Fraser Nelson

King’s ransom

King's ransom
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How much bigger does Britain's inflation have to become before Mervyn King realises it’s a problem? The VAT rise should have lifted prices by 2.1 percent – but shopkeepers over Britain have been applying far larger rises. Why? Because one of the most important factors in economics – expectation of inflation – is back. People are bracing themselves for another year of rising heat, transport and staff costs – so retailers hike up prices in anticipation, and a vicious spiral of inflation begins. The Retail Price Index was up 4.8 percent last November, and Consumer Price Index 3.3 percent. The price of this failure of monetary policy is paid by ordinary taxpayers, whose wages stand no chance of keeping up with the rise in prices. This is Mervyn King’s failure, and I look at this in a leading article in this week’s magazine - entitled “King’s Ransom” (subscribers click here, or join our subscribers from £1 per week). I thought CoffeeHousers may be interested in the argument.


1. Osborne has chosen a bad time to jack up VAT.  VAT is, indeed, the least-harmful tax. His ratio – of £1 raised in tax for every £4 borrowed – is rational. But Osborne would never have guessed is that when his VAT rise came, it would be compounding what is – with the exception of Greece – the worst inflation in Western Europe. Have a look at the Nov2010 inflation rates (graph below). So yes, Osborne is right in that conservatives prefer to tax consumption before income. But the price hike has come at a rather sensitive time.


2. Pretty soon, CPI inflation will be about 4 percent, twice Mervyn King’s target. This fits a trend of getting it wrong. The below chart looks at inflation, as measured against the target. It tells a pretty simple story: that the management of inflation in Britain has become a joke.


3. The Bank of England is fanning the flames of inflation with base rates at an absurdly low 0.5 percent. This implies that the British economy needs a fiscal life support machine. In fact, Britain’s economy is projected to grow by a very respectable 2 percent this year: our manufacturing sector reported the sharpest upswing in 16 years. Exports are doing pretty well. There is no justification in such low rates – especially with inflation so high. On the tube last night, I saw HSBC offering to lend me money at 2.3 percent a year. This is less than inflation; a real-terms negative interest rate. So, I’m being paid to borrow. They should plaster this sign at HSBC branches to tell robbers: it’s okay. You don’t need a gun. HSBC is offering people money for free. Precisely the craziness that landed us in the mess the last time.

4. Mervyn King’s excuse is that inflation is a blip. Doubtless, King has various complicated graphs which strip out the bad stuff suggesting that underlying inflation is fine really. He should ignore them, and head to the shops instead. The below graph looks at how various household items have risen in price. These are the metrics that govern the lives of ordinary taxpayers:


Click to enlarge (opens in new window)

5. Mervyn King seems to specialise in seeing no evil. The Governor did not notice that Britain was incubating a debt bubble the first time around, nor does he appear to notice a new one inflating. You’d think that he’d be making speeches galore about the limitations of inflation targeting, given that massive problem identified it in. By obsessing on CPI, he nurtured an asset bubble in Britain – and did so by needlessly fighting a benign deflationary shock. It is staggering just how little analysis there has been. As Johan Norberg argued last week in a powerful cover story, the crisis was caused by record-low mortgage rates, and debt-fuelled spending. To cure the crisis, the Bank of England has prescribed record-low borrowing rates, and debt-fuelled spending. The Bank seems not to have paused to consider that its ‘solutions’ are the same vices which caused the crisis in the first place.

6. At least King had an excuse in the bubble years. Namely, that the MPC was under only one set of orders: to make sure that CPI was 2 percent. These orders are flawed because they confuse general economic stability with consumer price stability. As the bubble years taught us, the two are not the same. But now UK inflation is rampant, what’s his excuse now?

7. If Mervyn King and the Bank of England is trying to inflate its way out of a debt crisis, we should be told. It’s a fairly well-establish tactic (especially in countries that finance government splurges by printing bank notes.) What happens is this: policymakers pretend to fight inflation, so feign surprise each month by how high inflation is. Then, they blame it on a short-term blip. But you soon lose your credibility – and, fatally, this is starting to happen to King. Already, the markets are beginning to price in the cost of inflation to gilts. From the Café Nero owner to the Japanese hedge fund manager, word is getting around: Britain is letting inflation rip.

8. Inflating away debt is politically attractive. It makes cuts all the more easy. Freezing pay means a 3.3 percent pay cut, thanks to inflation (of 4.8 percent if we were using RPI, as we did from the war until the Brown era). Reducing the actual amount of government debt – or staff salaries – is hard. But to debase the value of the currency in which they are paid has always been the easy option.

9. But once unleashed, inflation is very difficult to control. As we know to our cost. Rates have to be rammed up to emergency levels, and the only victors from such struggles against money tend to be people like George Soros. Fiscal problems do not go away if you ignore them – that was the moral of the last crisis. Credibility, once lost, is very hard to retain for a central bank. And, given how much debt the UK government needs to issue, credibility is a very precious commodity.

10. King should either control inflation – or make way for someone who can. Interest rates have to go up – with the Governor snarling at inflation, saying he won’t allow it. I can understand why King is reluctant to take away the debt from a nation of addicts. UK households are still not only the most heavily-indebted in the G7, but the most heavily-indebted any G7 country has ever known. But this is not a good thing. As Johan Norberg observed last week, we got into this mess with record-low interest rate and debt-financed consumption. What’s Mervyn King’s prescription? Record-low interest rates and debt-financed consumption. As Britain’s shoppers know to their cost, it’s not working out that well.