Sep
2022
Beginning to See the Light: Putting Out the Fire with Gasoline
DIY Investor
1 September 2022
‘Just be still with me
You wouldn’t believe what I’ve been through’
This week, aside for the never-ending Tory leadership saga, we look at inflation, and its impact. The most obvious impact is on heating, with the cap rising to almost £3,600 in October, and slated to top £5,000 in the new year.
Last year many forecasters, including central banks, said that the then rising inflation was transitory, largely due to supply chains catching-up post-Covid. The ‘no see ‘em’ was Russia invading Ukraine which, whilst Putin, had been threatening, few expected to actually happen.
Six months on, Europe has been pushed to the brink of a deep recession by the Kremlin’s use of energy as a weapon of mass destruction.
In truth, this is a crash that’s long overdue. Any nascent post-lockdown recovery is consigned to the bin, another nail into the coffin of laissez-faire economics.
‘a deep recession by the Kremlin’s use of energy as a weapon of mass destruction’
Earlier this month the Bank of England predicted inflation, already at 10.1% would peak at 13%, whilst Citibank, is predicting 18% next year. Despite no longer importing gas from Russia, we are still impacted as the market price is driven by their supply, or lack of.
Inevitably, workers are unhappy that their living standards are being hit by rising prices and are seeking higher pay to compensate, and strikes are becoming more frequent and wider spread.
Meanwhile, the Bank of England is raising interest rates in an attempt to prevent a wage-price spiral. Threadneedle Street accepts a recession and higher unemployment are needed to bring inflation back to its 2% target. There is no question that a winter of misery and discontent lies ahead.
The plans that both Liz Truss and Rishi Sunak have are both woefully inadequate and mis-guided. The energy companies know that millions of their customers won’t be able to afford to pay their energy bills, which is why they are pressing ministers to act now and act big.
Truss, who we are told is almost certain to be the next PM, is an enthusiast for market solutions, as such she misses the point totally.
‘There is no question that a winter of misery and discontent lies ahead’
Firstly, the market solutions to the energy crisis will mean the country goes broke. Secondly, the events of the past two and a half years were a turning point. From the 1980’s on the world has been organised along neoliberal lines, based on long and complex global supply chains, privatisation, deregulation, small government, weak trade unions and a dedication on the part of independent central banks to keeping inflation low.
Post Covid and war in Ukraine, the world is likely to change; self-sufficiency will be the new maxim bringing shorter supply chains in food, energy and industrial components, supported by greater regulation, and possibly nationalisation. Countries will shy away from reliance on autocratic regimes. The most seismic change could be a shift the balance of power away from capital towards labour.
Voters will no longer accept being the victims of a country’s foreign policy. No longer will governments be able to be interventionist overseas and non-interventionist domestically.
Covid showed that there was a need for the state to be involved. Furlough created a precedent which voters expect to see continued as they face spiralling energy costs. The public is now seeing the value of government intervention, which is why they have embraced Labour’s call for a freeze on energy bills.
‘Furlough created a precedent which voters expect to see continued as they face spiralling energy costs’
The problem we have is that supply-side inflation is very difficult to deal with. The energy crisis we are experiencing now are little different to that of the 1970s, both of which were based on geopolitical issues (1) (2).
How do we deal with it? Well, you can stop using the goods/commodities that are causing the problems.
How? Well, just stop, or find an alternative. The problem is that it will take time, perhaps 3 to 5-yrs to find an alternative, and we can’t simply stop.
Rising interest rates does nothing other than creating more inflation and misery.
As interest rise the cost of borrowing for everyone including businesses rises, too. To compensate prices go up, and hey presto more inflation.
‘The problem we have is that supply-side inflation is very difficult to deal with’
As people’s mortgages cost more their disposable income falls. Of what is left the cost of heating and energy takes an increasing share, leaving many in poverty. Even those better off will stop consuming ‘luxury’ items such as eating out, leading to closures and unemployment.
The old saying, ‘when you’re in a hole stop digging’, came to mind when last week, in Jackson Hole, Federal Reserve chairperson Jerome Powell said the Fed must continue to raise interest rates, even though it will ‘bring some pain to households and businesses‘.
This has the feeling of tokenism, doing something is better than doing nothing! Just like the BoE.
As is the case here, wages in the US haven’t kept up with inflation; Powell even admits this will get worse, as higher interest rates slow economic growth and result in ‘softer’ labour market conditions, I.E., lower wage increases and fewer jobs. In his words, ‘these are the unfortunate costs of reducing inflation‘.
‘Rising interest rates does nothing other than creating more inflation and misery’
Inevitably some see this an opportunity. Commerce Department figures show that corporate profits are booming, with profit margins at their highest since 1950. Inflation has enabled them to claim they have to raise prices due to the rising costs of materials and labour.
It is suggested that the biggest single unique source of inflation in the United States is the pricing power of corporations.
