Tuesday, 14 October 2008

Inflation vs deflation - you decide.

Yesterday, on the 13th October 2008, Gordon Brown nationalised the banking sector. Well, he took large stakes in certain banks such as LloydsTSB, RBS, and HBOS; other banks such as HSBC told him to stick his money where there is limited sunshine - they don't need bailing out.

Today we have new inflation data:-

CPI: 5.2%, up from 4.7% last month
RPI: 5.0%, up from 4.8%

The base rate you will recall is 4.50%.

Although inflation continues to soar up into the sky at the moment there is an irony here; we now have a good chance of deflationary collapse. Those numbers may come down, even go negative, without interest rates being raised. During the 1990s Japan had deflation with base rates at 0.25%. It is possible. However it is not a sign of masterly management of the economy by the government and the Bank of England. No, it's a sign of imminent recession, maybe even depression. Prices are falling because demand is falling because economic activity is stopping.

Economic activity is stalling because for the last ten years it has been driven by debt, and new debt has not been available for a year now. The government's nationalisation of the banks, with firm instructions to get lending again, is their latest, most desperate attempt to stoke up more debt-based spending. For a while it may work, but it should be obvious you cannot borrow forever. Eventually you must repay and the longer you leave it the more it will hurt.

The government now has two paths ahead of it: (1) keep injecting borrowed money into the economy, eventually running out of borrowings and printing money for people to spend, in which case we will have hyperinflation, see posts passim relating to Zimbabwe, or (2) start the painful process of repaying debt and constructing an economy based on wealth-creation, by which I mean, manufacturing, agriculture and genuine added-value such as pharmaceuticals or computer software design.

Which path will they take, I wonder?

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