Britain has been experiencing stagflation for a number of years and unless we see a radical shift in economic policy the nation is heading for a quadruple-dip recession and a Japanese-style lost decade. This article explores what stagflation is, why Britain is mired in it, and what it will take to get us out of it.
What is stagflation?
Stagflation is a term used to describe an economy in which inflation and unemployment are high and economic growth is low, and it is a term that accurately describes Britain today.
Last Tuesday the Office for National Statistics (ONS) reported that the inflation rate here in the UK (which is underreported) had picked up from 2.6% to 3.2% in October. The increase in the inflation rate (we use the Retail Prices Index (RPI) because it’s a more complete measure of inflation since it includes mortgage interest payments) was attributed to a recent round of energy price rises and a 19% jump in education costs after the government lifted the cap on university fees.
Inflation 2000-2012 – Percentage change over 12 months
Although the inflation rate is still below the record 5.6% it reached in September 2011, this latest rise reverses a downtrend that began last autumn and many analysts are looking for higher inflation going forward.
It is also worth noting that the cost of living, as measured by the government’s inflation benchmark, the Consumer Prices Index (CPI), has risen every month for the past 12 years.
According to the Office for National Statistics (ONS) the unemployment rate in the UK fell from 7.9% to 7.8% in September, putting the number of people out of work at 2.51 million.
Unemployment and claimant count in the UK: 1992-2012
Although the unemployment rate has been trending down in recent months the claimant count, i.e. the number of people claiming Jobseeker’s Allowance, has continued to rise.
For a person to be classed as unemployed they must not only be out of work, but must also be actively looking for work and available to start work within a fortnight. Therefore those that have given up looking for work are no longer counted as unemployed, however they still show up in the claimant count.
Between 1971 and 2012, the unemployment rate in the UK averaged 7.3%, however for most of the 2000’s it remained in the 4.5 to 5.5% range.
In the first half of 2012 almost 1,000 high street chain stores closed leaving a record one in ten shops empty.
Businesses are reluctant to expand and higher until they see signs that the economy is improving, as a result unemployment looks certain to remain high for the foreseeable future.
Low/ no growth
Last month the ONS reported that in the three months from July to September the UK economy grew by 1%, ending the longest double-dip recession since the Second World War.
UK GDP growth – quarter on quarter
Much of the growth that helped GDP jump from a figure of -0.4% in Q2 to 1% in Q3 however, was due to the Olympic Games, and many, including Bank of England governor Mervyn King, have said that growth in the fourth quarter may be negative once again.
Why we have stagflation
Stagflation is very costly and destructive, both in terms of budget deficits and to society as a whole. It is also very difficult to eradicate once it takes hold.
Stagflation has taken hold in Britain because our political leaders believe that a severe economic recession must be avoided at all costs. As a result, in 2007 and 2008 when economic growth slowed sharply and began to contract, rather than allowing the economy and financial markets to rebalance themselves, they began to prop them up by (among other things) artificially lowering interest rates.
These ultra-low interest rates are being created by the Bank of England via its quantitative easing (QE) programme. Since the beginning of 2009 the Bank of England has bought up 50% of the £724 billion in new debt that the UK has issued. This artificial demand for UK government debt (Gilts) – purchased using freshly printed money – has caused their price to rocket and the yield to fall.
The problem is, the UK economy cannot begin to grow in a sustainable fashion until the malinvestment that built up in the pre-2007 credit bubble has been cleansed. One reason that the US economy is experiencing far higher growth rates than those of the UK is because the US has been better at liquidating bad investment and allowing house prices to fall.
It is ultra-low interest rates thanks to quantitative easing that are preventing the bad debts from being written off. According to R3, a leading organisation in the field of insolvency and debt restructuring, the number of companies only able to pay the interest on their debts but not reduce the debt itself has risen by 10% in the past four months, to 160,000.
As Michael Stothard and Chris Giles noted in yesterday’s Financial Times, “One in 10 British businesses are so-called “zombies” being kept alive due to ultra-loose monetary policy and the reluctance of lenders to write-off bad loans, according to new data. The figures highlight concern that such companies are partly responsible for the UK’s sluggish economic recovery.”
Lee Manning, president of R3, commented that this, “is symptomatic of a stagnant economy, with a combination of low interest rates, low liquidation rates and many businesses running at a loss.”
Ultra-low interest rates prevent insolvency in the short-term but ultimately they cost the economy dearly in the long run.
“Zombie companies cannot invest or innovate, they just sit there slowly losing employees and customers and dragging on the economy,” said Mubashir Mukadam, the European head of KKR Asset Management’s restructuring arm.
Given that they are responsible for creating them, it seems more than a little incongruous, that last week the Bank of England warned us that these “zombie” companies were contributing to our weak economy.
Ultra-low interest rates (the lowest since records began in 1694) are also destroying domestic savings and therefore capital investment. As Marc Faber pointed out at last week’s LBMA Precious Metals Conference, “You don’t become rich by consuming. You need capital formation”.
Interest rates above the rate of inflation help preserve existing capital and promote saving, however the negative real interest rates we have today are destroying capital and forcing people to speculate, something which creates bubbles in the financial markets and ultimately destroys even more wealth.
The bottom line
What policymakers perceive as the cure, i.e. unprecedented monetary policy and ultra-low interest rates, will undoubtedly prove worse than the disease, i.e. a harsh recession which will serve to cleanse and reset the economy and financial markets.
The problem is, here in Britain, as with other G20 nations, there is zero tolerance for pain. However the adjustment process is unavoidable.
In order to begin a new cycle of true sustainable prosperity we have to embrace, or at least accept, the pain associated with an economic rebalancing. We could have gotten the pain over with in one big hit (we still could), but it is clear that our political leaders would rather drag it out for many years.
It therefore seems inevitable that we are heading for a quadruple-dip recession and a Japanese-style lost decade (or two).
The sad thing is, unless we stop trying to solve a debt crisis with more debt, when this period of stagflation comes to an end, we will experience a painful deflationary recession anyway.