Big business has the power to lobby in their own self-interest. For example, even though the Democrats passed a 1% percent tax on stock buybacks in the recent Inflation Reduction Act, they weren’t able to go beyond this despite having a Democratic president and control of both houses of Congress. Vested corporate interests still prevailed.
What are they doing with these windfall profits?
Nothing! They aren’t investing and looking to increase productive capacity, they are buying back their own shares to prop up falling prices caused by the anticipated Fed-induced slowdown. In Q2 share buybacks were up C. 7% year on year.
The losers, as ever, are working people and the low-paid, who are the first to lose pay and jobs as the economy slows. Just watch that wealth gap get wider.
Who in the UK is going to stop the doom loop? Well, like it or not, it looks like Liz.
What does she offer? Nothing of substance but she talks a good game:
- In the West Midlands she told them; ‘I will support businesses to get our economy firing on all cylinders – delivering growth and opportunity in the West Midlands and beyond.’
- In an article for the Daily Mail which she wrote; ‘My immediate priority will be to put more money back in people’s pockets by cutting taxes.’
- In East Anglia, she said; ‘If elected prime minister, I will turbocharge the economies of places like Norwich, Great Yarmouth and across East Anglia, by unleashing the private sector with tax cuts and better regulation …’
And woe betide any rational people like me who fear inflation, and the impact it will have on the population and the overall stability of the country; ‘I don’t agree with these portents of doom. I don’t really agree with this declinist talk. I believe our country’s best days are ahead of us.‘ Let’s hope that’s in my lifetime!
She told the Sun on Sunday ‘There is too much talk that there’s going to be a recession, I don’t believe that’s inevitable. We can unleash opportunity here in Britain.’
Potential cabinet members seem equally unhinged; David Frost who could have a senior role obviously doesn’t believe in net zero, blaming the policy for high energy prices. To the delight of right-wing commentators, he wants to be rid of the ‘green crap’, suggesting that gas prices will fall, and ministers can concentrate on the really important stuff instead.
This is the old mantras being relayed to the grey old men who represent her electorate. Its Brexit II dismissing gloomy facts as ‘project fear’. Can we forget Johnson decrying ‘the doubters, the doomsters, the gloomsters’ while claiming the ‘pluck and nerve‘ of the British people would ensure a prosperous future. I guess you could give him the benefit of the doubt as he didn’t say when!
‘To the delight of right-wing commentators, he wants to be rid of the ‘green crap”
The ‘believe in Britain’ mantra has the added of blocking off the opposition, as anyone who points out a problem is ‘talking Britain down‘. This might seem ridiculous but it’s been highly effective changing the polarity of the debate and framing any opposition as anti-British doomsayers.
Just remember when you can’t afford the heating or are skipping meals, it’s not real, it’s only crisis talk by people like me who don’t believe in Britain.
Her rival, Sunak, despite his obvious wealth, seems to have more understanding. The FT reported that, at a husting, he said that it would be ‘complacent and irresponsible not to be thinking about the risks to the public finances‘.
The FT continued saying; ‘During the Q&A, not a single Tory member mentioned the cost of living crisis, other than a question on better home insulation. The biggest applause came for Sunak’s stance on cultural issues: ‘I want to take on this leftie woke culture that wants to cancel our values, our culture and our women.’
The FT summed up how unrepresentative of the population the people who will decide our next PM are, saying: ‘Some have said the Tory leadership contest is taking place in a parallel world to that inhabited by many voters, and on Tuesday party members turned up in Bentleys and Porsches to hear Sunak’s pitch.’
What you won’t hear Liz say is that it’s our energy supply system that is making things worse. But it is; Deutsche Bank analysis shows that annual consumer price inflation for gas and electricity in the United Kingdom is forecast to average C. 80% this year, compared to an average of 40% across the 19 countries that use the euro (3.
In addition, our deregulated markets allowed smaller energy companies to proliferate, last year 31 went bust, forcing millions of customers onto the books of bigger suppliers, and to pay higher bills.
This the fault of the government who designed this mess. Henning Gloystein, director of energy, climate and resources at Eurasia Group said, ‘Many UK retail energy providers weren’t real energy producers. Instead, they bought electricity and gas in the wholesale market and then sold it on to retail customers like households.’
‘During the Q&A, not a single Tory member mentioned the cost of living crisis’
European countries have tighter regulations on suppliers, Gloystein said, including rules designed to shield them from sudden price spikes.
The prices we pay are subject to a cap, adjusted every 6-months, soon to be reduced to 3, meaning that bills rise more quickly in line with wholesale costs.
Our lack of storage has exacerbated the situation, partly caused by Centrica closing our largest gas storage facility in 2017, though it is in discussions with the government to reopen the site. Europe has more storage capacity, and has been rapidly filling it.
Klaus Müller, the head of Germany’s network regulator, Bundesnetzagentur, said they were ahead of their own target to fill gas storage facilities across the country, which were just over 83% full on Tuesday. The target is for 85% by 1 October. But a 95% target is expected to be reached only if industries and households make cuts of about 15%.
