Will Britain turn into Zimbabwe or Japan? In other words, will the fallout from the economic crisis precipitated by Covid 19 lead to hyper-inflation or to deflation? Are we going back to the 1970s – or to a strange world of which no living Briton has any recollection? Or, more graphically, will it be savers and bond-holders who get ripped off to pay to bills of the crisis – or do borrowers face being buried by their debts?
In May, the Consumer Prices Index (CPI) fell to an annualised 0.5 per cent. A fall was expected thanks to plunging oil prices. But many people fear it will only be temporary as the economy begins a fraught recovery. After all, what do the economic textbooks tell you to expect when you mix together an expansion in the money supply combined with a contraction in output? And boy, do we have those two ingredients at the moment.
Since the beginning of the crisis, the Bank of England has whisked another £300 billion out of the air – bringing total quantitative easing since the financial crisis of 2008/09 to nearly £750 billion. Meanwhile, shops, restaurants, leisure parks have been closed, reducing the things we can spend money on, and causing savings to rise, personal bank balances to swell. By the time the crisis is over, many businesses will have gone bust, yet extra money – effectively printed money — will be swilling through the system.
It seems so obvious that we will end up with inflation – and yet that was what many people were expecting last time around, after the 2008/09 crisis. Yet the much-feared Zimbabwe-isation of the UK economy never happened. Not only that, in 2015 inflation even turned negative for a time, though very briefly. Credit, then, to the Bank of England’s Monetary Policy Committee, which steered the economy through the unknown territory of quantitative easing by doing, er, virtually nothing – and leaving interest rates unchanged for seven years.
Could the benign outcome of the past decade, though, inspire complacency – and this time we really will end up with hyper-inflation? Bank of England Chairman Andrew Bailey last week said he was aware to the dangers by promising that QE would be reeled in. But then we heard that last time around, too – and it didn’t happen.
The alternative scenario is deflation. People feared that after the 2008/09 crisis and that didn’t happen either – except, as mentioned, briefly in 2005 when the CPI fell to 0.1 per cent for two months. That wasn’t a huge problem, but serious and prolonged deflation certainly would be. Older readers will remember well the hazards of inflation, when the real value of savings is eroded and workers start demanding three or four pay rises a year. Deflation, though, brings arguably worse horrors. Imagine if, in spite of you keeping up your repayments, the real value of your mortgage started growing month on month? Eventually, you would be overwhelmed – as would anyone with debts they had been unable to pay off. Given that the biggest borrower of all – HM Government – is up to its eyeballs in debt, deflation would soon bury the public finances, too.
In modern times, the model for deflation is Japan, where prices started turning negative in the mid 1990s. Between 1998 and now – except for a brief period during the commodities boom – inflation in Japan has been persistent in its habit of diving into negative territory. Never, though, has it dived very far – it is more Tom Daley than someone exploring the ocean bed in an iron suit. Borrowers have not been subsumed. Similar persistent deflation was experienced in Britain in the latter half of the 19th century.
There is perhaps a good reason why economies can suffer chronic deflation but don’t tend to suffer the mirror image of inflationary spirals that have taken down economies such as that of Mugabe’s Zimbabwe and Weimar Germany. The dynamics are very different. It is one thing to jack up your prices or demand higher wages to keep up with perceived inflation; but who is going to demand a pay cut to keep pace with deflation?
There is another guard against deflation. With vast national debts, it is hard to imagine Britain, the US or any other developed country allowing deflation to occur. They simply can’t afford to allow it to happen. They will do everything they can to avoid it. If QE doesn’t do the trick, they will surely try something even more blatant: helicoptering money direct into our bank accounts. In the end, they will be far more relaxed about risking inflation than they will deflation.
Forget consumer prices for a moment; after 2008/09 we did experience inflation – asset price inflation. The excess liquidity was sucked into stock markets and property markets. As the rising stock market suggests – the US market is actually higher than it was in February, before the crisis – that is quite capable of happening again. Don’t be surprised if we end up – even more so than over the past decade – with markets that are rather stronger than the economy.
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