Wednesday, 23 April 2008

It looks like stagflation

Each month, the Bank of England's regional network of agents go out and ask companies how they feel about the current economic climate. This survey is then collected into a survey that scores sentiment across a number of key variables.

The recent survey makes uncomfortable reading. The Bank of England's agents are picking up clear signs of both continuing inflationary pressure and a slowdown in economic activity.

The price pressures are unmistakable.

Meanwhile, retailers are reporting a slowdown. It is more evidence of declining consumption. Households are being hit on several sides; higher prices, zero wage growth and higher debt servicing costs. It all adds up to a hard time for retailers.

Tighter credit conditions is playing havoc with investment plans.

Manufacturing and export-based firms are also bracing themselves for a slowdown.

Slower growth, more inflation, that is called stagflation.


TJ said...

That is what I see on my high street. Fewer shoppers, higher prices, and a drift into recession.

Anonymous said...

you can almost spell a downturn.

Anonymous said...

you can almost spell a downturn.

CWS said...

Whoever you are, anonymous, you are an idiot.

aSteve said...

I don't think we're seeing stagflation - or, at least, not the stagflation of our parents.

My definition of stagflation requires a stagnant economy and price inflation leading to spiralling wages/prices. This is what happened in the 1970s. Rising costs prompted workers to demand increased wages (while striking and reducing economic output) which lead to even higher prices and even greater demands from workers.

I think this is extremely unlikely today. The workforce is not in a strong negotiating position and the striking unions were broken by Thatcher - probably never to return. Don't get me wrong, I think the public would love to see spiralling wages and prices - it would allow them to enjoy their recent purchases on credit without worrying too much about the burden of their debts.

I think the problem with inflation is that there is no consensus about what it actually means. To some it is the money supply (which is complex); to some it is the availability of credit (which is contracting sharply); to some it is the cost of goods and services - and to others it defines their future wage packets.

Yes, we're seeing strong price inflation for manufactured goods and other essentials. Yes, we're seeing a stagnant (or contracting) economy. No, I don't envisage wage inflation; No, I don't envisage debt to be eroded as it was in the 1970s.

I don't see stagflation... there was a clear way to deal with stagflation: buy a house! It didn't matter much which house - any would do... anything to get rid of cash savings into hard assets - and anything to take on debt to leverage this strategy. In my opinion this will not work with what we're faced - a credit crunch... a situation for which the only exemplar is the great depression of the early 1930s. If I'm right, the correct strategy here is to hold cash and liquid investments rather than assets and debt. Holding cash strengthens your position in an environment where credit is contracting.

The masses have been gambling on stagflation - I think they've lost.

If you're looking for a label for our outlook, I think you wouldn't go far wrong with "Biflation" [ ]

Alice Cook said...


First, let me thank you for a very helpful and thoughtful comment.

What you appear to be saying is that you expect deflation, and implicitly a slowdown in growth. In today's uncertain environment, it is very defensible position. Many of the arguements are highly convincing.

However, I believe we are heading the other way, i.e. inflation and a slowdown supported by rising inflationary expectations and wage-price inflation spiral.

Why? First, the data tends to support this view. The RPI is consistently above 4 percent, sterling is sliding (higher import price inflation), and commodity prices are exploding. None of these factors suggest deflation.

Second, insofar as we see a credit crunch, it is quite a localized affair, and based on real estate. There are no signs of a corporate credit crunch. Although rates have risen, and firms are finding it a little more difficult to lend, it is still reasonably easy to access credit, so long as you aren't buying or building a house.

Third, there has been a little asset deflation. Some stock markets are down slightly and houses are definitely on the slide. However, I believe that most non-housing assets probably won't fall further. Asset deflation will be restricted to housing. I think this because for the most part (and there are exceptions), stock prices haven't enjoyed quite the same capital appreciation as housing.

Third, monetary growth remains remarkably fast, even in the last two or three months (perhaps I should post something on this).

