but their economy will de-industrialize and increasingly rapid and observable clip over the 6-36 month time period. This is likely why Russia is trying to inflict as much economic pain it can on Europe between now and early next year (it is their time of maximum opportunity) in order to persuade Europe to relax its sanctions.
I said right at the start of the lockdown to anyone that would listen (and to anyone that wouldn’t) that it would end in economic disaster with rampant inflation, falling living standard leading serious levels of unemployment and probably war.
Historically periods of economic and social dislocation have always rocked the established order and as it begins to look vulnerable very quickly things that once seemed unthinkable become thinkable.
Trying to get my point across to some lockdown advocate, I said that when it was all over the dead would be the lucky ones. That comment is new looking less facetious by the month
Even for an economist Paul Krugman is vastly overrated.
Can I have my Nobel Prize please
For the record, Paul Krugman did not win a Nobel Prize. He was awarded the Sveriges Riksbank Prize in Economic Sciences.
What do you know? Clearly you don’t know – or choose to ignore – that China imposed and continues to advocate far more draconian lockdown restrictions on its citizens than any country in the West.
I think many throw around the idea of “establishing a new reserve currency” without thinking through how hard that is. Just ask yourself, what would it take for you to be willing to be paid your salary in something other than dollars? Now multiply that angst by about 1000 and you have some idea what it would be like to have multi-year, international sales contracts denominated in something other than dollars.
Can it happen? Absolutely! Are the BRICs a real threat to US economic hegemony? Absolutely! Are we doing everything in our power to destroy our own currency’s international value? No, but we’re doing a lot wrong. That said, does anyone really think that the yuan (a currency controlled by a totalitarian dictatorship) is actually preferable? The Real (a currency which may well be controlled by a Latin American tin-pot dictator should Balsonaro decide not to leave)? The Ruble (a currency controlled by a man who fancies himself Vladimir “Nicholas III” Putin? And if none of these look promising, why would a hybrid currency (the EU shows how well that works) controlled by all 3 of them fare any better?
I’m not dismissing the possibility, just pointing out that reserve currencies are built on both military power and economic trust, and you don’t create either overnight or by fiat.
I remember Boris mocking the Russian GDP figures as if they meant something. No actually GDP prom producing oil, wheat and steel is not the same as GDP from someone ordering a deliveroo.
Why not ? Have you redefined GDP ? Are you expecting a Nobel Prize for this discovery of “good GDP” and “bad GDP” ?
In general, countries which have more services have greater value add and higher GDP than those with unprocessed raw materials and commodities. They also tend to have better wealth distribution and lower corruption than those with basic extractive economies.
touche!
Again the frustration of getting down-voted without having the benefit of knowing what the person disagrees with. I get the feeling that, all too often, it’s just that some readers don’t like what is being said rather than disagreeing with it.
What you say is sound, but I have a problem with the final sentence – is it just that extractive economies are in countries in which corruption is endemic rather than the fact that they have extractive economies?
Linda, I read a book about the parallel development of North and South America which was very informative on this. At the start of colonisation, South America was far wealthier and had all the gold and silver. The easy money was made there. North America was far less populated and starting from a lower level. For that reason the price of labour was always higher (hence the mass emigration from Europe) and productivity always a much greater concern.
Back to the point – in the extractive economy where the wealth is there just waiting to be claimed (rather than created by hard labour like building farms and developing technology and factories) it tends to concentrate in the hands of a few rich people. Which is the reason resource-rich countries are often not as rich as they should be and have poor wealth distribution. Whereas places like South Korea, Singapore and Japan which have almost no resources can be very rich.
Very interesting. Peter, thank-you. I had never really considered this dichotomy before; it’s well worth investigating.
But, Peter, it may be a good idea to look at redefining GDP. How many goods contain ‘bads’ (ie pollution costs, decommissioning costs)? How many services turn out to be disservices (gender reassignment to name a topical niche service)?
Whether something is a good/service or not (even the reverse) is not cast in stone for eternity.
Value is not a hard and fast, therefore measurable, concept. Value to who might be the first question.
But, of course, whoever defines or redefines GDP controls power.
Not redefining GDP at all I’m saying it is not an accurate measure of power. “Value add”, GDP, low corruption or wealth distribution is not really relevant when we are discussing geopolitics and your enemy has the power to starve and freeze your population.
