An eerie echo of the past

Earlier on I set out how 80 years ago an Austrian economist predicted the ineffectiveness of current efforts to intervene to improve economic conditions.

I have since been directed to an interview with another Austrian economist (this one also a British citizen) that - aside from the poor quality and the stilted voices - could have been recorded yesterday.

In it, Nobel laureate Prof. Friedrich von Hayek explains that inflation is always the result of government action, is the great evil against which we need to battle, and that efforts to intervene to prevent recessions that follow from periods of government-led inflation are doomed to failure.
The part of the inteview from 14.00 minutes to 16.50 minutes is particuarly chilling!

The following is a summary of what he says (I have slightly augmented it with my own understanding of his take on economics, though where possible I have enclosed these additions in square brackets):

1. Germany out-performed the UK in the three decades after WWII because the German trades unionists remembered that inflation is the enemy of the working man;
2. If people do not recognise the danger of inflation they will continue to believe that it can be used as a short-term solution to economic problems, as a result of which inflation will continue to wreak havoc upon the economy;
3. Unemployment results from inflation, which encourages the misdirection of labour [because easy money is made available to enterprises that would not, under normal conditions, be viable, allowing them to offer higher wages than would be possible if the easy money had not been thrown into the system by Government], so it is wrong to suggest that in the long term one needs to tolerate unemployment to curb inflation;
4. Curbing inflation will cause short-term unemployment, but this need only last a year or so [before the market re-asserts itself and labour is employed once again];
5. As Jeffrey Tucker notes, the “hilariously naive and idiotic” line of questioning demonstrates how “people really believe that policy makers can manipulate the economy like a machine, trading off unemployment for inflation and back again, with no trouble”
6. Non-compulsory planning will have no effect and so can do no harm [or, indeed, any good];
7. “Stopping the printing presses” is a euphemism as the real cause of inflation is credit expansion rather than the actual printing of hard money;
8. “All inflation is ultimately the problem of activities which government determines and can control. And all inflations have been stopped in the past by the governments stopping creating money or preventing the central bank from creating more money” [thus putting the lie to the government’s suggestion that inflation is caused by outside factors such as rises in the cost of commodities];
9. A tax cut will not work to stimulate the economy because deficiency of aggregate demand is not the problem. Rather, the problem is that the boom and employment that has been created by the previous inflation can only be sustained by further inflation [which, if perpetuated, would lead to hyper-inflation and ultimately a crisis];
10. If government continues to inflate to sustain the boom it may have to try to ameliorate the effects by imposing price controls which will lead to the imposition of a planned economy [i.e. socialism];
11. Political freedom exists hand-in-hand with economic freedom and the former cannot exist without the latter;
12. The power of labour unions and corporations does not lead to inflation unless that power is used to encourage inflationary policies;
13. Wages/Prices/Incomes policy is utterly ineffective except as a means of managing in the very short term the period of deflation/restoration;Not all problems are solvable in the short-term and trying to do so may cause more harm than good;
14. Equities remain a good investment in the long term;
15. “Inflation is like over-eating and indigestion. Over-eating is very pleasant; so is inflation. Indigestion comes only afterwards and so people do not see the connection”;
16. Economists are intellectually attracted to the concept of a system that they can control and therefore are instinctively opposed to free markets and non-intervention;
17. Continued government-induced inflation and subsequent intervention by government will inevitably destroy capitalism [as Karl Marx predicted and hoped for].

Hat tip to Kit for drawing it to my attention, and to mises.org for hosting it.

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.

Inflation hits where it hurts

Having just been to Earl’s Court to worship at the temple of hedonistic binge drinking, I am horrified to discover that inflation is really beginning to hit where it hurts.

According to CAMRA (one of the few special interest groups with which I have some sympathy), by the time the Olympics arrive a pint of beer will cost £5. By beer they mean the usually-cheaper foamy stuff such as bitter and ale, of course; the story will be worse for larger.

Indeed, “By the end of this year the cost of a pint will have risen by an inflation-busting 25 pence”, and in London they have found beer for sale at £3.70 a pint.

(Amateurs! I was in the Bunch of Grapes in Borough a couple of weeks ago and was charged £3.95!).

Of course the price has already been way above that in clubs, bars and swanky outlets, but in the traditional (and not so traditional) British pup one had hoped that reality would not bite. But with the cost of fuel, agricultural produce and potentially labour on the rise, it won’t be long before we reach the next horrendous milestone.

You must be NUTs

Before I discuss the latest example of union brass neck, I need to declare an interest.

