Prospects For The UK And The Pound

This article assesses the likelihood of the pound following the dollar into monetary hyperinflation. Between March and September, the US Government financed twice as much of its spending by bond sales — mostly through inflationary QE — compared with tax revenues. And there is much more monetary inflation to come.

A hyperinflating dollar is now the international backdrop for all currencies, including sterling.

To date, the UK’s budgetary arithmetic is less alarming than that of the US. In theory, the UK government has a workable plan, to turn the UK into a global entrepôt. However, if, as is becoming increasingly certain, the dollar falls heavily on the foreign exchanges in the coming months, dollar interest rates will rise, and so will those for sterling — catastrophic for government finances and the future of debt-laden zombies. Furthermore, with counterparty exposure to insolvent Eurozone banks and escalating covid-related insolvencies, British banks are not strong enough to withstand the general credit contraction a rise in dollar rates would trigger.

As a matter of utmost urgency, the UK Treasury should rebuild the nation’s gold reserves, secretly if necessary, so that the government can stabilize the pound by backing it with gold at the appropriate time. There is then a way out of this mess, but will the UK government take it?

image source

Introduction

Living in the UK one is all too aware of the visible damage the virus lockdowns are doing to the economy. Hotels, pubs, and restaurants have been driven towards bankruptcy, and only those whose owners have enough stored wealth to pay the bills while there is little or no income will survive. Many retailers whose margins were slim after paying rent, local authority rates, and sales taxes have closed forever. To some extent these problems have been deferred through payment holidays and furlough schemes. But the fact remains that high streets in the market towns up and down the country have had the heart ripped out of them.

Major retail chains are now going bust. If only the government could recognize it, the changes we see today were going to happen anyway. But instead of an evolutionary process, it has been brought about all of a sudden by the covid crisis and its handmaiden, a likely banking crisis to follow. Schumpeter’s process of creative destruction has been bottled up for ten years before being unleashed.

If permitted, the new world that beckons the UK is high streets which combine housing, shops, and all the other facilities that humans decide between them are required and desired, and not those mandated by planning laws and local government. The travel industry has taken a massive hit, with spontaneous airline travel probably going out of fashion: why not stay at home nine times out of ten and watch documentaries on the places you would otherwise have visited? British holidays taken by Brits who in the past went abroad could become a future growth industry.

One could go on, but the point is that Britain is not going to return to the old normal. And the principal obstacles to change are central government and the local authorities. Through massive waves of monetary inflation, central government is supporting the world of yesteryear, of business zombies. And because they are losing income from business rates, the local authorities are resisting the change of use from retail to housing. In fact, if they embraced this evolution in the towns and cities, much of the “housing crisis” everyone talks about would disappear without the need to concrete over much of rural England.

To be fair to the politicians, they are always elected not so much on a manifesto, but to maintain the status quo ante. No one votes for evolution. They vote for new businesses, green energy, and the rest, on condition that their existing businesses and jobs continue unaffected by change. And in a Keynesian world, where monetary capital can somehow be created out of thin air, it appears to everyone to be eminently possible. And as is the situation in nearly all advanced economies, UK government policies backed by monetary inflation have resisted change, fostering crony-capitalism, regulatory protectionism, and zombie businesses.

The current UK government and its cabinet ministers must be extremely frustrated by the predicament they find themselves in. As elected politicians they started out being perhaps freer market-orientated than any post-war administration. All that intent is now on hold, and they are forced into retreating into the same old botched policies of perpetuating yesterday’s businesses and backing today’s failures.

This article examines the specific economic and monetary situation faced by the United Kingdom. There is an eventual way out of the covid trap, but it cannot be achieved by relying on bureaucratic intervention and ignoring monetary and economic developments elsewhere.

