This is the promised/threatened third in my trilogy of posts on the economy, this time on inflation. It strikes me that no-one less than half way through their career will have experienced significant inflation, while those of us who lived, worked and had a mortgage through the 1970s remember all too well what an economy in its grip feels like.
For myself and Mrs H it wasn't all bad, indeed rather the opposite. We bought our first house in 1975 with a mortgage at an interest rate of 11%. There were 18 changes of interest rates over the next 18 months when the rate peaked at 15%*. This could have been very tough as I had fibbed just a little on my earnings to secure the necessary loan, saying that the overtime shown on my payslips was guaranteed, which it wasn't. We also started off with no washing machine, three handed down armchairs and a home made coffee table. We had a dining suite donated to us by Mrs H's grandmother but nowhere to put it as the carpet in the living/dining room stank of cat pee and had to be thrown out. We couldn't afford to replace it for many months. We had a rented TV but the house never did have central heating while we lived there. I know, I know boxes on us feet, violins etc.
But this was an era of a wage-price spiral and we were on the right side of it. It was a time of government price and wage controls, introduced by Heath's Tories, which Labour changed to voluntary restraint in its "social compact" with the unions after the elections in 1974. I recall getting a satisfactory pay rise at my first ever annual pay review in April 1974 (I still have the letter - it was 11%). We were all pleasantly surprised when, in October, pay letters were issued out of the blue and I got a further 20%! The company had acted because it was concerned that formal pay restraint might be brought back in and that it could be trapped with uncompetitive wages (one of the reasons pay controls don't work). Things went on in much the same way: in the 12 months after we took out the mortgage my pay went up by 50%. Mrs H did even better - hers doubled, by the simple tactic of getting her annual pay rise and then moving job for a further rise to a company that had still to make its annual adjustment. In three years as well as my annual increase I had a further three pay rises thrown at me. I was of course in the early stages of my career so this included some significant progression as well as annual rises but looking back those percentages look extraordinary.
When we took out a bigger mortgage to move house in 1980 I recall saying to Mrs H that the recently elected Mrs Thatcher had said she was going to kill inflation and noting "that might not actually be good for us right now, we need this mortgage whittled down by pay rises. But it won't happen". (It did, but not quickly, fortunately for us. And then they caused it to surge back. It wasn't really fully under control in the UK until the 1990s. See Was the Tory reputation for competency a myth? from 30 October).
So this all seemed hunky dory to us but it wouldn't have been so great for many others. And so, in different circumstances, with retirement looming and with it the end of annual pay reviews I've been concerned about the risk of high inflation returning since the 2008 financial crisis. I instinctively thought that the mysterious smoke and mirrors of quantitative easing might actually equate to old fashioned printing of money. Oh, I understood the theory alright - that the central banks were acquiring assets which could later be sold, so there was a sorely needed injection of liquidity without a one way irreversible injection of cash. But would it actually work that way? It did and inflation remained low, with interest rates held down at historically low levels for so long that people under about 40 had never known any other financial environment.
I eventually concluded that everything was probably going to be ok, though also that I would be happier once the QE process was reversed and the assets sold back into the market, a process known as quantitative tightening (QT). And also with some residual nerves that a large debt hangover from the enormous budget deficits we had run always tends to supress growth.
But then we had a global pandemic, resulting in even larger deficits and higher debt and deferring the start of QT. I suspected that the re-opening of the world economy after the massive perturbation of covid and its lockdowns would stimulate inflation. It seemed inevitable that there would be huge disruption to supplies while demand could jump quickly back to previous levels. Or even higher as companies tried to rebuild stocks. We also had the effect of what in the USA became known as the "great resignation" as lots of people decided they quite liked a different work-life balance or that they could get by quite happily without going back to their old, inconvenient or uncomfortable job and would rather do something more congenial, even if it paid a bit less, but allowed them to spend more time with their families or just doing more of what they wanted. Millions disappeared from the workforce in the USA, UK and Europe. Supply chains were disrupted in many ways and for many reasons.
When demand switched back on, the price of shipping went through the roof and shortages put a traditional upward pressure on prices in line with the only other immutable law besides the second law of thermodynamics (i.e. the law of supply and demand) it seemed inevitable to me that inflation would return.