Actually, revenue and profit is measured in ‘Lsd’ so it is. Deliveroo does not, of course employ the same volumes of people, but it does buy its raw materials, also paid for in lsd. It is such a common misconception that revenue from services is somehow different from same in manufacturing: there are many other arguments as to why having a manufacturing base is a positive, not lease because those employed spend, save and invest, not least in pensions ( just look at Ping An and China Life and their financial power?) – Overseas revenues in foreign currency, just for an example in accounting, non-life insurance, media and entertainment and advertising, provides effective ” net” income and enployment without the ‘ danger’ of having to import raw materials paid for in foreign currency.
The Next move is that Truss will impose GDP as a test for the BoE. This would be an huge error.
She Should of course impose GDP per capita. The Words Per Capita are crucial.
Otherwise all the bank has to do is to encourage more immigration to cause an increase in GDP. Or even just increase house prices.
hear hear!
Do read https://www.goodreads.com/book/show/66499.The_Creature_from_Jekyll_Island. It’s an “easy read” and flows very well. I just found myself being…gobsmacked… I wonder if you will have the same experience too. Jekyll Island refers to a secret meeting between five bankers in 1910 that led to the creation of central banks… That’s nothing perhaps shocking – although highly undemocratic – but it’s the QE/money printing that is just astonishing… how Bankers (hey I’m a capitalist more so than socialist) funded both sides of wars… e.g. Germany and Allies… It’s all here: the cause of wars, boom-bust cycles, inflation, depression, prosperity. Creature from Jekyll Island is a “must read.” Your world view will definitely change. You’ll never trust a politician again or a banker. Not that I ever did tbh. Enjoy!
There is in fact a solution, but it requires inventing a time machine, going back, and making different choices. Ideally back to the mid-sixties, but at the very least back to the start of the pandemic and managing the lockdowns very differently. Now, most people likely know this is not possible, but economists would undoubtedly seize on this as a great solution (if the thought were to occur in their tiny little brains, so shussh here about this please in case one of them comes across this BTL post and takes the suggestion up to the BoE MPC). I mean, any grouping that can believe in modern monetary theory is not going to have a problem with believing that time travel is possible. And as is their wont, they will suggest entire frameworks of policy based on the assumption that going back in time is in fact a given, and will then blame the failure of their policy recommendations on imperfect execution – viz the fact that time travel was not in fact utilised.
Surely it is the job of the bankers, central or otherwise, to ‘fail us’, and to enrich themselves while destroying others. The premise of the article seems somewhat absurd to me.
And that is the point. I feel sure if perchance some banker were to come along and offer the author of this article a few millions for writing very nice things about bankers and defending their actions, he would turn around, put his halo on, and refuse, saying it all goes against his ethics, and he in fact as an economist has been put on this earth to serves the higher purpose of the betterment of the whole of humanity (as of course is the wont of economists, because lets face, it they are a better class of humanity than the rest of us in the gutter, neither Gandhi nor Mother Teresa has a patch on them for sheer goodness). And if some economist were to actually make such an action, and said economists’ partner/spouse/dependents turn around and say what the f**k did you do something so stupid for, I’m ditching you, well I’m sure said economist would accept their fate stoically, such is the sheer innate goodness of economists.
What exactly is a ” Banker”? The manager at the Local Bank of Toytown? An Equity salesman? a bond prop trader? A load syndication boss? An equity capital markets director?…… Most people do not even know what these people are, let alone what they do?!
It’s like asking what a programmer is – I don’t know if I have a definition, but I can sure tell you if they are one, if you point me to them.
It is someone who lends you money. Whatever they call themselves.
Real inflation has been very high for decades. If you focus solely on retail purchasing power, this fact was disguised by such things as outsourcing of much manufacturing to “low wage” economies. This gave the illusion that Western wage earners’ purchasing power was not declining (much).
However, most of the inflation was going into asset prices, making it more and more difficult for wage earners to accumulate real capital assets (such as buying a house). In real terms, the “rich” became richer because they had access to the cheap credit afforded by the “quantitative easing” while wage earners did not. This is a manifestation of the Cantillon effect which transfers wealth to the privileged few who get the new money first.
As a result of the lockdowns and and other recent insanely disrupting political policies, the factors which created the wage-purchasing-power-stability illusion ceased.
Unfortunately, I think there may be two competing factors, and controlling them both without a recession is unlikely.
