economonkey

So, that was it. The worst recession in living memory is, if you believe the latest government think tank reports, now over. The recession that Alistair Darling said would be the worst for 60 years (and he recently revised that estimate upwards to 100 years) has passed with nary a whimper in real terms.
True, if [...]

This is an article that I could have written a few months ago, when the Bank of England stated its intention to begin ‘queasing’. But it has become rather more relevant now that one of the pronouncements of the G20 summit is that the International Monetary Fund (IMF) will itself begin to ‘print’ additional SDRs (Special Drawing Rights, effectively the IMF’s own currency) which its contributor countries can draw down in the shape of dollars, euros, etc.

Note my use of the word ‘print’ in the above paragraph. The days when first world countries used the printing press to increase the volume of money in circulation have long gone, assigned to eras such as Weimar Germany. Paper and ink are still heavily in use in Zimbabwe, of course, but for countries like the UK, where the notes and coins in circulation account for only about three percent of the total ‘money’ in the system, we’re really talking about digits on a computer screen.

Even so, while the phrase ‘quantitative easing’ sounds nice and strategic, in reality it has a similar effect to printing addition bank notes and throwing them out of the Bank of England’s window into the street.

To take a step back for a moment, let’s look at the main blunt instrument used by policy-makers to control the velocity of money and the rate of growth of an economy: interest rates. Set the base rate low, goes the received wisdom, and people will ‘invest’ their money rather than leaving it idle in a bank account earning nothing (or, depending on the level of true inflation, less than nothing). If the economy starts to run away from itself and bubbles form in a particular investment market, interest rates can be raised, increasing the appeal of saving and reducing the relative gains to be made by investing in speculative markets.

I’ve written in a previous article about the various concepts involved in economic inflation and how it can affect the value of your money, your wages and the things you buy.

The opposite of inflation is deflation, which I’ll explain in this article before going on to discuss the probable and possible situations in the UK for the next few years. The ‘deflation versus inflation’ argument is more important in the UK today than it has been at any time in the last 30 years, so it’s worth thinking about in some depth.

So, deflation. If inflation is a general increase in prices and/or wages driven by the greater availability of money (whether ‘real’ money or debt), then deflation is a general decrease in prices and/or wages driven by the much reduced availability of money. This is widely considered to be a bad thing.

But isn’t a reduction in prices a good thing? At a simple level, yes it is. Your wages – assuming they aren’t cut at the same rate – go further, your savings buy more over time and there’s less of a ‘treadmill’ effect where people feel that they are working ever harder to chase money to buy the same purchases, as happens in inflationary environments.

But politicians and economists fear deflation for a good reason. Fundamentally it stops the economy dead in its tracks. Nobody will buy something today that they don’t really need if they know it’s going to be cheaper tomorrow. This applies to companies as much as to individuals, which means that investment stops, companies cut back their staffing levels and unemployment rises. We end up with a deflationary spiral that’s every bit as traumatic as a highly inflationary one.

Deflation also makes it harder to pay off the principle amount of any debts, because wages tend to go down in nominal terms but the amount owed remains the same. This, incidentally, is why some newspaper pundits are now calling for deliberate inflation in order to wipe out the value of many people’s (and the nation’s) ill-advised debts, though such pundits are ignoring several important points about the banking industry’s methods of counteracting inflation through charges and wider interest rate spreads.

You might remember that about ten years ago, when the current government was elected, Gordon Brown made a big deal about his strict new rules for government borrowing which were all part of his ‘no more boom and bust’ promise. Anyway, now that we’ve come to the end of the biggest boom in British history [...]

“Economy at 60-year low, says Darling. And it will get worse.” So says The Guardian which also quotes the Chancellor as commenting, “People are pissed off with us.”
Quite.
The penny at last seems to have dropped, with Alistair Darling stating that the economic times faced by Britain and the rest of the world “are arguably the worst they’ve been in 60 years [...]

So, despite enjoying a decade of prosperity in one of the world’s richest countries, it seems the British middle classes have suddenly found themselves mired in debt and are struggling to make ends meet. It’s easy to be at least a little sympathetic to skint people who have over extended themselves and perhaps lived a [...]

I am writing to enquire whether you have any vacancies on your strategic board for someone of my talents. I realise that it is a little unorthodox to apply ‘on spec’ for such a high-ranking position within your organisation, but I believe I have the necessary skills to further increase the profits and assets of Big Bank Plc. In this letter I will attempt to demonstrate my knowledge of the challenges and opportunities in our marketplace.

1) Who are our customers?

I understand that our most lucrative customers are those with the least awareness of financial matters; indeed, the less numerate they are, the better. Rather like the dear old PM, in fact.

If they don’t know the difference between APR and AER, if they fail to read the small print in their credit contracts – not that it matters, as I’m sure I have the necessary legal skills to make such text impenetrable – and if their limited attention is grabbed by an ‘introductory’ rate, then they are exactly the kind of people we need to target.

I think that if we closely follow that other highly successful model of commerce – drug dealing – we won’t go far wrong in attracting and retaining the right customer base.

2) How do we get people to take on more debt?

It sounds like a daft question, doesn’t it? Money is the notes and coins in your pocket, the numbers on your bank statement, the limit on your credit card. You use it to buy things. Simple as that.

However, as with many seemingly daft questions, this one is worth scrutinising more carefully. For instance, why are those particular notes and coins ‘worth’ something? Why can’t we make our own? Why do we need money in the first place? How do the electronic numbers in bank accounts become the ‘real’ notes and coins in our hands? All of these questions and more spring up when we ask what money is.

Not all the questions can be answered in one short article, but we can lay the groundwork here. We’ll start with a basic premise and work upwards. Here goes: money is a medium of exchange.