As we lack the buffer that Europe has built our natural gas contracts for Q1 2023 are C. 7% more expensive than European benchmark contract prices as we have to rely on ‘real-time flows’ of gas , according to Tony Jordan, director at Auxilione.
Besides a nonsensical supply system and little storage capacity, the government has been slow to offer troubled households any real support. In May, the government announced a £15 billion package of support, including a £400 ($482) credit to 29 million households from October, which will be spread over six months.
By comparison, France has capped electricity price increases to 4% until the end of the year.
How, and when does all this end?
It will end badly; we are already seeing increasing numbers of workers striking, and, despite union bashing in the right-wing press, polls show that most working-age Britons back them.
- According to YouGov’s poll, a majority of ‘red wall’ support the renationalisation of the energy industry.
- A majority of Conservative voters are in favour of allowing councils to buy up empty properties and provide more social housing.
This will be the tip of the iceberg, I can foresee civil unrest on par with the Poll Tax riots. People have been used and abused by the Tory’s for too long.
‘It will end badly’
I give Truss 12-months. By which time she will have hung herself. The Tories, ever mindful of their rightful place in government, and with an election fast approaching, will ditch her.
What might come next? Boris will be a name on many Tory MPs lips, assuming his past misdemeanours don’t disqualify him. Or, perhaps the Tory’s will split, with the lunatic fringe joining forces with some form of revamped UKIP, and led by the terrible twins, Johnson and Farage, forming our first Fascist government as opposed to quasi ones.
Whatever, it isn’t going to be pleasant.
‘Someone to blame
Someone to shame
Someone not you can claim
Go back to pass the parcel
And follow the leader’
Notes:
An extremely comprehensive piece from Philip this week, and just about as gloomy as it is possible to be; the next few years promise to be horrific, with one commentator asking if this is the end of discretionary spending.
With 70% of pubs and hospitality venues apparently facing an existential crisis, and the BoE fanning the flames by raising interest rates, there has been no sign of compassionate conservatism during the Tory leadership marathon.
Truss looks the answer to a completely different question, but that didn’t stop the old buffers braying along; Philip’s articles during the Boris era were often incredulous at some of his behaviour and chutzpah.
I sense the Truss period will be an increasingly unpleasant and acrimonious time; civil unrest will surprise nobody. I’m pretty sure nothing I could say would hold a candle to his preamble:
This week we look at inflation, the energy crisis, and consider it in the context of the UK.
Supply-side inflation is always difficult, especially when it’s based on what is an essential commodity. For the life of me I can’t see how a policy based on raising interest rates does for anyone other than rentiers. Central banks seem blinded, they have no other tools, therefore they might be best served leaving well alone. All they will do is squeeze the life out of economies, ensure a recession, with the only winners being rentiers, again!
This is a political issue, the only way to solve it in the short-term, i.e. the next 2-3yrs is for governments to step-in. France is a good example, capping the increase at 4%, not 400!
The UK reaction is out-dated, and shows a fundamental misunderstanding of the situation. Tax cuts, small government, are the total opposite of what is required.
As Covid proved, whatever your political creed, in times of crisis you need more government not less. Tax cuts, if they are a solution at all, are a long-term solution to an immediate problem. However, they are a scatter gun putting money in the wrong places, whereas direct help can be targeted.
The Tory leadership contest only serves to highlight how far detached from reality the majority of the party is. They are like Thomas Newton in “The Man Who Fell to Earth”, strangers looking around, blinking, unable to comprehend what they are seeing, and then retreating into their own world.
Truss will be a total disaster, she is deluded and dangerous. I am beginning to understand why people prefer Johnson, he seems to have some compassion and understanding.
Her stated policies will do nothing to help alleviate people’s suffering this winter. After Covid lockdowns, and the non-appearance of levelling-up I believe this will be the straw that breaks the camels’ back, and will end in social unrest.
Truss will be a short-lived disaster, the party will soon turn on her when it becomes clear she will lose an election. Where we go after that is unclear. Can the Tory’s see the error of their ways? If not I foresee a hard-right alliance, and fractures appearing everywhere.
Gloomy? Yes? Pessimistic? Yes. I am just the type Liz hates. The thing is, if it looks like shit, and smells like shit, it probably is. And this definitely is.
Oh, and expect stock markets to fall. Where else can they go?
Musically, we start with Bowie and ‘Cat People (Putting out the fire with gasoline)’, which is exactly what central banks are doing. We finish with my old friend Siouxsie, the queen of gloom, and ‘Playground Twist’
@coldwarsteve
Philip Gilbert is a city-based corporate financier, and former investment banker.
Philip is a great believer in meritocracy, and in the belief that if you want something enough you can make it happen. These beliefs were formed in his formative years, of the late 1970s and 80s
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