Monday, January 12, 2009

Reflation As Redistribution

Governments have never been good at turning on these

However we look at it, a prolonged recession now appears unavoidable. And the overwhelming consensus among at least 364 economists is that in order to mitigate its effects, our government should ditch all the normal rules of fiscal and monetary prudence. Governments should ramp up spending, borrow more, and pump money into the economy by all means possible. Saving should be discouraged in order to address Keynes' famous paradox of thrift.

As regular readers will know, we have serious concerns about all this. Not only will it bury us under a mountain of debt and taxes for years to come, but we also reckon it runs a high risk of triggering another inflationary spiral. Indeed, we confidently expect governments here and abroad to actively promote that inflation in order to default on the very debts they're currently amassing.

True, we're not alone in these concerns. John Redwood has been splendidly vocal - especially over the last week - Liam Halligan had a good piece yesterday - and Prof David B Smith, the chairman of the IEA's Shadow Monetary Policy Committee, says:
"What we're doing now, in terms of rate cuts and fiscal stimulus, will not prevent the current recession, but it will have serious consequences at some point in the future... Even at their current rate, lower interest rates will put a hell of a lot of stimulus back into the economy, and we could easily go back to boom and bust again.

The Keynesian bandwagon has allowed the Government to go on huge spree, and the evidence from the 1990s is that you could easily have a situation where public spending holds up GDP but also induces a collapse in private sector activity which could be equivalent to the Great Depression."

In other words, all this government spending could easily crush the private sector, preventing it from generating the growth that we must have to recover (cf the famous Eltis and Bacon analysis of Britain in the 70s - Britain's Economic Problem: Too Few Producers).

Because beneath the macroeconomic headlines, there's something else going on here - a massive redistribution of income and wealth from the productive to the unproductive (or at least, the much less productive).

Let's recap on the losers from reflation:
  • Savers - they have already lost bigtime from the slashing of interest rates, and look set to lose more as the government pressures banks to cut loan rates
  • Taxpayers - they will have to pick up a hefty tab for servicing the government's huge new debts; increases in National Insurance and higher rate income tax are already in train, and there will be much more to come
  • Those on fixed incomes - just like back in the 70s, anyone on a fixed income, like a pension annuity, will lose as inflation takes hold; similarly all those who hold their life savings in bank and building society accounts will lose, as will those who've placed their trust in the government's laughably misnamed Gilt-Edged Securities (unless they've been cute enough to buy the index-linked variety)

All of the above will lose in order to support a burgeoning public sector, plus a soaring bill for welfare and all those job subsidies. The productive and the thrifty - the very people on whom our long-term prosperity depends - will be penalised to support an even higher number of state dependents.

Now those 364 reflating economists are basically saying don't worry about the long-term because in the long-term we're all dead. And anyway, the government will be able to turn policy on a sixpence just before the dire long-term consequences kick in. Here's how the normally sensible Roger Bootle describes it:

"In the short term, we must rely on an increased government contribution to demand through higher borrowing and increased consumer spending... Within a couple of years, though, these two sources of demand can be wound down as two others take over – a huge boost to growth from our net exports and a concomitant rise in corporate investment.

The winding down can take place through cuts in government borrowing, achieved through cuts to spending and higher tax receipts generated by economic growth, as well as higher interest rates, effectively undoing the stimulus packages of the last year."

Hmm. In my lifetime I have never seen a government that was able to execute that kind of policy switch before the ordure hit the whirling blades.

The reality is that the productive and thrifty will be picking up the pieces for many years to come.

Unless they leave, that is.

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