Inflation is currently running at a red-hot 10.1 per cent in the UK, the highest for over forty years. But that’s only part of the story. The real prices that consumers care about, such as food and energy, are going up even more. Energy prices soared by more than 54 per cent in the year to April 2022, and food price inflation hit 14.5 per cent in September, one of the highest figures ever. The UK now has the highest inflation rate of any G7 nation. Households in the bottom two quartiles are getting crushed.
But why is this happening? Central banks argue that the main pressures are supply-side. However, careful analysis suggests something different. The real issue is monetary inflation in asset prices and the unwinding of what billionaire investor Jeremy Grantham calls a “superbubble.” Put plainly, there’s simply too much liquidity in the economic machine chasing after too few goods.
Disrupted Supply Chains And Chinese Lockdowns
In its recent November 2022 release, the Bank of England states that the “production difficulties businesses have faced are starting to ease.” Hence, authorities are placing the blame squarely on companies, the Chinese COVID-19 policy, and problems with shipping.
However, these accusations are disingenuous. Granted, in 2020, there were supply-chain shortages for certain products, such as cars, bicycles, and computer chips. But from 2021, these largely began to ease. Chinese factories started up again, and other major suppliers, like Mexico, South Korea, the US and Australia all began shifting products into global shipping lanes once more. In fact, many prices that spiked early on in the pandemic are collapsing. Used car prices fell by 0.5 per cent in October 2022 even as everything else shot up.
As monetarists and Austrian economists will point out, supply chain disruption-induced price rises aren’t real inflation. Instead, they reflect a transitory increase in the production costs of some goods. Now, these are normalising and relative prices are being restored, so why is there still so much inflation?
Energy
Authorities are also pointing the finger at rising energy prices due to the war in Ukraine. The whole world is suffering, they point out, so the UK is no exception.
Wholesale energy prices have risen. And this is one area where policymakers probably have it right. The shutting off of the Nord Stream pipeline (and later sabotage) means that demand is vastly outstripping supply.
But none of this inflation needed to happen. It is only occurring now because the UK and Europe failed to invest in reliable energy generation over the last twenty years.
In the 1980s and 1990s, Britain got most of its energy needs from North Sea oil and gas, but regulations reduced investment in these considerably in latter years, with production falling well below national consumption from 2000 onwards. Energy costs are rising because of green concerns, not because of any underlying economic or technological constraints.
How much energy factors into UK inflation is not clear. But given that the UK is a far less energy-intensive economy than Germany (because of all its heavy industry) it seems strange that inflation would be lower in its EU rival. If energy sector inflation pass-through is such an issue, then German bratwurst should be going up faster than Lincolnshire sausages – and that’s not happening.
Pound Slump
Prices are messy, so politicians and central bankers will always claim that supply chain disruption and rising wholesale energy prices are to blame for the general inflation we see. But that’s not true. While the UK faces multiple inflationary storms, the real issue is Sterling. The pound slumped in 2022, down over 10 per cent against a basket of top foreign rivals.
This slump is a reflection of fiscal and monetary policy in both the short and long term. In 2020 and 2021, the government spent £372 billion on various COVID-19 furlough and business support schemes, more than a third of regular annual spending. Deficits grew and investors started asking for higher interest rates to compensate them for increased lending risk. Money ploughed into stocks as citizens saved more of their income. Now that the pandemic is largely over, all that cash is coming home to roost.
But these short-term issues conceal the larger forces at play: namely, the secular rise in asset prices versus goods and services in circulation. As billionaire hedge fund manager Ray Dalio points out, asset prices have been on a tear over the last decade. Fuelled by loose monetary policy and crazy-low interest rates, housing, stocks, and bonds have seen the biggest bull markets in their collective histories. From an accounting perspective, there’s more money in financial assets than ever before.
Now that liquidity is leaking out, in search of real goods and services. After all, the only purpose of owning these assets is to eventually cash them in for real goods and services. Boomers are retiring, demand for goods is increasing, and prices are rising. It’s like the 1970s all over again.
Given how interest rates affect inflation, the Bank of England is now scrambling to raise them as fast as it can. However, most of this bombast is probably just signalling: an attempt to bring down inflation expectations. Andrew Bailey is largely powerless to stop the inflationary storm hitting the economy. The money is already out there. If he and the monetary policy committee continue to raise rates, it’ll crash the housing market, causing political and economic agony.
Inflation And Gold
When stagflation, a time of high inflation and declining economic output, is on the cards, many investors will identify the need to diversify their portfolios. 2022 already saw routs in the bond and stock markets, but the housing market could well be next. A broad portfolio of uncorrelated asset classes is often seen as the best way to spread risk in turbulent markets. Gold generally holds its value against fiat currency in the long run, which might explain why central banks are furiously buying it right now!
If you wish to diversify by making a precious metals purchase, then get in touch. We would be happy to explain the process and answer any questions that you may have.
