Baby-Steppin' Back To The '70s
"...A short-back and sides
for the value of Sterling
– Trim, trim! Snip, snip...!"
"ON THE DOWNSIDE," said the Bank of England when it trimmed UK interest
rates by 0.25% on Thursday, "the disruption in financial markets could
lead to a slowdown in the economy sufficiently sharp to pull inflation below target."
Note the Old
Lady's choice words; the banking crisis "could lead" to lower inflation.
Note also her
logic – that an economic slowdown can do her work for her. And she is 314 years
old, after all, poor thing. Defending the value of Sterling for more than three centuries (the
real meaning of her "inflation targeting" task) would wear out the toughest
old boot!
But with the
British Pound now worth less than half what it bought twenty years ago, the
Bank will need all the help it can get in pulling inflation back below target.
Just like the United States, the UK is now suffering the worst
inflation in industrial costs since the runaway inflation of the late 1970s.
Only this week,
the UK's
official data agency pointed to 21% year-on-year price hikes on average. The
Bureau for Labor Studies said US
import costs rose 14.8% in March, up from 9.1% six months before.
Now you might
counter that both countries – both dependent on imports for much of their industrial
input, including crude oil – are also suffering on the currency markets. Both
the Pound and the Dollar have been hammered vs. the Euro and Yen, not to
mention the Chinese Yuan.
But that would
only be to say just the same thing. The value of money is precisely the inverse
of your rate of inflation. Currency traders only add to the pressure; they
don't create it.
Back on Threadneedle Street
meantime in the City of London, let's finally
recall the Old Lady's decision this week: the Bank of England cut interest
rates, albeit by a slim 0.25%, in the hope of forestalling the very same slowdown
it hopes will ease the UK's
inflationary pressures.
Okay, so Mervyn
King and his interest-rate trimmers are less melodramatic than Ben Bernanke's
crowd in Washington.
But can they really have it both ways? Just what do they want – a slowdown or
not?
Snipping and
trimming at the value of Sterling, we fear here
at BullionVault, the UK
will get a slowdown regardless, plus persistent inflation, taking us straight
back to the stagflationary '70s.
Yet so far, at
least, British savers and spenders still seem happy enough!
"We will have
to lower our expectations of what property we can afford," grin a young couple
splashed across the front page of Friday's Times.
The credit crunch starting last summer has kept them and their baby locked out of
the UK's
decade-long property boom. Merely tinkering with the cost of money looks
unlikely to change that. Four major mortgage lenders actually raised their fixed-interest deals on the
Old Lady's decision.
"It's not
just the cost of hotels, it's the weak Pound," adds a young father, also
snapped for The Times. Already
planning his family's summer vacation in Europe,
he's spotted the link between a currency's value and power. Yet he too smiles
like inflation's not really a worry.
"My household
bills are creeping up every day," agrees a young medical doctor with
another soft smile, seemingly happy with the snail's pace of Sterling's destruction. Perhaps the average GP's
pay-rise of 58% since 2004 helps raise his spirits, up there at £113,164 per
year ($221,800).
So it's left to
two pensioners, Frank and Dorothy Beevers of Bexley, London, to bring true gloom
to The Times' doom-laden headline –
"Consumer Crunch".
Trying to get by
on the state pension – plus a private pension worth £4,000 per year ($7,850) – "it's
not just the price of diesel that's going up," they mutter glumly. "It's
more expensive for us to heat our home.
"Inflation is
having a real effect," they add. And for them of course, aged over 65, it
always has.
Back at the start of the 1970s – that most inflationary
of decades – the United
Kingdom got rid of its boring old Pound and
its boring old pennies.
Out went the 240 pence of pre-decimalization. In came the
new 100 pence of the decimal Pound. And funnily enough, the Pound has indeed
been decimated since decimalization! It buys barely 9% of what the brave new
Pound first bought back in 1971.
But the fastest destruction of Sterling's spending power came in the nine
years ending 1980, when the Pound lost three-quarters of its value at an
average annual clip of 12% annually.
Now throw in that decade's disastrously high tax
rates, and cash-in-the-bank just couldn't keep pace either, despite the
record-high interest rates of the mid-to-late '70s.
In 1976 alone, even basic-rate taxpayers gave away one-sixth
of their savings to tax and inflation if they dared save for the future by
putting cash on deposit. Which incredibly is just what most people did...
The cost of borrowing soared as the cost of living
shot higher.
Encouraged by these apparent great rates of return, British
households piled their cash into savings accounts. As you can see, the ratio of
savings to disposable income mapped the gross returns paid to cash pretty much tick-by-tick.
But what nobody told them – and what headline interest
rates still keep hidden from view – was the true cost of saving £1 today to
provide for the future.
One hundred New Pence tucked away in the bank during
Jan. 1975 bought less than 63p worth of goods at '75 prices by the start of the
'80s. That loss of more than one-third came despite interest rates averaging
almost 11%.
Yes, things were very much worse three decades ago.
But there's scant hope the Bank of England will avoid a repeat if it keeps
snipping at base rates with its patented "baby step" cuts.
With the Old Lady
now running interest-rate policy in line with both bond-market forecasts and
the government's public instructions, the net loss to cash savers only seems set
to grow worse.
"If you look
at [the financial crisis] situation," said Gordon Brown, the prime
minister, ahead of the BoE's vote, "because we've got low inflation we can
cut interest rates."
If not quite a lie,
it was a woefully misinformed claim. And either way, cash savers in Britain – as in the United States – might soon start to
wonder:
Just what's the point
of prudence?
Adrian Ash
Formerly City
correspondent for The Daily Reckoning in London
and head of editorial at the UK's
leading financial advisory for private investors,
Adrian Ash is the editor of Gold News and head of research at BullionVault – where you can Buy Gold Today vaulted in Zurich on $3 spreads and
0.8% dealing fees.
(c) BullionVault 2008
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