Why the current economic crisis is far more serious than 1970s stagflation

July 12, 2022 1 Comment

The risk of economic collapse is growing by the day. High rates of inflation – in some countries already approaching hyperinflation – are quickly destroying savings, pension pots, and the purchasing power of wages.

My recent report, Hyperinflation Survival Strategies, describes various ways people can try to protect themselves from soaring prices. But many people, in the West at least, are complacent. They think a major inflationary crisis could never happen here. This article therefore sets out some of the reasons why inflation could explode.

Once the rate of price increases hits a certain threshold, there may be little governments can do to stop them rising further. The problem is loss of confidence in the currency. If pounds, dollars or euros buy less and less, then what is the point of holding on to them?

Faced with the rapid erosion of their savings, people are likely to respond by hoarding goods. Durable items will tend to retain their value far better than cash in the bank. But this “flight to real goods” increases demand, creates shortages – perhaps even panic buying – and tends to push up many prices even further.

To make matters worse, high inflation in itself tends to have a negative effect on supplies. It makes it more difficult for businesses to plan ahead. It disrupts trade and investment.

While panic buying and price hikes send a signal to increase production, this often takes months or years to come to fruition. It may require the creation of additional capacity – recruiting and training new workers, purchasing machinery etc. Entrepreneurs will also understand that the spike in demand is likely to be temporary, and could relatively soon be followed by a slump. So, investing in new capacity could be a big mistake.

A key question is under what conditions or at what point panic buying, or a perhaps more orderly “flight to real goods,” will occur.

In 1970s, for example, the official inflation rate peaked at around 25% in the UK. For much of the decade it was in double figures. Bad as things were, the economy did not spiral towards even higher rates or hyperinflation.

Yet there are a series of disturbing differences between the current situation and the 1970s, suggesting the risks of inflation taking off could now be far greater:

  • Interest rates on savings were typically much higher in the 70s than they are today, albeit still negative in real terms for much of the decade – and negative by a large margin during the short-lived inflationary spike in 1975. By contrast, interest rates across most of the West have been close to zero since the financial crisis that began in 2006. If a big gap persists between the inflation rate and interest rates, then this massively increases the incentives for savers to implement a “flight to real goods” strategy.
  • Underlying growth appears to be far lower than during the 1970s, at least in the major Western economies. In many countries, real GDP per capita in 2022 is little different to the levels of the early 2000s. By contrast, despite the fluctuations, growth was robust during the 1970s, averaging roughly 2.5% per annum in the UK, for example.
  • Government debt is now much higher. It has now reached the equivalent of c.100% of GDP in the UK (and 125% in the US), compared with around 50% back then. Worse still, off-balance-sheet liabilities such as public-sector pensions have ballooned, while sluggish growth negatively affects tax revenues, increasing the temptation to resort to money-printing to fund state spending.
  • The demographic situation is far less favourable today. An ageing population puts upward pressure on public spending – for pensions, social care, health, and so on – while also tending to reduce the number of net contributors to the tax system. The average age of active voters has also increased, making it politically difficult to cut expenditure on the elderly.
  • Society has changed in other ways since the 1970s, and arguably in a negative direction in some respects. There are big social divisions and a high degree of polarisation. Unlike older generations, much of the population has never experienced real hardship. The welfare state has encouraged short-termism and dependency on the government, so most households are likely to be ill prepared for a serious economic crisis in which preparedness, self-help and resilience are likely to be major advantages.
  • A high proportion of the population is now heavily reliant on government handouts, or works for the government or companies that depend on government contracts or favours. By contrast, those with significant cash savings are a minority. Moreover, if economic problems lead to social unrest, this is likely to be concentrated in groups with few savings and heavy dependence on the welfare state. This means there would be strong political incentives for governments to steal from savers via inflation rather than cutting spending.
  • The West’s geopolitical dominance in the 1970s enabled governments to rig markets to favour Western big business and exploit natural resource rents from the bloc’s neo-colonies. The petrodollar system is one example of how this worked in practice. But Western geopolitical power is now declining rapidly, lagging but following a diminishing relative economic weight. At a certain tipping point, the leaders of the neo-colonies are likely to seek either genuine independence or form new protection rackets with rising powers. This process is likely to speed up the West’s relative decline and intensify its economic problems.
  • Alongside waning hard power, Western elites are also losing control of the narratives fed to their populations by the media. Yes, censorship has been ramped up, but the rise of the internet means that a significant share of the population now sees through the propaganda and disinformation spread by establishment media organisations. In turn, it’s likely that more people are awake to the real causes of soaring inflation and will more easily learn how to prepare for the consequences, spreading this knowledge to their colleagues, friends and family. This was unlikely to be the case in the 1970s, when deep state-controlled media held almost complete control over the economic discourse.  
  • Finally, there are elements within the Western elite who would like to bring about a “monetary reset.” There are several aspects to the plans, which include imposing a cashless society in which every transaction is monitored, and the introduction of programmable central bank digital currencies (which potentially could only be spent on state-approved goods and services). The abolition of national currencies is another key element of this agenda, with the euro acting as a testbed for and stepping stone towards a “one world currency” that would be used across the West, its vassals, and perhaps beyond. But achieving this goal would require overcoming public opposition to a major assault on national sovereignty. A severe economic collapse could be used to manufacture consent for monetary reform, with the new system promoted as the only solution. Globalist factions within the transnational elite might therefore welcome or even encourage a hyperinflationary crisis as a means to this end.

The preceding analysis does not of course mean that very high or even hyperinflation is inevitable. A sensible approach is to view the risks as significant enough to make some basic preparations worthwhile.