The government spending problem

The screenshot below is taken from the UK’s Office for Budget Responsibility’s Economic and Fiscal Outlook, published in November.[i]

(Click on image to enlarge)

Screen Shot 2020 12 10 at 1.52.14 PM

It is probably true that in the few weeks since it was published this central forecast has drifted somewhat towards a worst case, particularly as it is now unlikely that covid restrictions will cease before the end of the first quarter of 2021. With nearly four months yet to run, the estimate of public sector net borrowing for the current fiscal year to 5 April 2021 is likely to be revised up from £393.5bn to well over £400bn. And the estimate that it will then fall to £164.2bn in 2021—22 appears increasingly optimistic. Elsewhere in the document, the OBR admits it is guided by the IMF’s World Economic Outlook, published in October, “[whose] projections were, however, compiled before the strength of the second wave in Europe and the US became evident”.

As is usual for all government agencies, the OBR seems oblivious to what GDP actually represents. Their analysis is on the basis that GDP is economic activity, when, in fact, it merely records the monetary value of included and recorded transactions, a value that only reflects the addition of central bank money and bank credit in the period covered. The easiest way to goal-seek a nominal GDP number is to print money, which is exactly what the Bank of England has been doing ever since the Lehman failure. Quantitative easing between 2008 and 2019 produced an extra £645bn in circulating currency, during which time nominal GDP increased by £625bn, a difference of only 3.2% which could easily be attributed to other factors. Subsequently, in 2020 the extra QE to deal with the virus is £250bn, an additional 13.8% to M1 money supply, before supplementary lending schemes by the Bank through commercial banks are taken into account.

The pretence that inflationary financing is beneficial arises only from what is seen; the magic of government money being distributed for the common good. What is not seen is the dilution of everyone’s savings, assets, earnings and pensions for the benefit of the government’s finances. The transfer of wealth leaves everyone worse off, once the economy has absorbed the extra fiat money. The benefit is visible, while the cost is hidden and cannot be easily quantified. And every time the Bank deploys QE it is transferring yet more wealth from the productive economy to the government. It is a policy that ends up bankrupting the nation and destroying the currency.

In common with other central banks, the Bank of England denies that wealth is transferred, or at least if it is it is limited to the 2% inflation target, which is somehow “stimulative”. But as a consequence of the statistical imperative to reduce the cost of indexation to the government, changes in the CPI as a measure of the general price level have become both misleading and meaningless. There is no independent estimate of the UK’s rise in the general price level, but we know from the US that independent calculations place the rate of US price inflation closer to ten per cent every year for the last ten years[ii], while the official CPI has hardly deviated from its 2% target, the same as that of the Bank of England.

The evidence is that government statistics have become so self-serving that in any proper analysis they must be ignored. The expansion of the money quantity is the relevant story to follow. Since the Lehman failure, the UK’s M4 broad money supply has increased by about 50%, diluting the monetary value of GDP accordingly, a process likely to accelerate even faster in the future as a result of covid.

Rather, therefore, than challenge the OBR’s assumptions about future GDP, we should accept it is a meaningless figure, useless for estimating economic progress and its future course. And being the basis of all economic modeling by government departments, their models should be rejected as well. Furthermore, the OBR’s forward projections look eerily similar to the guesswork of the US’s Congressional Budget Office.

Neither agency can have a clue about future economic activity. It is unknowable. As Ludwig von Mises put it, the assumption is of an evenly rotating economy, where the human action that drives economic progress is ignored. But by not understanding the difference between progress and an accounting total, it inevitably leads to an error: the support of yesterday’s businesses which are less relevant to the future, and that consume capital instead of adding value demanded by consumers. Evidence of policy support for these zombies is found in the Bank’s Term Funding Scheme (TFS) and the incentives for commercial banks to lend to smaller businesses, leading to £56bn in loans being made under these schemes since March.

In the narrow context of public sector indebtedness, the situation is nowhere near being a disaster, as the next screenshot, of central government debt to GDP shows.

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Disclaimer: The views and opinions expressed in this article are those of the author(s) and do not reflect those of Goldmoney, unless expressly stated. The article is for general information ...

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