On the one hand, the money supply was grown dramatically during 2020-21, which is, of course, inflationary. On the other hand, there was already inflationary pressure and supply chain squeezes before 2020, but it was not manifest in rapidly rising prices, just rapidly rising labor rates.
It may take a recession to reset the fiction that is backlog. Backlog that is persistent becomes self-prepetuating, as lead times grow, so does the pressure to overorder, which makes backlog worse. All of that dies in a heartbeat when retailer inventories suddenly balloon as the economy slows, and suppliers get stuck holding the bag. Then prices crash and no one cares that interest rates are high, because there is no longer any incentive to invest in ramping up production.
This may be the best economic analysis of the invasion consequences I have seen in any major media outlet. The problems of our globalized supply chain (which is really just a fancy way of saying rich countries export their pollution and manual labor to poor countries) is perfectly encapsulated in this sentence: “The BRICs are done playing second fiddle to the West.”
While the consequences will likely be a fall in Western living standards (we’re already seeing some of that), it will also open opportunities for those who have been left behind. We have a large, economically inert, cognitively lower, class in America that is largely unemployable due to lack of skills (or at least skills that we consider useful today: social media, coding, etc…) In short: we exported all the jobs our fellow citizens who were “not-college-material” used to do, so all our citizens who were college material could get the stuff they wanted cheaper. If that is really coming to an end, it will be devastating to the educated urbanites, but may actually create opportunity for the rest.
Let us hope so – otherwise those unemployables will soon be fashioning guillotines in their (rented) basements…
Gosh, I don’t know. UK M0 went from £82 billion in early 2020 to £96 billion in early 2022. I’m sure that wouldn’t have any effect on prices, because wise rulers.
But M0 right now is trending down a little. I wonder what that means.
So how does the massive reduction in the actual use of cash affect the old “M” metrics? A genuine question?
The author is clearly an amateur who gets his info from the newspaper. Almost everything in the piece is wrong, like it was in his comic attempt at explaining EUR weakness (a USD strength story).
Outside of Asia, inflation is a global phenomenon. It is the result of mostly, but not exclusively, the US central bank and its fiscal analogue conspiring to turbocharge recovery from Covid despite potential output taking a severe hit. All large central banks and fiscal authorities other than the PBoC did the same although the scale of the US fiscal-led money print was way ahead.
The result was entirely predictable – a massive stay-at-home demand boom in merchandise goods, financial assets and houses. Supply and global trade grew at historically record levels throughout 2021 (look at CPB.NL data) but simply couldn’t keep up.
There wouldn’t have been an inflation issue of anywhere near the size we have now had CBs and fiscal departments done their jobs and started to remove the punchbowl at the end of 2020 or early 2021. The one good thing is that hard money has returned to center stage and the thankfully short era of heterodox pretend economists, MMT ‘theorists’ and pink FEDs is finished and disgraced.
Yours,
M (economist, a real one)
It’s spelt ‘wrung’; otherwise, an excellent article.
It is ridiculous to pretend to be containing inflation while house prices rocket skywards. The control should be of both consumer prices and asset prices.
It’s the arbitrary decision to only measure CPI inflation that leads to the error in terminology. If you create money out of thin air, then you dilute its value. That’s inflation. Often the CPI is the last thing to move. And of course governments constantly tinker with the CPI to ‘hide’ inflation.
Money is created out of thin air in, just for example, retail banking, millions of times per second each day… You go over your overdraft limit, because you have no money… the bank credits itself with a ” fee” charging you for going o/d, and that effectively becomes instant ” real money”: to be fair, it is ” paid back” when ” real” money reappears in your account… BUT if the bank extends your o/d to ‘ pay itself’ and uses its balance sheet to itself borrow, its balance sheet comprises of assets that are also loans, so long as they are being ” serviced” … if they are not, viz interest/ principal not being paid, these ” assets” move to the ‘ liability” side of the balance sheet… and another amusing fact to ponder… your bank can leverage/ lend against ” n” x multiples of its assets ( including your debt) but only allows YOU to borrow against a proportion of YOUR assets!
Again, 99 pc of people have no idea as to how bank balance sheets, and accounting conventions work, nor that they are completely different in, say, UK, EU and US… and that Germany is even more stringent than other countries in the EU, as there accounting convention suppresses balance sheet asset values, as a legacy post Weimar inflation.
