In the panelled Court Room of the Bank of England, just below the ceiling, is
a dial linked to the weather vane on the roof of its Threadneedle Street
headquarters.
Two centuries ago, when it was erected, the vane told the Bank, quite
literally, which way the wind was blowing for the economy. The strength and
direction of the winds accurately predicted the arrival of ships sailing up
the Thames to the port of London. Every time a ship arrived there would be a
surge in demand for cash to pay for the cargo. So the weather vane enabled
the Bank to make sure there was enough money available.
In the past few months the weather vane has been revolving more furiously than
ever. The storms blowing across the global economy are buffeting Britain and
other countries. Two big and malicious weather fronts – the credit crunch
and a surge in world oil prices – are combining to create the toughest
economic conditions for decades. The world, which for 15 years has been an
economically benign place, is suddenly looking harsh and unpredictable.
These conditions are also, for the moment at least, producing a profound shift
in the global balance of economic power. While America, Britain, Europe and
Japan – the old powers – are struggling, plenty of other countries are
making hay.
The credit crunch has crippled the West’s banking system at a time when record
oil prices, which reached nearly $140 a barrel earlier this month, double
their level of a year ago, are resulting in a massive transfer of wealth
from the oil consumers to the oil producers: $1,800 billion (£926 billion) a
year, according to Goldman Sachs.
While Britain’s builders are suffering their deepest downturn in living
memory, it is boom-time in the Gulf as the oil-rich states spend their
revenues on stunning new skyscrapers and executive homes and apartments.
Last week a dispute by fuel tanker drivers in Britain produced desperate calls
from the government for motorists not to panic buy petrol. In Spain the
situation turned nasty. A strike by lorry drivers protesting over record
diesel prices led to empty supermarket shelves and factory shutdowns. One
driver who broke the strike was badly burnt when his lorry was set on fire
by the protesters. Other drivers have had to have police escorts. In
Portugal the government bought off a similar strike last week by cutting
fuel taxes and toll charges.
If it isn’t fuel, it’s food. Food prices have jumped by 55% in the past year,
according to The Economist index, with the biggest increases in staple
products such as corn, wheat, rice and soya beans.
For most consumers this means unpleasantly higher prices, but for the world’s
poorest it means what the World Bank has called the “silent tsunami” of
famine and death. There have been violent protests at food prices across
Africa and Asia.
The credit crunch, meanwhile, continues to wreak havoc on western economies.
On the stock markets it has become a race to the bottom as investors rush to
unload their shares in banks and housebuilders.
Although there are tentative signs of improvement in the American economy, US
house prices continue to dive. A crisis that began with a Klondike rush into
so-called sub-prime lending – loans to “ninja” borrowers (no income, no job,
no assets) – and an even bigger rush by the world’s banks into sophisticated
financial instruments based on these same dodgy mortgages have produced what
the International Monetary Fund has called the biggest financial shock since
the great depression.
That shock has produced a mortgage famine for new borrowers in Britain.
Lenders who, a year ago, were bending over backwards to hand out cash, now
no longer have the funds and are strictly rationing their loans. The result,
said the Royal Institution of Chartered Surveyors last week, is the sharpest
downturn in transactions in the 30 years that it has been surveying its
members. House prices are falling in an echo of the slump of the early
1990s. Housing in Spain, Ireland and other western countries has also turned
down sharply.
What has caused these changes, how bad will the pain be and how long will it
last? A FEW days ago, at its headquarters in the 16th arrondissement in
Paris, the Organisation for Economic Cooperation and Development unveiled
its latest thoughts about the world economy. The OECD, which started life in
1948 as the body that distributed America’s Marshall aid to war-ravaged
Europe, now counts all the West’s advanced economies among its members.
The OECD has seen plenty of global economic crises during the past 60 years,
but probably never anything quite as unusual as this one. What Jorgen
Elmeskov, its head of economics, describes as months of “market turmoil”
have left the outlook “particularly unsettled”. For an organisation whose
natural language is understatement, this shows how worried it is.
The highly unusual thing about the turmoil is that while the OECD’s members
are skirting dangerously close to recession, those who are not members of
the club are enjoying an economic party. America is growing by barely 1%;
Britain, Europe and Japan by roughly 1.5%. But in the rest of the world,
growth rates of more than 7% are common, particularly in China, India and
commodity-rich nations such as Russia and Brazil.
There have been big transfers of wealth to oil producers before, most notably
in the 1970s. Rarely, though, has the world looked as lopsided as it does
now.
The unbalanced nature of the global economy is one reason why things are so
tough. In the past, a slowdown in the advanced economies hit demand for raw
materials and energy and brought down their price. The oil producers of Opec
held sway during the 1970s, but the power to set prices essentially rested
with western consumers. That has now changed dramatically, as Elmeskov
pointed out.
During the long upswing from the early 1990s, globalisation was a boon to
western consumers. Countries such as China provided cheap manufactured goods
which helped to keep inflation low. Not only that, but rather than spending
all their new-found wealth these countries saved a sizeable chunk of it.
This generated a world-wide glut of savings which in turn helped to hold
down interest rates in the West.
Now, however, the West is seeing the flipside of the rise of China, India and
the other emerging giants. Their demand for oil, food and materials “is an
important factor behind high commodity prices”, the OECD says, and it is
sustaining “tensions” in the markets for these basic products. We have had
the benefit of cheap imported goods; now we are paying the price in higher
prices for essentials.
