Soapbox: The Devil and the Deep Blue Sea

The Confederation of British Industry (CBI) came out with a grim forecast this week. A year-long recession will hit the UK in 2023, said its director-general, with gross domestic product (GDP) dropping by 0.4%; the CBI’s previous forecast, in June this year, said the country’s GDP next year would grow by 1%. In the Eurozone a recession is still widely predicted for 2023 but it now appears to be less dire.

As for the US, opinion as to the possibility of a recession is divided. The chief economist of Moody’s Analytics argues that the US will narrowly escape a recession, but S&P Global Ratings expect a “mild” recession, with a GDP decline of less than 1%. A recession, to remind us, is technically defined as two successive quarters of economic decline.

As for so-called ’emerging markets’, they are truly strung out between the devil and the deep blue sea. Bloomberg puts their dilemma thus: “As long as the [US] Federal Reserve keeps raising rates and China is hobbled by Covid, policy makers in poorer nations remain at the mercy of factors beyond their control”. Maybe China is starting to emerge from Covid. But economic growth has hit a wall in many countries, now facing currency collapses, partly as a consequence of higher US interest rates, and cost-of-living crises. The chance of policy errors – putting interest rates up too high and thus inciting a recession or leaving them too low and thus letting inflation run rampant – is heightened for emerging markets, says Bloomberg.

The devil – inflation

The Eurozone saw inflation reach almost 11% in October when averaged across the 19 countries belonging to the bloc. In the Baltic states – Estonia, Latvia and Lithuania, also members of the Eurozone – inflation was above 20%. While attention for much of this year has been on the rising cost of energy prices as a result of the Russia-Ukraine war, food prices have been on a dash too – up by an annualized 12.4% in November in the UK according to the British Retail Consortium, which follows a 16.2% jump in October. In the European Union as a whole the cost of food in October rose by an annualized 17.26%. In the US food price inflation slowed a bit in October, down from an annualized 11.2% in September to 10.9%.

Across Europe, food bank usage is “soaring” as high inflation eats away at disposable incomes; in Germany the Tafel food bank says demand for its aid has risen more than 50% this year.

This burst of inflation, the worst in almost five decades, is starting to make consumers in Europe tighten their belts. Retail sales in the Eurozone dropped by 1.8% in October compared to the previous month. The European Commission said its consumer confidence index rose to minus 23.9, from 27.5 in October. But that’s still well below the long-term average of minus 11. In the US, retail sales in October rose by 1.3% month-on-month, suggesting that “the economy got off to a good start in the fourth quarter”. American consumers carried on spending, taking advantage of discounts from retailers who have inventory gluts and are trying to shift shelf stocks. They have a government-funded cash cushion. US consumers earlier this year were estimated to have $4.7 trillion in cash, up from $1 trillion towards the end of 2019. The cushion is less plump in the European Union or the UK, hence the growing divergence between US central bank policy and those on the other side of the Atlantic.

The deep blue sea

Central banks have the ambition to get inflation down. But they don’t really know what is causing inflation. They point to Russia’s war with Ukraine and argue that has pushed up prices but this is putting the cart before the horse, rather as happened with Covid.

The assertion that Covid caused global economic damage is false; it was the global response to Covid, i.e. a worldwide lockdown that stopped people from going to work, making and delivering things that caused the damage. With Russia and Ukraine it’s not the war itself which has pushed up energy and food prices, it’s the response of the West to the war – the imposition of sanctions, the weaponization of the Dollar – which has driven up energy prices. This is not to take either a pro or anti attitude towards the Covid lockdowns, or the sanctions on Russia; it’s simply to straighten out our thinking.

But we are where we are. Central bankers only know one tool to fight inflation – make consumption more difficult, make credit more expensive, put up interest rates. The fact that higher base rates set by banks pushes up the cost of mortgages and credit card use, and therefore inevitably worsens the cost-of-living ‘crisis’, is an uncomfortable paradox that central bankers tolerate.

So, rates in the US this year have risen from 0.25%-0.50% to 3.75%-4.0%. The rate is likely to rise again mid-December, by at least 0.50%. In the UK, the base interest rate of 3% will likely be pushed higher, even though one of the Bank of England’s (BoE) rate-setters, Swati Dhingra, has said that a higher rate will deepen the expected recession. The European Central Bank (ECB) has increased its deposit rate from minus 0.5% to 1.5% in the past four months and is expected to announce another rise to at least 2% at its next meeting in December.

Yet everywhere central banks shy away from putting rates up above – or even close to – inflation. Perhaps they are preparing the ground for accepting a higher rate of inflation than their 2% ‘target’. The former chief economist of the International Monetary Fund (IMF), Olivier Blanchard, floated the suggestion of doubling that to 4%. Why 4%? Because, he said, a Google search for ‘inflation’ shows that if it is around 3-4% “people simply did not pay attention. Above 3-4%, they did”. Setting an inflation target may be silly, but setting it according to a Google search seems quirky beyond belief.

Not waving but drowning

Amid all the noisy conflict over rampant inflation versus higher rates plus recession it has been forgotten that we have been here before. Interest rates at very low levels – as we have had recently – “fuel speculative manias, drive savers to make risky investments, encourage bad lending and weaken the financial system” says Edward Chancellor in his excellent new book, The Price of Time. Memories of central bankers are distressingly short, and they are often subject to ‘regulatory capture’, a form of corruption that happens when a regulator is co-opted to serve the interests of a particular constituency. Thus the UK is about to reverse a crucial move which was designed to prevent the kind of domino bank collapse of 2008.

Following the 2008 Great Financial Crash UK banks were required to ‘ring-fence’ themselves – separate their retail banking from investment and international banking services. That strict regime was introduced to prevent banks from recklessly gambling with their retail depositors’ money; but it’s now going to be relaxed. “Ring-fencing doesn’t work”, according to Tim Adams, CEO of the Institute of International Finance, (IIF). “It makes a more brittle system, it precludes institutions’ capacity to move capital around to their best uses”. As the boss of one of the world’s most influential bankers’ clubs, Adams is hardly neutral on this issue. The memories of 2007-08 have disappeared like a bad dream. We can all go back to trusting banks to take the greatest of care with our money – not. Surely once bitten, twice shy?

Some thinkers seem rather more attuned to what is going on in the economy than Blanchard or Adams. Nouriel Roubini said recently that there are “three solutions to the problems of inflation, debasement of currency, political and geopolitical risk and environmental risk”. Among his pieces of advice is to “go into gold and precious metal”. He says that “if central banks are going to blink and wimp out” (start to ease off interest rate rises) “gold is going to rise in value. Gold is going to rise in value also because the enemies of the US are subject to sanctions. China right now is worried they have a trillion dollars of reserves in dollars that they have to move to other things. If it’s euro, yen, it can be seized. The only thing that cannot be seized is gold”. We would also add – thanks to your Glint App and Debit Mastercard®, gold can now be used as everyday money.

At Glint, we make every effort to demonstrate a balanced conversation between gold, crypto and fiat currencies when it comes to purchasing power and, while we strongly believe that gold is the fairest and most reliable currency on the planet, we need to point out that it isn’t 100% risk free. While we have seen a steady increase over time, the value of gold can fall, which means that its purchasing power can also decline.