All of that is true, but we are not talking about the relatively small and inconsequential money creation of bank balance sheets. The issue is the massive expansion of the money supply that only governments and central banks can create.
supply/ demand matrix?
Agreed – and, I would have thought, entirely obvious – so WTF have these people done to the next generation ???????????????
” inflation” as a term, is like ” property prices”: it is not and can not be a generic term. The simplistic 1974 ” wage/ price” inflation in the days before computer modelling, instant electronic capital markets, and derivatives power and influence is no more comparable that a wooden cart wheel to a Formula 1 car wheel… they are both round and… errr… that it.
Inflation rates, on a one dimensional basis are fed to the mainly innumerate public, based on a selective method of complilation.
Capital markets control and manipulation of every facet of commodity pricing, not least in oil and gas, has the consumer as the eternal ” undated” dumb counterparty. The situation of high employment and low wages driven by downwards markets ‘ buy side’ pressure is hardly ‘ inflationary.
The internet’s freedom of choice in buying goods on line has had a deflationary pressure on the pricing of goods, but the converse is true when the consumer ( rail tickets, water, electricity, for example) is again a capitive dumb counterparty with zero plethora of choice: the latter is the most modern manifestation of post industrial capitalism, whereby a free market allows free entry, to then ” close” that market to competition.
So, please, let us not simplify ” inflation” as like ” interest rates” it is a highly complex subject that, to be entirely fair, is simply not a subject that 98 pc of people should reasonably be expected to have any training, let alone knowledge or understanding in.
The economy is a complex system – perhaps one of the most complex systems there is. But wasn’t the onus on the proponents of ‘modern monetary theory’ to prove that they would not cause massive inflation before the massive policy shift? If decades of accepted wisdom and government restraint is thrown out the window, and then the feared inflation materializes, can’t we then question whether a massive mistake was made? I don’t think the “well its much too complicated for you simpletons to understand” is going to cut it. And it is very convenient that the people who made the catastrophic mistake are still in power and don’t particularly want to admit that the mess we are in was something they created by idiotic acceptance of a ‘too good to be true’ new monetary theory.
have you actually read what I have written? Judging from your response, “no”?
Not sure by what magical powers you deduced that I did not. But sorry you didn’t like my response. I was reacting to the idea that the complexity of inflation means 98% of people can’t understand it. I don’t disagree, but i think there’s more to be said. I don’t understand fully how my car operates, but I do know that if I put water in the gas tank and pretend the tank is ‘full’, bad things are eventually going to happen.
Well, I do actually have training in it (most of a master’s in economics — to be fair, mostly micro and game theory) and I have no problem with the use of an “inflation” number. It tends to overstate in some ways (it fails to accurately account for substitution in its basket, for example) and understate in others (food and fuel are not weighted properly compared to most families actual expenditures) but it’s useful for what it is.
Inflation numbers are like GDP. They’re not perfect models, but they are meaningful, particularly when compared to their own historical data. I would agree that the speed of communication and broad availability of price data at essentially no transaction cost has rendered the inflation number somewhat obsolete even before its published though. These days, it sends to just codify what you already knew instead of providing new data.
The economists got their forecasts wrong because most work for financial firms who will suffer severely from rising interest rates. Others work for right-wing organisations who have a vested interest in defending economic policy since 2010. Most of those who work for left-wing organisations are globalists and being supporters of identity politics are contemptuous of the white working class. That leaves a small number of economists, typically left-wingers who supported Brexit or at least sympathised with those who did (hopefully you’re beginning to get an idea of how few there are), who for decades have criticised growing economic inequality and seen globalisation as playing a key role in it. They have been smeared as cranks and Marxists and their views have been dismissed.
thanks Philip, many have been predicting this and it is good to have someone actually QUALIFIED to confirm the dynamics. Now how do we best position ourselves to get thru this ?? Sell our houses and buy gold ? cash in all our shares and buy silver coins ? Come on now you must have thought this through – please let us know your best guesses – naming the problem is the easy part…
The “bankers” haven’t failed. They are executing on their plan.
Does anyone really think Krugman doesn’t understand economics 101?
Printing six trillion dollars is going to cause massive worldwide inflation on purpose. We know this because they are continuing to print trillions on the “Inflation Reduction Act”.
We are being systematically lied to, while simultaneously destroying western economies.
Um, and buying gold wont work when they pass laws that make owning gold illegal. This is what they did the last time (look it up).