Monday, 20 October 2008

How Labour caused the economic crisis

Four weeks ago I demonstrated how the current financial crisis was a disaster of government's own making. However, most of that was focussed on the American government. In so doing I failed to point out how Gordon Brown (as both Chancellor of the Exchequer and Prime Minister) created the problem.

It is true that the US governmetn deserves much of the blame for forcing banks to lend to un-creditworthy (sub-prime) borrowers and (through the para-statal company Freddie Mac) inventing the practice of securitizing the debt.

But the main source of the problem has been the massive expansion in credit - and indeed money - over the past decade. And while the American government has been as guilty as any of inflationary policies over the past decade, it is Labour that has led UK investors up the garden path with dangerously loose monetary policy.

Having spent ten years allowing Gordon Brown to fan the flames of in an inflationary boom, we are now reaping the whirlwind.

But, I hear you cry, has inflation not been running at around 2%? Isn't that very low>

Well, yes, but only if you look at consumer/retail prices. Sadly for us, economic inflation isn't caused by inflation in the price of consumer goods, which have in fact been falling in real terms since China got its act in gear in the 1990s. Inflation is caused by loose money, which floods through banks, via loans, to be invested in (particularly) capital-industry and land. So the important measure of the inflation isn't CPI or RPI but the money supply.

And how much has the money-supply been inflating over the past decade? The Market Oracle provides this handy chart, which suggests that over the last 5 years the quantity of money swirling around in our economy has doubled.

And where has all that spare cash, utterly un-backed by a corresponding doubling of growth (see GDP figures for 2002 and 2007), gone?

It has been used to bid up the prices of property, shares and capital goods.

However, as demand for them is not actually changed by the new banknotes (electronically) manufactured by the Government, the inevitable "readjustment" is at last taking place as the cost of these goods begins to fall, reflecting their real, non-inflated, value and the cost of consumer goods begins to rise to accomodate the new money in the economy.

As I mentioned a three days ago, further inflation, interest rate cuts and borrowing cannot stop the recession. They can perhaps delay it, and certainly extend it, but in the long run recession is inevitable. We have Labour to thank.


KIt said...

I agree entirely but I just wish someone/anyone in Parliament (or the British media) shared this analysis.

dreamingspire said...

I just wish someone / anyone in Parliament (or the British media) shared this type of analysis of many views of government activity, central and local, which has at the same time become frenetic and fragmented, and thus enormously damaging. We are closer to the USA model of public administration (and law) than to the nearby mature European countries - that mid Atlantic island thing - and the clash between that and Brussels is not being addressed, so we grossly underperform. This morning's story: the National Grid hasn't been updated to handle the output of any more wind farms - this kind of neglect of core infrastructure is typical, in a country whose engineering skills and management ability once benefited not only us but many other nations.

Anonymous said...

Sorry to be thick but what are the axis on this graph? The horizotnal is presumably years but whats the vertical? Millions of pounds?

Tom Papworth said...

A good question. The answer is that it appears to be hundreds of billions.

Broad Money (M4) is now growing at an annualised rate of 15.1%, which (if maintained) means that the amount of money in circulation will double by 2013.

It might rescue the house prices and prevent a few bankruptcies in the short term, but in the long run it means more malinvestment and another bout of consumer-price inflation in the near future.

Maybe Gordon's laying a minefield for the next Government.