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Robert Jenkins, current chairman of the Investment Management Association, has a formula for spotting where the next shock in financial markets is likely to occur. It is to look at the agendas for the myriad financial conferences that take place at any given time and try to work out what does not feature. Two years ago, he tells us, the topic no one wanted to hear about was risk management, because they assumed they had nothing left to learn.
Complacency catches everyone out in the end so it is worth applying his formula today, to find out what could easily be plaguing us in two years' time. While it is difficult to spot what is not there - in the sense that it could be almost anything - nevertheless, the issue that stands out by its absence more than anything else is inflation.
Many might find this astonishing - or rather those of us who were working through the Seventies and Eighties might find it thus. But there is a big divide. No one who has become economically active since 1990 - anyone under 40 - has much first-hand knowledge of inflation, just as they had never seen falling house prices until last year. So their default position is once again that it is not going to happen. Hence, it is nothing to worry about.
Let us hope they are right, but it is probably not the way to bet. The big news yesterday was that the Bank of England is to extend its programme of quantitative easing as a technique for injecting liquidity into the economy and freeing up the credit markets. It has spent £50 billion buying Government bonds so far, and it wants permission to buy a further £75 billion.
No one really registers how much sums like this mean - which is why governments can get away with spending it so easily. Suffice it to say that if you signed a dollar bill every second - or a Scottish £1 note as they still have them there - 24 hours a day, seven days a week and with never a break, it would take more than 30 years to get to a billion. So quantitative easing is deploying a truly staggering sum of money - more than the annual yield from National Insurance and council tax combined.
Now as long as the credit markets are frozen, this money can be poured into the system with little inflationary effect. But once things start to free up, it is a different matter. Indeed the Bank of England acknowledges that when conditions improve, it is going to have to move fast and suck back out of the system all the extra money it is currently putting in.
In theory this should give no grounds for concern but in practice it is surely a different matter. If, when the time comes, the Bank moves too slowly, or if it fails to withdraw enough of the stimulus, the inflationary risk multiplies considerably. The practical problem it faces, however, is that economic statistics are hopelessly unreliable in the near term, so the Bank will not know for sure whether the economy is on the mend or not. Even if it senses that things are improving, it is unlikely to want to reverse policy immediately, for fear of repeating a mistake made in the Nineties by the Japanese, who killed off their recovery by acting against it too soon. All the pressure will be aimed at making sure any recovery is firmly established so that it will not be derailed by the Bank withdrawing the stimulus. It seems almost inevitable as a result that the reversing of policy will come too late. As a consequence, we will get inflation.
In a way we are seeing signs of that already. The Bank's decision to expand its policy got a relatively easy ride in the markets yesterday but that was a bit of a surprise. Monetary policy takes time to work through the economy but since last year we have put in place a stimulus of a size we have never seen, plus of course the further impact of fiscal measures and the pound's devaluation.
One might have thought the Bank would want to stay its hand, to wait for these to take effect before piling more on the fire. But that obviously is not the mood of the times - which is why my bet is that in a couple of years' time, inflation will be a major concern.
Reader views (2)
Glad someone's on to this. Inflation always comes when we lose sight of the value of money. Aside from rising food and energy prices, the UK Government has long been pouring cash into non-productive items such as war, ineffective and unnecessary quangos & regulators, ID cards, rubbish computer systems etc etc. Meanwhile the MPs expenses "scandal" illustrates that, at Westminster, money is simply regarded as another variable rather than a store of value. Such foolishness means that, when inflation breaks through, the following wind will be a hurricane. But my guess is that the Bank of England will turn, not when the recession looks beaten, but when the banks have restored their balance sheets and the financial system is robust enough to take a beating on interest rates.
- Peter K, Taunton, UK, 08/05/2009 13:35
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Quite right Tony. Inflation has definitely not gone away - it only appears to have done so because people are paying so little for their mortgages at present. But the CPI which doesn't inlcude mortgage costs remains stubbornly high. Sterling will fall further as QE increses so imports will get ever more expensive: the Bank will have to be very fleet of foot indeed to stop a serious rise in inflation as we emerge from this recession.
- Andy, London, 08/05/2009 12:43
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