Occasionally I dine at the expense of the National Union of Teachers (NUT). They kindly and generously like to lay on a fish and chip supper with complementary wine at the close of the Liberal Democrat Party Conferences (I think they do both), and I have been known to avail myself of their hospitality.

The cynical among you my wonder whether the NUT hopes to curry favour with the Lib Dems through this act of largesse (If only they were trying to curry favour!). Shame on you for thinking so. I’m sure it has never crossed the mind of the NUT to try to gain access to our hearts via our stomachs.

And to prove that there is no link between free food and drink and political favour, I am going to now point out how disgraceful and irresponsible the NUT’s latest pay claim is.

Now lets be honest. Few of us would not like to enjoy a 10 per cent pay rise, with a minimum raise of £3,000 a year. I know I could put it to use. But if we were all to enjoy a 10 per cent pay rise then the 2.8 per cent CPI and 4.5 per cent RPI inflation that Steve Sinnott is using as justification for his demand would soon rise sharply.

Not that the NUT has any interest in the rest of us. It is only interested in its members, which is understandable. However, the fact remains that a 10 per cent pay rise with a minimum rise of £3,000 per annum is greedy and selfish. 10 per cent is way beyond that enjoyed by the rest of the country, and as it would be funded from general taxation, it would further reduce the net gain of those whose pay rises were far more modest.

It would also punch a hole right through the government’s (long overdue) public sector pay restraint. Where teachers lead, doctors and nurses would follow, and soon hundreds of thousands if not millions of public sector workers would be agitating for higher wages. This would necessitate higher taxes – as previous public sector binges have done, pushing the tax burden and the size of the public sector up to record levels – and stoke higher inflation, which is already beginning to escape the iron grip of the Iron Chancellor and push interest rates up to uncomfortable levels.

Again, the NUT are not interested in the rest of the public sector (at least, not that they would admit, though I suspect that all the public sector unions agree that public sector employees as a whole should be paid a lot more). They simply want “pay levels for teachers that are competitive with comparable employment.” But what, exactly, is comparable employment?

As the son of two teachers (another interest I’d best declare) I have spent a lot of time around teachers, and have heard them compare themselves countless times to the other great “professions”: lawyers and doctors. This is largely based on the rather facile fact that educational professionals require a university degree, though these days the same could be said of work in a call centre. While there are undoubtedly many dedicated and well qualified teachers out there (my chemistry teacher had a PhD and my parents used to do marking throughout their evenings and weekends), the fact remains that teaching does not require the qualifications or the training that is required of a lawyer or a surgeon. Nor do they put themselves in harms way (at least, willingly!) as do police officers or fire fighters. Nor again do they need to demonstrate the research acumen of the only profession that really is comparable – that of university lecturers.

Mr. Sinnott is correct about one thing, however: “This is an illustration of the failure of successive governments to recognise the importance of the teaching profession to society. It must stop.” The solutions are straightforward.

Firstly, put an end to national pay bargaining. There is absolutely no logic in paying a teacher in Grimsby the same as a teacher in Gravesend. Salaries should reflect supply and demand, and the sum needed to tempt a teacher to work in any particular school is largely dependent on the local cost of living. National pay bargaining simply transfers money from teachers in areas with high costs of living – who struggle to afford houses and other necessitates – to those in poorer areas for whom the national salary goes a lot further. It is no wonder that it is hard for teachers in the South East. The Government lacks the spine for this, however, and would rather respond to the failure of their meddling with further meddling.

Secondly, if there really is a shortage of good teachers, as the NUT would have us believe, then pay should be based upon an honest assessment of the number and quality of teachers required. If this necessitates higher salaries, so be it. But higher salaries should be based upon an assessment of what is needed to get more and better teachers into the profession, not the self-serving demands of those who represent people who are already doing the job.

Thirdly, break up the public sector education monopoly. The only reason why the NUT has so much power is that its members almost exclusively work for a single employer. If tens of thousands of independent schools were negotiating with their discrete workforces, wages would reflect local need. There would be no government cap on pay rises; nor would the NUT be able to demand a set rise for all. What is more, as schools competed for the most talented educators (and other staff), really inspirational teachers – and we’ve all known some – would be properly rewarded. Meanwhile, the ineffective teachers – and I’m sure we can all think of some of them, too – will be encouraged to move to new careers where their talents would be put to better use. Good teachers would benefit, and so too would some of the bad, but most of all, the children would benefit.

