This time last year, I spoke at an event for Fairbridge, a brilliant charity that works to help disadvantaged young people.
I talked about the hideous difficulties facing the world economy, the contraction of bank credit and why everyone should buy When Money Dies, Adam Fergusson’s brilliant book on hyperinflation in Weimar Germany.
I was followed by the FT’s US managing editor Gillian Tett, who explained how we had managed to move from a society in which we mostly trusted our big institutions to one in which we absolutely do not.
Five years ago, we trusted the big banks to keep our money safe and they trusted each other to stay more or less solvent. That’s not the case any more. I went on to predict a period of deflation before a period of much higher than expected inflation. Gillian went on to predict that the next stage of the crisis would involve a collapse in trust between populations and governments.
I’m speaking again this year (with the FT magazine’s Mrs Moneypenny this time) and a few weeks ago I got a copy of the draft invitation to Edinburgh’s financial community. It announced that at this year’s lunch “Merryn Somerset Webb will explain why she was wrong on deflation.” You don’t get much quarter from charities these days.
So why was I wrong? Or, for that matter, was I wrong? At the time, I was looking at the UK banks and seeing a very deflationary scenario. There was no way that it was possible, given the state of their balance sheets and of the capital requirements in place, that the banks could increase their lending. I was also worried that their balance sheets were in even worse shape than they looked.
Both concerns were entirely valid and remain so. James Ferguson of Arbuthnot has a nasty looking table, which shows how far we still have to go to resolve our banking crisis. During a “typical” single country crisis, loss rates as a percentage of risky assets tend to come to around 10 per cent. In Japan, they have so far come to 20 per cent. In the UK in 1989-1993 –what you might call a non-crisis recession – they came to 8.5 per cent. This time round? A mere six per cent. Our banks have barely begun with their writedowns. The upshot is that it will be a long time before they can lend with abandon again. That is clearly a very deflationary influence, as are falling real wages and falling real house prices: people who feel poor and who can’t borrow don’t spend money.
So why are our CPI and RPI so high? Because the deflationary effects of the ongoing credit crunch have been utterly swamped by the flood of money that has been quantitative easing; by the consequent rising prices of global commodities; and by the falling value of the pound (down over 25 per cent since 2007 on a trade-weighted basis). So, instead of getting deflation followed by inflation we’ve had them both at the same time – with rising imported inflation being the thing reflected in our indices. Stagflation, if you like.
So what next? More of the same. The deflationary influences will remain with us for years – and may well be multiplied a hundred times by a new banking crisis in Europe – and it looks like the price rises will too. For starters note that, thanks to droughts in China, the US and the UK, we can’t expect good harvests this year. And bad harvests mean rising food prices.
I should point out that Gillian’s prediction in June last year was entirely right. Look at Greece and you can see that the next stage of their crisis, at least, has been a breakdown in political trust.
But something else interesting is happening there. Along with losing faith in their politicians, the Greeks have lost faith in their currency. This makes sense. After all, if you think that there is a chance that Greece might end up out of the euro, why on earth would you hold any money on deposit in a Greek bank? Instead of taking the risk that you would end up holding a large pile of devalued New Drachma instead of the euros you thought you had, surely you would shift it into a country less likely to see a huge currency devaluation – Germany, Switzerland, or Norway perhaps – or you would swap it for any hard asset you can get your hands on.
That’s why the Greeks are, as the FT reported on Wednesday, fast swapping their euros for olive groves, Swiss francs and gold coins and why the Portuguese probably are too. I mention this simply because hyperinflation usually starts with a sudden loss of faith in paper money. And the reason I suggested everyone read When Money Dies at the end of last year’s talk was because I figured that, given the levels of sovereign debt knocking around the world, there weren’t many ways out. There would be either defaults or more massive rounds of money printing. Either way, at least some of us were likely to lose faith in our currencies. So at least I got something right. I’ll be mentioning that in this year’s talk.