The inflation surge is now upon us. The CPI rate again “surprised” to the upside – Britain is the only major economy in the world to have inflation doing this. But given that the Bank of England’s printing presses have been working overtime to fund a fiscally irresponsible government then little wonder things are different here. To understand just how unusual the UK situation is, consider the below graph: despite suffering the longest recession in G20, we have one of highest rates of inflation in the developed world.
The next few months will see this push higher, potentially reaching 4 percent in March and busting the 2 percent target. Without the temporary VAT cut, inflation would never have dropped below the 2 percent target rate the Bank of England is mandated to follow – so, in a way, the VAT cut helped Brown justify turning on the Bank of England’s printing presses. It helped provide cover for the “independent” Monetary Policy Committee to fund the government deficit through money printing, but now the inflationary price needs to be paid. The pound fell sharply through the latter part of last year as the scale of the UK’s fiscal and banking problems became clear, and the intention of the Government to use the printing press to fund spending became apparent. With the manufacturing sector halving in size since 1997 (and they blame Thatcher for hitting manufacturing!), the UK now imports most of its consumption.
Why does all this matter? Well, sterling has fallen by about a third versus the Euro since the beginning of the banking crisis in July 2007 (see below). As our currency falls, the costs of imports rise – passed on to consumers. If we are to maintain inflation stability (as per Brown’s target) domestic prices have to decline – so net result is wages stagnate or fall, while the cost of living rises. This causes living standards to decline. And this spells misery.
So, memo to Brown: this is why most properly-run countries chose to sort out government debt problems rather than revert to the oldest tool in the central bank toolkit – debasing the currency to cover government debt problems. A nightmare scenario looms for Britain.
All told, David Cameron’s comments in his conference speech that printing money was the wrong solution to the UK’s debt problems and risked inflation are looking increasingly prescient. While the usual suspects lined up to deride his economic ignorance, the facts increasingly bear out the disaster that the Labour’s print and spend policies are about to unleash.