It may very well be true that education is a commodity that we naturally under-consume (or under-fund) because the benefits are delayed or because those who pay are not those who benefit. Nonetheless, I believe that parents on the whole are more concerned with the welfare of their children than the policy officers in unions. Give them the money – through an education voucher scheme – with which to buy their education, from any private, public, voluntary, charity, social enterprise or any other kind of provider whom they choose, and further allow them to top up the voucher with whatever they can afford, and I’m sure that for the most part they will pour far more into their children’s education than the three to four thousand pounds currently spent by the state.

Parents are bound to be more liberal with their money when they can control how and where it is spent. And by exercising choice they will drive up standards in the profession. This may not be what the NUT want, but it is undoubtedly what children need.

All of which aside, I will thank the NUT next time I use their fish and chip supper to line my stomach before a night at the Glee Club.

Economics 101: The difference between “Fiscal Drag” and “Bracket Creep”

Gordon Brown is a tricky soul, isn’t he?

He maintains that he has been raising the income tax brackets in line with inflation – in fact, that this has been the case since 1977. Yet somehow over a million more people are paying higher rate income tax than when he became Chancellor. How has he managed to square both?

The key is in the difference between Bracket Creep and Fiscal Drag (often called Real Fiscal Drag, with the clue being in the “Real”). Bracket Creep is the effect of inflation on taxpayers: if tax thresholds stay the same, but inflation raises wages, people are carried into higher tax brackets even if they are earning the same real income (because inflation affects outgoings as well as incomes).

Real Fiscal Drag is something different. Inflation may be harmful, but as the years pass we would all hope that our wages would rise because we ultimately expect to become richer. If this simply referred to individuals getting richer as they get older then this may not be a concern – richer people pay more tax in our progressive system, and age is no defence.

But we do not simply expect to get richer as individuals. We expect to get richer as a society; I expect an average 34 year old to have a far higher real income in 2020 than the average 34 year old now. For this to be the case – and it generally is, if one does not live in a blighted country such as Zimbabwe or Venezuela – incomes must rise faster than prices and so faster than inflation as a whole.

This is where Real Fiscal Drag kicks in. Because our real incomes are rising, more of us will end up paying higher rates of income tax even if the tax thresholds are raised in line with price inflation.

So the Chancellor can claim to be raising tax thresholds in line with inflation while using the growing prosperity of society to draw ever more people into higher rates of taxation. In a parody of a David Cameron expression, Brown expects the share the proceeds of our growth with us by taking ever larger portions of our increasing wealth.

I’m not generally a fan of the phrase “Stealth taxes” but Gordon Brown’s ability to increase by 56 per cent the number of people burdened with marginal taxes of 40 per cent is frankly underhanded.

Who knows what tricks he’ll pull once he’s moved next door!

EXCLUSIVE: Mervyn DID draft a letter to Gordon!

It's amazing what one finds in the rubbish bins behind Threadneedle Street!

Obviously the person who drafted this letter realised they didn't quite need it after all:


Dear Gordon,

As you may have noticed, inflation appears to be spiralling out of control. The consumer price index (CPI) is now at its highest since 1995, while the retail price index (RPI) is at its highest since 1991. I imagine it must be pretty embarrassing, presiding over an economic record worse than that of the Major administration, which Labour have been criticised so vocally over the past decade.

I feel duty bound to provide an explanation for this rising inflationary tide. I attribute it to a number of key factors, none of which are beyond the wit of man to cure.

1. House prices

House prices have spiralled over the past decade. This has a direct impact on RPI and has also facilitated unprecedented levels of equity withdrawal, fuelling consumer price rises.

House price rises are largely to do with property speculation. While interest rates can curb house prices to a degree, they are a blunt tool in that they also affect other lending and borrowing. High interest rates would, for example, reduce investment. One means of curbing property speculation without harming investment would be to introduce land value taxation, which economists recognise is among the least distortionary form of taxation. Sadly, the Government has shown no willingness to investigate this option.

2. Public spending

A grotesque rise in public spending over the past five years has increased inflation. A particularly egregious example has been overly-generous public sector pay rises that bear no relation to productivity gains.

3. Public borrowing

The Pre-Budget Report forecasts net debt at the end of March 2007 of £503.9 billion. This budgetary imprudence has injected massive liquidity into the public sector and the economy more widely. Effectively, more money is chasing the same number of goods.

4. Taxes

In the pre-budget report the Government added 1.5p/litre to petrol duty. This has been the major factor in the 2p rise in the cost of a litre of petrol, which in turn accounts for two-thirds of the rise in CPI last month.