We will be paying that price indefinitely, according to the Treasury. While
speculation may have been a factor in the recent sharp rise in prices,
consumers are going to have to become accustomed to paying more for food and
energy than in the past, it concludes in new research.
“Prices are likely to remain higher than their historical averages, if lower
than today’s levels, with continuing and perhaps more frequent shocks,
driven by continuing strong demand and a continuing slow supply response,”
the Treasury said. “This demands a strong response at a national and
international level to protect the poor and continue sustainable economic
growth.”
A rise in the global population from 6.7 billion now to 9.1 billion in 2050,
and the need by 2030 for grain production to rise by 50% and oil production
by a third, underline the scale of the problem.
“The era of cheap food is at an end,” said Tim Lang, professor of food policy
at City University. “We have developed the view that consumers can get what
they like when they want, and it is wrapped in plastic and arrives by truck.
But that recipe is not going to carry on.
“I am not a Malthusian but the issue of feeding nine billion people as opposed
to six billion is a lot of food. It needs land and we’re not making any more
of it. There are no existing technical fixes to deal with the problem.”
What is true of food is, say experts, also true of oil. While mainstream
opinion dismisses the idea that the world is already producing the maximum
that it can – so-called peak oil – all agree that finding and developing new
sources of it will be more difficult in the future.
BP reported last week that world oil production fell last year, despite strong
demand, and predicted that global supply and demand would remain tight for
the foreseeable future. Tony Hayward, its chief executive, blamed political
factors and high taxes for restricting oil supplies.
“When it comes to producing more oil, the problems are above ground, not below
it,” he said. “They are not geological but political.”
Those factors are not going away. Hugo Chavez, Venezuela’s outspoken
president, predicted last week that oil would hit $200 a barrel and blamed
“mismanagement” of America’s economy and the weak dollar. Gazprom, the
Russian energy giant, said oil was heading for $250. Record oil prices are
lining the pockets of the undeserving, whose glee at the discomfiture this
is causing the West is undisguised.
WHEN times are tough, George Soros is never far away. He was the man who set
the seal on Britain’s most turbulent recent economic episode, the “Black
Wednesday” crisis that saw the pound forced out of Europe’s exchange-rate
mechanism in 1992.
Now he thinks western economies are getting their comeuppance for decades of
overexuberance. In his book The New Paradigm for Financial Markets, Soros
describes a “super-bubble” that has been building for years. One aspect of
that bubble was America’s housing market, but the other was an overreliance
on financial markets – what he calls “market fundamentalism”.
“This time, the crisis is not confined to a particular segment of financial
markets but has enveloped the entire financial system,” he writes. “This is
the first time since the great depression that the international financial
system has come close to a genuine meltdown.”
Larry Elliott and Dan Atkinson, in their new book The Gods that Failed, also
lay the blame on financial markets and the investment banks that run them.
Governments, they say, were dazzled by the bankers. “They promised economic
stability, order and prosperity,” they write. “But, instead, the world’s
bankers have delivered chaos, debt and uncertainty – and then blamed the
feeble governments that surrendered control of the global economy to them.”
After the credit boom comes the hangover, which will last. That is why Britain
and other countries are reeling under the impact of the credit crunch. It is
why – although the international financial system may have been brought back
from the brink – the economic repercussions have yet to play out fully.
Is this a rerun of the “stagflation” of the 1970s? Stagflation, the
combination of economic stagnation or recession and high inflation, was
coined by Iain Macleod, the Conservative frontbencher, in November 1965,
when Harold Wilson’s Labour government was struggling with one of a long
series of economic crises.
Macleod, briefly chancellor in 1970 under Edward Heath, died before he saw
true stagflation. After the world reeled under the impact of Opec’s first
big oil price rise in 1973-4, Britain saw inflation climb to 27% in 1975 and
plunged into the longest and deepest recession of the postwar period. The
global “golden age” of the 1950s and 1960s was replaced by something much
darker and more threatening.
Few think that present conditions are remotely as bad. Derek Scott, who was an
adviser to Denis Healey, chancellor in the 1974-9 Labour government,
dismisses the comparison. “I think it is very different,” he said. “I don’t
see a big inflationary threat at present. Most of the dangers are on the
other side – very weak growth.”
While inflation is high in many of the fast-growing economies as a result of
oil and food – on one calculation two-thirds of the world’s population will
be experiencing double-digit inflation this summer – it remains low by past
standards in Britain and other advanced economies.
Figures in America on Friday showed that even record petrol prices have pushed
inflation only to 4.2%, similar to the rise in Britain’s retail prices
index. Mervyn King, the Bank of England governor, is expected to have to
write an open letter this week to explain why inflation on the government’s
target consumer prices measure has risen above 3%. While this is
embarrassing for the Bank, the figure is extremely low by past standards.
Scott, who subsequently became economic adviser to Tony Blair and has publicly
criticised Gordon Brown, also thinks it is wrong to say that Britain is
uniquely vulnerable to the shocks rocking the global economy because of
Brown’s decision to stay out of the euro. “Britain is in a better position
than most other European countries,” he said. Britain’s ability to set her
own interest rates and allow the pound to move up and down provides a
flexibility that other countries lack, he believes.
That may be of small comfort. The next 12 to 18 months will be rough going,
with unemployment rising, businesses failing and inflation uncomfortably
high. Even if it is not a recession, it will feel like one.
Worse, some of the changes will be permanent. The age of cheap food and energy
is over. The days of easy credit will not return for years. A new era has
started with an uncomfortable jolt – and it does not look nearly as nice as
the old one.
