It’s great to be an economist…
The prize for the most cheerful headline of the week, goes to the Daily Telegraph for its most read finance article: “Euro ‘will be dead in five years’”. This was the most striking conclusion of a survey carried out by the paper of 25 London based economists covering a variety of topics.
Of the 25 economists who took part in the survey, 12 predicted that the euro would not survive in its current form over this Parliamentary term, compared with eight who thought it would. Five said that they didn’t know.
I’m not sure if brain surgeons were allowed to be as diverging in their views that things would pan out as well for those going under the knife. Such are the luxuries of the world of the economist – it tends not to be remembered whether you were right or wrong, but more how confidently you state your claim. It’s lucky for them that there’s nothing important at stake – it’s only money.
Anyway – the potential ‘death of the Euro’ is only one of a number of interesting conclusions from this survey, including some thoughts about the prospects for inflation or deflation in the UK, where again there is plenty of variety in the views expressed. On balance the economists see inflation as the more likely danger, as the government looks to erode the value of huge debt pile it owes. I would tend to agree.
This topic, although it sounds pretty dull – whether prices will go up or down and by how much – really is at the epicentre of all that is going to guide the world’s economic success or failure over the coming years.
The report card for the global policy response to this economic crisis is broadly a case of so far so good. Policymakers have had the ability to pump liquidity into the financial system to stimulate economic activity without causing significant inflation, and to do it in sufficient size that the risk of deflation has been minimised.
The task of maintaining this so-called Goldilocks situation is getting trickier and trickier, however, and the proverbial can hit the fan very quickly if policy-makers start to make a mess of it.
Divergence of opinion between economists on this issue is genuinely understandable. After the mini-inflation scare following the ECB’s bailout plans for Europe, we seem to be having a deflation scare. Prices may be sneakily rising in the UK, but Spain is now in outright deflation (exclude energy and food, and prices are falling) and core inflation across Europe and the US is very low. In Ireland prices have recorded falls for 17 consecutive months.
The fact is that the substantial money-printing across the world has not yet brought us proper inflation simply because the mechanism for passing it on isn’t working very well: the world’s banks are too busy repairing their balance sheets to lend it out. European banks own so much of the sovereign debts of other struggling European countries, some on the brink of default, that the prospect of maintaining or increasing lending rates has to be a difficult one to contemplate. The increasing Libor rate – the rate at which banks lend to each other – is testament to these concerns.
But there is nothing like deflation to bring on hyperinflation: governments desperate to prop up prices and economies, despite being broke, print reams of money – money that eventually enters the market in a rush, flipping deflation to inflation almost instantaneously.
The Weimar government in Germany in the early 1930s is a good example – the huge reparation payments demanded by foreign governments after German defeat in the First World War led to deflation for a period of time as economic demand dried up domestically. This rapidly flipped to hyperinflation as printing money became the best way to ‘afford’ reparation payments, in the absence of sufficient tax receipts from a struggling domestic base. The government soon collapsed and paved the way for the far right views of the Nazi party to be broadly supported, and we all know that particular episode of history didn’t end too well.
While the economists in the Telegraph survey are on balance in the inflationary rather than deflationary camp, there is still a significant minority who don’t follow this view. With prices already edging down, substantial excess capacity in the system, and the Eurozone about to withdraw large amounts of demand from the world economic system as lean times bite, it is reasonable to worry that a Japanese-style deflation is in the the Western world’s future.
If this is the case, it is hard to reverse: knowing that prices are declining, consumers defer purchases, which causes prices to fall further, which in turn causes consumers to keep their wallets and purses zipped. This death spiral resulted in Japan’s so-called ‘lost decade’.
On the flip side; with many governments running huge deficits, while simultaneously printing money, we may have an inflationary spiral, with the value of the dollar declining, savers devastated, and interest rates soaring as investors demand higher and higher rates for their money, knowing they will be repaid in dollars with reduced purchasing power. In that context the flight to gold seems to be a pretty sound strategy as it’s widely accepted as a hedge against inflation.
Or, if you prefer your inflation to be of the imported variety, the tale of woe is along these lines: The declining euro, headed towards parity with the dollar, will limit US exporting capacity. The US will ‘import’ a financial crisis, as its banks take big losses on sovereign debt and on loans to Greek and other enterprises. Already, banks are hoarding money, and companies have decided to rein in borrowing, given the uncertainties in credit markets.
There are sound arguments for the occurrence of either inflation or deflation. My bet is on a period where we teeter on the brink of deflation as excess capacity builds up across the global economic system. Policy-makers will continue to do all they can to ensure that deflation doesn’t become widespread; quantitative easing, low interest rates etc., and we will run the gauntlet of a sudden flip into hyperinflation. Over a reasonable time period (5-10 years) I think managing to avoid significant inflation is very unlikely.
Like most economists, I am almost sure that this will be the case. That is to say that I am 20% certain.