Fourth, a related point; there is one sure guide of an inflationary evironment - real interest rates. If they are negative, then expect inflation. Certainly, they are negative in the states, they are also negative in some emerging market economies.

It is arguable whether they are negative here in the UK, but with rates coming down and RPI inflation picking up we are getting there. The RPI is 4 and rates are around 5. That implies very low real rates.

Now, what of the labour market? I think you are going to be surprised at how unions rise up from the dead. People misunderstand Thatcher and the unions. Union membership exploded in the 1970s because of inflation. People without unions experienced real wage cuts, and therefore people joined on mass. BTW, between 1970-79, union membership increased from about 9 million to 13 million. Thatcher reduced inflation and undermined the rationale for union membership.

So, in summary, I expect inflation not deflation.


CWS said...

Inflation or deflation - only two choices?

aSteve said...

It would be very dull if everyone agreed.

Your arguments for price inflation do not seem to contradict my own view... prices of goods, if not services, are on the up - of that there is no doubt.

I do not think we will see wage demands being met in the medium term - in the public sector we're constrained by national debt, while globalisation of labour markets constrains the private sector. I admit that this falls to intuition and instinct - mine is that wage rises will be at rates below RPI on average. Maybe we'll have to wait and see?

Monetary growth I find fascinating - and relish every detail I can establish. I admit that I was extremely surprised by recent M4 figures - as I had previously thought that I understood... M4 expands as people take on debt (mostly with mortgages) and pay others to swell total amounts in bank accounts. If this hasn't stopped, then I want to know who is borrowing, and who are they paying? I know that sounds simplistic, but in order for money to have an inflationary effect, it must find its way into consumers' pockets. (N.B. we can 'import inflation' by way of a weak currency - and that might simply reduce living standards - without.) I want to know which individuals/companies are now flush having been paid by the recently borrowed funds? Who is on the hook for repayment? I can't identify any demographic... which makes me suspect that I'm misinterpreting M4 statistics. For example, if the 'new M4' represents lending to banks to take SIVs back on-balance-sheet (I don't know if this makes sense - but it is an idea some have mooted) then maybe recent M4 expansion really represents previous monetary growth and an underwriting of the value of securitized debt? Or, in other words, a technicality affecting the statistics, but not the effect of monetary policy on the "real" economy.

You're right that 'real' BoE rates are extremely low - but retail customers are now paying a risk premium... I think it is important to compare retail to retail. ;) I think the effect of a low BoE rate will primarily be to devalue currency... this is generating today's price inflation - it isn't about the availability of money pushing prices up.

I think you're being optimistic in thinking that only the housing market will be affected. The availability of credit (which is intimately tied to house prices) will also affect other "big ticket" purchases - for example, cars; luxury holidays etc. - and this will surely affect the wider economy. I am surprised to have seen the FTSE recover some of its lost ground - but, I suspect, it will be lost again as profit warnings arise and confidence wanes again. At the moment shares seem to be defying gravity... I predict that we will see 5250 before we see 6750.

Anonymous said...

Assets right now are at extremely high P/E ratios based on the assumption that currently extremely fat corporate profit margins will continue into the future.

There's a few problems with that:
- the recession will kill margins;
- alot of the earnings are fictional, due to accounting manipulation;
- counterparty risk will materialise through mass defaults, causing recurring "one-off" losses

Even if we somehow avoid a stockmarket crash, P/Es are coming down.

When the boomers retire starting this year and there's mass selling into a credit crunch, I think a crash is more likely than an orderly decline.

We are just entering a deflationary depression. We are still in that period of having jumped off the cliff and enjoying the exhiliration of zero gravity, and trying not to think of the ground.


Anonymous said...


Best not to worry about M4. Credit has to be repaid or it gets defaulted on and evaporates. If incomes aren't rising (and they aren't) then it'll default.

The expansion in M4 is at par value where it really needs to be marked to market. I'm with Mish on this one - net evaporation of credit is far bigger than creation of new credit but won't show in the stats until it's properly marked to market - which everyone is currently trying to avoid.