So I snorted when the US Federal Reserve pronounced that inflation would be "transitory". I could see the argument that things would gradually return to normal: the savings many of the more fortunate had built up would be finite, stocks would be rebuilt and demand would return to more normal levels. But I was concerned that a wage-price spiral might take hold, especially when I read that some unions in the USA were only accepting wage settlements if they included COLA provisions: automatic cost of living adjustment contingent on the level of inflation. This is a step on a behavioural slope which says things like "buy now, it will only be more expensive next month".
This of course leads to demands from relatively well paid folk like train drivers for inflation linked pay rises which, when you think about it, amounts to letting the devil take the hindmost. The rail sector is state subsidised so their larger pay rise reduces the amount of money available for other things like protecting benefits**. When times are tough there may be falling living standards for a while and surely the better paid should not be protected in those circumstances. I include the about to strike nurses in that too (their pay is above average for the UK).
Moreover, since the Fed made it's eventually retracted prediction about the inflation surge being transitory, Putin's invasion of Ukraine caused a dramatic increase in what were already high energy prices post-covid as well as intefering with supply chains for fertilisers and staple foods. And President Biden has chosen, as Irwin Stelzer put it, to pour petrol on the fire by launching multi-trillion dollar spending programmes on an economy unable to meet the current levels of demand, while the Fed directs a water hose at the market.
I paint a bleak picture but I accept I may be being pessimistic as inflation does appear to be levelling off or falling in the USA and that may be a harbinger for western economies in general. Irwin Stelzer noted a month ago that trans-Pacific cargo rates were down 75% from last year, for example.
But I remain uneasy that the Truss-Kwarteng special financial operation deferred the start of the Bank's quantitative tightening. It has since started but at a tiny level, only 99.9% still to go. The days of Trussonomics were brief but it did introduce us to the odd situation of the Treasury trying to pump up growth by fiscal loosening while the Bank tried to damp down the econmomy by monetary tightening. While this seemed strange it's an artefact of having an independent central bank and wouldn't seem unusual to the Americans for whom the opposite policy directions being taken by their administration and central bank noted above are not unprecedented.
And the cynic in me doubts the resolve of western democratic governments to take the unpopular decisions necessary to quell inflation quickly. Ian Cowie opined recently that the massive debts run up by governments around the world to prevent the coronavirus prompting a global depression can never be repaid because electorates will not vote for the necessary spending cuts or tax hikes, but inflation offers a stealthy way to reduce the real value of the debts in what amounts to a slow motion bank robbery, where the victims are risk-averse savers. A bit like my mortgage getting whittled away by inflation in the 1970s.
Stelzer is more optimistic; he thinks the good news trumps the bad. He says every ill affecting the USA is man-made, created by a policy error. America contains all the oil it needs if it would allow it to be drilled for. It can reduce its deficits if its politicians decided to do so. It has a large entrepreneurial class capable of producing the answer to global warming, is a magnet for the world's best and has a military that would make enemies tremble "if they thought we knew how to use it". All that needs to be done is to do as Nike advises - "just do it".
I wish I was as confident that Sunak and Hunt could be free in a single bound. It looks a bit trickier than that to me. I expect they will try to balance the political unpopularity of tax rises and spending cuts with the need to restore the public finances and go only as hard as they dare. I can but hope - probably in vain - they will make clear that everyone who is in the better off half of the population (like train drivers, doctors, nurses and teachers for a start) will have to feel a bit of a pinch. As they won't be that brave, inflation will reduce but maybe only gradually, running the risk that it gets entrenched. But hopefully not like it was in the 1970s.
Back then, of course, we also had energy crises. If energy prices stay at current levels inflation will fall back but there will still be a lot less money for everything else because we'll all still be paying a lot more to heat our homes. The rate of inflation isn't the only thing that matters, actual cost levels do also.
Fair warning: I've been meaning to write about energy for quite a while...
* No, I don't remember this in detail of course, though I do remember that our first mortgage had a double digit interest rate. The rates recommended by the Building Societies Association from 1939 to 2013 are available from the BSA (https://www.bsa.org.uk/BSA/files/5c/5c180498-5e52-4a41-b022-5821c25f3cbd.pdf)
** I realise the rail dispute is also about "protecting jobs". But rail travel is down, why should all rail jobs necessarily be protected?
Irwin Stelzer's weekly American Account column appears in the Sunday Times.
Ian Cowie's Personal Account column on investing appears in the Sunday Times Money section.
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