Ann Pettifor

Central bankers, not inflation, the real threat

I’ve dubbed the 9th August, 2007 ‘debtonation day’ – because on that day banks froze lending to each other, central banks panicked and began providing ‘liquidity’ – i.e. new loans to banks in trouble – and the Credit Crunch took hold.

By strange coincidence, it was on the 9th August (see Charles Kindleberger in ‘The World in Depression’) that the Federal Reserve Bank of New York raised interest rates from 5 to 6% – an act that helped precipitate the Great Crash and then the Great Depression.

The Fed had started ‘tightening’ i.e. increasing the real cost of borrowing in 1928, and persisted in this tight monetary policy after the Crash had started. The Fed had been determined to raise interest rates to (finally) prick a bubble of its own creation: the easy credit bubble that fuelled the stock market of the roaring 20s. Taking away the punch bowl by raising interest rates, proved very unhelpful to bankrupts and debtors – of which there were many millions in 1929.

Similarly in 1990 the Bank of Japan acted to keep interest rates high, and thereby prolonged Japan’s slump, described by Graham Turner in his new book on the Credit Crunch as ‘an economic calamity unparalleled in modern times’.

The rationale behind the latter case was the Bank of Japan’s concern to prick the bubble of speculation in property that it had itself encouraged.

The Bank of Japan, like today’s Bank of England and Federal Reserve, veiled its determination to raise interest rates behind talk of the risk of inflation, in particular wage inflation, even though this risk, as Turner argues, was minimal in Japan (‘unit labour costs were falling’ writes Turner.) High rates of interest proved the last straw for many struggling companies and consumers.

Today, the Bank of England, backed up by the Chancellor and the Prime Minister warn just as the Bank of Japan did in 1990, that inflation and pay rises, particularly public sector pay rises, represent a major risk to the economy, and must be resisted. This is nonsense.

There can be no doubt that a falling dollar has forced up the price of oil, and given impetus to inflation. (Its important to remember that oil producers are obliged to denominate the sales of their oil in dollars (very few traders would be willing to pay for oil in e.g. the Nigerian currency – the Naira.) If the dollar falls in value, oil revenues fall in value too. And producers like the Saudis and Nigerians find that their dollar assets (US Treasury bonds etc.) fall too. To compensate for these losses they raise the price of oil.)

And rising oil prices have inflated commodity prices, including food prices.

At the same time, the ‘wall of money’ that had been invested in property, including sub’prime, has now moved to invest in, and gamble on commodities.

These price rises impact disproportionately on the poor.

But while commodity prices and oil are rising, many other prices are falling. An entirely logical state of affairs.

Over the last two decades consumers and businesses have borrowed to finance their purchases or investments. This led to a boom in consumption and investment, and was actively encouraged, and certainly not discouraged or regulated by central bankers in NY and London.

Now the debts are coming home to roost, and many are using all, or most of their disposable income to pay off debts. Many companies do not have enough ‘disposable income’ to pay off debts, so go bankrupt and lay off staff. At the same time because Americans for example, are using their disposable income to pay off debts and not to shop at outlets like Wal Mart, they are buying fewer goods, and fewer Chinese goods.

In the UK High St. retailers are struggling to sell their goods to debt-strapped consumers. And so, while their own production costs are rising, they are largely absorbing those costs, making losses, and still not managing to sell well on the High St.

Prices for textiles, white goods, gadgets, mobile phones – are all falling. Ask any electrical retailer.

Over the last decade or so, China has invested billions in new companies whose sole purpose has been to provide/export goods for American markets. Once Americans slow down their shopping, those businesses will develop ‘spare capacity’. Machinery, men and women will become idle. Because China is a communist state, and because it also faces great political risks, the government is unlikely to sanction redundancies and a rise in unemployment. Instead the Chinese will keep churning out stuff, and will sell off their surpluses at lower prices to all comers – holding down prices worldwide.

Because it will take a very long time for economies built on the Anglo-American debt model to clear their debts, it will take some time before American and British consumers and companies start buying again. Time will pass, inventories will rise, goods will pile up in shops – and prices will fall ….i.e. deflation will prevail.

This threat is real and scary. But perhaps the greatest threat comes from central bankers, finance ministers and Prime Ministers determined it seems, to use higher interest rates to kick debtors off the crumbling cliff on which they, and the economy, are clinging by their fingernails – into the abyss of bankruptcy and value destruction.

So it is central bankers, not inflation that pose the greatest threat to the economy.


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