A Slog special today: buying stuff and asset worth…why ‘indeflation’ is indeed coming to pass

Today if I may, I’m going to try and bring some helicopter sanity to the observation of What’s Going On in terms of fiscal, financial, economic and commercial problems around the Globe. I hope there’ll be a couple of posts at least, depending on what else important crops up during the day.

First, some credentials….and there is a point to this beyond told-you-so: I got many things wrong in this sphere over the last ten years, but most of that was based on underestimating the criminality of bankers and sovereign legislators. However, I still think that the lack of ‘normal’ fundamentals as a result of such mass mendacity and manipulation doesn’t mean waves can henceforth travel backwards. I’ve been saying this since the days of Not Born Yesterday during 2007-8, and during that era I coined the word ‘indeflation’. It later turned out that someone else had the same idea, but its meaning – about the cost of buying and the worth of assets being at odds with each other – has been broadly borne out by events since then.

There’s quite a bit I’d change from the August 2010 piece below, but the basics are still sound. Later I want to discuss how contemporary weirdness reflects a continuing process.

MPC ANALYSIS: Why the inflation v deflation debate may prove inconclusive in a UK context.

The UK is heading for Government cost inflation and private sector deflation.

Today’s news that the ‘headline’ inflation rate has fallen to 3.1% won’t settle any arguments about the main monetary threat we face: if anything, the debate will intensify as the economic equivalent of the climate change bunfight gathers pace.For a good eighteen months now I’ve been, on balance, in the deflation camp; but a year ago I wrote a piece describing ‘indeflation’, a Slog-invented buzz-word meaning a mixed outcome whereby some things go dramatically up in price (taxes, fuel, energy, health and transport services) but others plunge in price (clothes, food, most cars and of course house prices). The more one looks at the situation developing in the UK, the more this seems to me quite likely. Government reporting of the monetary effects of one policy or another therefore quite probably needs to be broken out in order to look at the overall effect on living standards and costs.

There is still no doubt in my mind that the overall effect upon the UK population will be to lower its standard of living, simply because as a heavily indebted nation paying its citizens far too much in all sectors, we are just as likely as others in the ‘EU West’ to become poorer. But I can’t off-hand think of any other developed country going so quickly from a hugely unproductive and overstaffed public sector to a relatively small public sector alongside falling output, falling demand….and the need (probably) to raise taxes still further in order to pay off a long-term structural debt.

In a nutshell, there are both deflationary and inflationary elements in all this. The ‘indeflationary’ likelihood comes from a stronger Pound bringing a higher trade gap, but also lower import/raw material costs. The rest of it lines up like this:

Deflationary: Austerity cuts + tight money + higher unemployment = lower domestic demand + lower output = falling food prices and falling durable/house prices.

Inflationary: Increased unemployment = higher cost of benefits = increased central taxes.
Lower local Government subsidies = higher council taxes.
Rising cost of energy + eco-measures = increased transport and heating costs.
High level of banks’ debt = increased service costs + rising borrowing costs.
Declining economic output = more QE.
Less money for State pensions = lower spending power of weekly OAP amount.

This is a massive simplification of the factors involved, but basically the unique combination in most of our lifetimes of cheap Asian imports combined with banking disaster and a deeply troubled economy is in my view bound to be the more decisive determinant. The deep pockets of many food distributors, the dependence of many hitech suppliers upon consumption of innovation, and the real effects of property default (plus strangled supply of and demand for houses) must mean that a domestic Pound will go much further by 2013 than it does today.

But as always, which side of the equation dominates depends on what our (and other) governments do. Delaying sovereign debt repayment while unwisely stimulating a dead economy would have produced hyperinflation in short order. But neglecting to subsidise new output sectors and exports (and leaving taxes too high for too long) will result, for sure, in a disastrously vicious cycle of deflation. China halting the Yuan’s flotation will make matters worse….as will EU governments remaining in denial about their debt obligations and deficit dangers.

My outlook as a whole suggests a lower cost of private purchasing and a far higher cost of government. Unless that government takes the wise decision to withdraw more and more from its non-productive commitments, there will be anything from widespread taxpayer disobedience to serious social unrest – and probably both. As I’ve posted before, what happens after that stage – for assuredly, government no longer knows how to withdraw – is anyone’s guess.

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The obvious hostage to fortune above – that the ‘domestic Pound’ would go much further in the property market by 2013 – is something where the Slog money has been put where the Slog mouth is. I am now cashed-out of the UK property market, and still counting on the realities of UK property coming to the surface during this year. However, the cost of purchasing everyday needs hasn’t fallen in any clearcut sense at all: durables are holding value, and food is (now at last) going up in price.

But at the same time, I am also betting on a silver and gold upsurge over the coming months. The jury is utterly hung about that one….as the next post on this issue will discuss.