5. Trade barriers

Cheap imports of goods from emerging Asian manufacturers has applied downward pressure on prices, particularly in clothing and electrical goods. Sadly, the Government and the European Commission (led by Trade Commissioner Peter Peter Mandelson) have imposed additional and ongoing quotas on Chinese textile imports. This is in breach of our commitments under the World Trade Organisation. The result is that customers have been forced to purchase more expensive European products, pushing up retail prices.

6. Immigration

The low inflation enjoyed by the UK over the past two years has been in part due to immigration. As my colleague, David, pointed out a couple of weeks ago, the availability of highly skilled Eastern European workers has kept wage demands within sensible limits. Sadly, the Government has decided not to take advantage of another wave of immigration from Romania and Bulgaria, instead imposing a daft and distortionary quota system. This has removed a further buffer against inflation.

As you will see from the above factors, there is a clear single cause of inflation. Sadly, it is beyond my authority to do anything about it. I think it’s over to you, old chap.

I remain your humble servant,

Mervyn.

The end of the free society?

I came across some disturbing statistics over the weekend. Apparently, less than half of the eligible voters in the UK work in the private sector. The rest are either state employees or on state benefits.

This is important because a free society requires the citizens to keep their government in check. It is easy for those who do not rely on welfare and who are not paid a salary by the government to insist that their rulers take a long term view of their needs, look to the health of the economy and not just the wealth of the public finances, and rule in the interests of the nation and not simply serve a host of special interests. But a client nation where the citizens rely on receiving money from the state cannot exercise the same restraining hand.

Of the 44 million on the electoral register, only 20 million are either employed in the private sector or are self-employed. Over a third as many (7.1 million) are employed by government, and their interests lie in pushing up public sector salaries and benefits at the expense of taxpayers; we have already seen the effect of this in the government’s spineless and unprincipled decision not to properly reform the civil service pension scheme. The rest are made up of 11.8 million pensioners, 2.7 million on incapacity benefit and 3.2 million on various other benefits, many of whom pay very little direct taxes and yet all of whom have a vested interest in seeing public spending – and consequently direct taxes – rise.

Benjamin Franklin described democracy as “two wolves and a lamb voting on what to have for lunch.” In this case, the welfare dependent and those on the government payroll now outnumber those whose productivity must ultimately pay the government’s bill. Yesterday I wrote that “It may seem at present that intervention and the large state dominates, but the tide will turn. The voters, be they the over-taxed middle class or working class playthings of bureaucracy, want freedom.” However, if over half the voters are dependent on the government’s ability to squeeze money out of the remaining less-than-half, that is not the case.

Ultimately, freedom relies on autonomous individuals agreeing to pass over a proportion of their wealth to the public good. This is not the case if a predatory government can use the votes of its clients to extract ever more from a minority of independent wealth producers. The results will not only be spiralling taxes and unemployment and a generally worsening economy, which we are already seeing. It will be to draw ever more people into government control, ever expanding its power until we are all its subjects.

Three-out-of-three is bad

Before Christmas I reported that the Labour Government has managed to increase both taxes and unemployment. In my enthusiasm for the festive fun, I overlooked a third painful statistic: inflation, too is rising.

That taxes and unemployment were rising simultaneously should come as no surprise, as high income and corporate taxes squeeze entrepreneurs and businesses, while high employment taxes (National Insurance to my British audience) raise the price of labour and make expansion unprofitable or shift the balance in favour of capital (i.e. it is cheaper to mechanise than to employ).

In the dark and dismal past, however, it was generally held that unemployment and inflation were opposing sides of a great balance. Between the 1940s and 1970s economists – inspired by J M Keynes – convinced governments that unemployment could be countered by inflationary policies (which surreptitiously reduce real earnings and so free up capital to employ extra workers). This was a flawed thesis, as demonstrated by Nobel economics laureates such as Milton Friedman and F. A. Hayek, who persuasively argued that policies aimed at full employment were both misguided and counter-productive.

Even more flawed, perhaps, was the resulting myth that inflation and unemployment were a trade-off. In theory, unemployment could be reduced only by inflationary policies, while the eventual need to rein in inflation would cause unemployment. It did not, however, follow that the two were in balance. In fact it is possible to have both rising unemployment and rising inflation. Our current Labour government is in the process of proving it.

Britain’s consumer-price inflation rate in November was 2.7 per cent, the highest rate since records began and also the highest rate since Labour took office. Combined with the rise in unemployment to 5.6 per cent from 4.7 per cent a year ago, a budget deficit of 3 per cent, further expected tax rises and GDP that is predicted to fall in 2007 and this is a pretty miserable picture of Labour economic failure.