Perhaps our “independent” central banks will take the difficult steps needed to get inflation rates down – even if the resulting slowdown creates widespread unrest and severe problems for the political elite, together with big losses for their cronies in the financial sector. Maybe our politicians will turn over a new leaf and implement a radical programme of deregulation and tax simplification to encourage wealth creation and growth. Perhaps they will also defy the special interests and welfare recipients by cutting spending, reducing off-balance-sheet liabilities, and getting government debt back down to sustainable levels. But how much of this is plausible given the short-term incentives facing our leaders, their tenuous grasp of economics, and their appalling track record?

Richard Wellings

Image: Shutterstock

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Euro crisis no surprise to economists

February 23, 2013

They were warned. In the late 1990s, eminent economists queued up to explain the flaws in the euro project. Chief among them was Nobel Prize winner Milton Friedman, who in 1999 – the year the euro was born – predicted that “sooner or later, when the global economy hits a real bump, Europe’s internal contradictions will tear it apart”.

But the fatal conceit of EU policymakers triumphed. The euro was a key plank of their long-term programme to centralise power at supranational level. Given this agenda, it is unsurprising that the EU’s response to the current crisis has been to further emasculate member states. Following the bailouts, the fiscal policies of Greece and Ireland are severely constrained. In the longer term, a similar approach may be rolled out across the Union.

The Stability and Growth Pact was supposed to prevent governments getting into too much debt. Budget deficits were to be under 3 per cent of GDP, while national debts were supposed to be under 60 per cent of GDP. But the pact proved impossible to enforce. Several countries – including Germany – broke the agreement, with no sanctions. Others only satisfied the criteria through creative accounting.

Stricter EU controls on government borrowing – for example a new Stability and Growth Pact with real teeth – clearly have the potential to reduce the economic problems associated with government debt. But policymakers are deluding themselves if they think this approach will solve the fundamental problems of the eurozone.

Applying a one-size-fits-all monetary policy to a huge geographical area with different cultures of saving and debt, different banking systems and different economic conditions, will inevitably blow up inflationary bubbles where interest rates are inappropriately low. The effect is exacerbated by the implicit bailout guarantee given by eurozone membership, which reduces the risk premium demanded by lenders.

In Ireland and southern Europe, a fake boom based on credit rather than productivity growth led to a huge misallocation of resources – particularly into property markets. Wages rose rapidly, especially in the construction sector.

Once the supply of credit dried up, this house of cards collapsed. And the countries that experienced inflationary booms now face a very painful adjustment process. Bad investments must be liquidated and wage rates will have to fall by around 25 per cent to become competitive with the core nations of the eurozone. This is horrendous. It suggests countries such as Greece and Portugal face a fall in living standards comparable to that suffered in the United States during the Great Depression.

Worse still, high levels of employment regulation in southern Europe are a huge obstacle to the necessary correction in wage rates. The likely result is mass unemployment. Southern Europe is also cursed with traditions of social unrest and hostility to economic liberalism. Moreover, rapidly ageing populations will put extra pressure on public finances, while environmental policies threaten to undermine vitally important tourist industries by dramatically increasing the cost of air travel.

Yet recovery is still possible and the EU could do a great deal to help southern European countries bounce back. In particular, it could undertake a systematic programme of deregulation, rescinding directive after directive to lower dramatically the costs of doing business. The EU can also encourage member states themselves to reform, for example by liberalising labour markets. But so far the response to the economic crisis has involved more regulation, not less. For example, many more restrictions have been placed on financial markets, which are crucial to the investment that drives recovery.

The absence of a deregulation agenda raises the question of whether the eurozone should be broken up, with some countries re-adopting national currencies – though perhaps still allowing the euro to be used as legal tender. The new currencies could fall in value, allowing wage rates to fall without overt cuts in pay. However, the devaluation option – which happened repeatedly in many countries before the euro – arguably encourages reckless tax and spend policies.

A break-up could also lead to mass defaults on euro-denominated government debt in those countries that left the zone. Much of this debt is held by banks across Europe. Default could trigger their collapse and demands for yet more bailouts. Break-up of the euro would also be deeply humiliating for politicians and bureaucrats who have staked so much on the project and a European centralisation agenda that appears to have no reverse gear.

There are large political incentives to maintain the status quo. Struggling countries will continue to be propped up by subsidies and the fundamental flaws in the euro will remain. The EU may increasingly become a transfer union which redistributes resources from more successful countries to failing ones. Necessary adjustments will be delayed and eventually the economies of the stronger nations may be undermined.

For the last twenty years, Western Europe has suffered from slow growth and rapid relative decline. The euro crisis threatens to speed up the region’s descent into economic irrelevance.

23 March 2011, PSE

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Are large benefit increases wise in a recession?

February 17, 2013

Benefit rates are set to rise substantially next month. State pensions will rise by 5%, while means-tested payments, such as Jobseeker’s Allowance, will rise by 6.3%. The new rates, based on the Retail Prices Index (RPI), were determined in September 2008, when inflation peaked, but now represent significant increases in real terms.

Higher welfare spending will push the public finances even further into the red. The prospect of yet more government borrowing and tax rises in the future could undermine economic confidence and deter investment in the UK.

Moreover, at a time when many workers are being made redundant and others are facing pay cuts, higher out-of-work benefits will reduce the financial incentives for jobless people to take employment, particularly since in many cases they will also be entitled to Housing Benefit, which pays their rent. Combined with the minimum wage and restrictive employment regulation, this is likely to make the surge in unemployment even worse and condemn many more people to a life of welfare dependency.

It could be said that “rules are rules” and it is just an unfortunate coincidence that benefit levels were set in a “freak” month for RPI. However, imagine inflation had fallen to -5% last September before rising to become positive again in April 2009. Is it credible that the government would have imposed benefit cuts?

12 March 2009, IEA Blog

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