You did hit on one good point about where it's going. Two places:

- a commodity / oil / gold bubble
- trapped in banks witrh nobody borrowing it (so velocity is zero and in inflationary terms it might as well not exist)


Anonymous said...

Oh, I see the unions are gearing up to bilk the taxpayer out of more money. Here's hoping they fail miserably under the combined weight of global wage arbitrage and a mass of private sector workers extremely unimpressed with their me-me-me theft-marches.


aSteve said...

Nick... Interesting reply.

I'm not so much worried about M4 as fascinated. While I admit that some of my interest is self-interest, I'd like to understand what is being borrowed/spent. If I'd understood in 1998 what I understand about money now, I'd have optimised my behaviour somewhat.

Among commodities, food - for example - seems a remarkably poor store of wealth... and I utterly fail to see value in precious metals. Oil is interesting - but I see it as being a shift in the balance of power in negotiation of price rather than a speculative bubble.

I am inclined to think you might be right about funds 'stuck' that can't be lent because banks don't want to write off bad debts... yet are required to hold adequate capital ratios. This also makes sense in the context of a decline in confidence in pensions.

Ray said...

Those charts look miserable to me. Hard times are on their way.

George said...

The BoE survey tells a very consistent story, rising price expectations and a more gloomy outlook. It doesn't look good for UK PLC.

Anonymous said...


This is my take on commodities....

... Benanke tried to reinflate the housing market by reducing interest rates (the only way to do that is printing or issuing more debt). Only thing is, once people get hold of this money the LAST place they want to put it is into a bursting market. So it didn't go into housing.

What are the only asset classes that looked like rising? Commodities, oil, gold and treasuries.

So all the speculative capital (and the sovereign wealth funds and hedgies) move there. Treasury yields went close to zero as a safe haven from default risk. Gold for that reason and also because of panic over potential inflation. Also the gold market is so small that it only takes a diversion of 1% of the Dow's capitalisation to double gold prices.

We've got a few things going on which are getting misinterpreted so people don't see deflation:

- Peak oil. 2003 was the global production peak and demand keeps rising, so prices go up. It's a supply-demand issue that HAS NOTHING TO DO WITH INFLATION.
- Gold. It is a tiny market with a tiny float. Even a small inflow into it pushes prices insanely high. Again, not inflation.
- Treasuries. Pure default fears from corporate treasurers who don't trust anything else and have far too much money for FDIC insurance to matter.
- Commodities. A bubble aided by ethanol subsidies. Demand going crazy against a fairly fixed supply that recently had some interruptions (e.g. rice crop failures).

So long as you insist on calling all price rises "inflation" you'll never be able to separate price movements due to normal supply/demand factors and those due to printing more of the units these things are denominated in.


aSteve said...


I agree with most of what you say... and wholeheartedly agree that inflation is widely misunderstood.

I find oil to be complex - partly because it has such a direct effect on industry... and partly because I mistrust almost every "fact" I read - suspecting every one is either misinformed, misleading - or both. Luckily, in the UK, we're used to high prices for fuels - and this means the public are shielded to some extent from a global shock. I agree that the price of oil is influenced by factors far greater than inflation.

Gold, while I've read and understood the arguments still leaves me cold. I see no value whatsoever in gold.. and can't help thinking that others will see this soon too.

Treasuries are interesting - since they represent (as closely as possible) risk free debt. This means that their yield should always be lower than the rate at which money can be borrowed. Maybe this isn't going to be the case for banks who can borrow from the central bank... the government coud write more and more treasuries to pay for social programs... say... but I can't imagine that they would be constrained by exhange rates and foreign national debt.

I agree that speculative capital may move in this direction - but I don't expect leverage in these markets - at least not for very long... so I doubt that bubbles of the sort we've seen in mortgage debt or houses will re-emerge in commodities. Commodity markets can react more quickly to supply and demand.