In the Eye of the Storm

House prices are once again on the rise. London has seen the fastest increases to date with money slowly filtering out towards the rest of the country. Mark Carney, the Bank of England Governor, pays empty lip service to interest rate rises. Even if they were to go up tomorrow the damage is already done. It was done when they bailed out everyone, slashed rates and embarked onwards with Quantitative Easing. Raise interest rates tomorrow and we would be back where we started only worse. However history shows that central banks are always reluctant to raise their rates in a timely manner, even when they are raised they stagger it over months and it then takes months or years for the broader economy to feel the restriction of credit once more and fall back into a recession.

The 21st Century will view the central planning of money as an absolute disaster and free market alternatives will replace the current defunct system, good money always drives out bad and Government money is never good. Many Central Banks are using their faulty inflation rates as guidance as to when interest rates should rise but their metrics are critically flawed. 

Inflation is not just the price of staple goods such as milk, televisions, cheese or oil. If the price of the stock market rises that's inflation. If house prices rise that is inflation. If Gold rises that is inflation. If the price of a Picasso masterpiece rises, its inflation. If we take these items into account, the hard assets, then inflation is rising at increasingly faster rates. Its important to understand that the prices of these items are inflation the Central Banks just choose to ignore them in their indexes.

Another problem facing the planners is that interest rates can't rise or at least not by much. Many Governments don't want them to rise as it impacts on their already woeful deficits. It would hurt their tax receipts. It would ruin the "feel good" feeling in the run up to the UK election. People are beginning to stretch themselves once more and pile up debt on the low rates that are currently on offer. Mark Carney blames everything but loose monetary policy the real fuel to the fire that sparks off an asset price bubble. The same reasons that were cited during the previous boom are once more trumpeted to causing the recent house price rises:

• Too much Demand
• Too little Supply
• Not enough building

The real reason is excess credit. Its loose monetary policies that are causing house prices to rise once more. Demand and supply dynamics have changed no more than back in 2009, the difference is Central Banks have turned on the taps once more to release more credit and banks are once more recklessly lending to anyone with a pulse. Same with Gold. Same with art collectables or with vintage cars, the free market can not produce hard assets to keep up with inflation. Electronics and consumer goods hide real inflation as capitalism does such a wonderful job of providing these services in ever greater quantities at lower prices. We are not building more land. Houses are getting built but its the land they sit on that causes them to rise in value. 

So we are in the eye of the storm and if I'm a betting man it will go on for a few years at least. "Get it on tick" is once more a way of life for people. Once the tanker moves in one direction it generally holds course for longer then people can call it. When will the crash come? No one knows. What format will it take? Again no one can say for sure. All we do know is that the fundamentals are progressively deteriorating. When the 2000 stock market bubble popped the central banks re-leveraged the system, cranking down interest rates to low levels. Then 2007 and interest rates went to zero and monetisation actions were also taken. So once interest rates rise (if they do) then once more they will see-saw back to zero but it will be very hard to get credit moving with all the extra problems. Again monetisation of debt will happen, this time will see even more draconian manoeuvres. We could get "Bail-ins", similar to a Cyprus situation where money is simple taken from the wealthiest account holders (or even across the board) to try and bail out the system; a direct attack on freedom. One thing is for sure, it won't be pretty and it won't be moral.

The asset price bubble is global. This pod-cast with Krassimir Petrov highlights Asias problems and how it is creating reckless bubbles. House prices are rising there even faster than the UK, yet no doubt the same reasons are given, limited supply, too much demand not enough new builds and so forth. As mentioned near the end of the pod-cast central banking really does change the morality of people for the worse. Excessive credit does great harm to us all.

Tory Election Boom

"The panic appears to be over. Now is the time to get worried."

William Keegan, Author and Journalist

It's been over three years now since the formation of the UK Coalition Government between the Conservatives and Liberal Democrats. Austerity was supposed to be on the agenda but the reality differs, there is still budget deficits, increased spending and lots more debt. Private debt still remains at historic high levels. As all politicians always do, with an election due in less than two years its time to engineer a boom based on a policy of reckless monetary and fiscal policy. Public debts are over 1 trillion pounds, yet mainstream politics has a consensus towards further spending.

The conservatives have recently announced the "We'll help you buy a house" scheme to try and inflate the recently lagging housing market, creating the voter "feel good" factor. Monetary tightening is mentioned, as it has since the crash of '08, but words do not match the actions of our monetary overlords who continue with loose money and low interest rates. BoE recently appointed Governor Mark Carney is all for abandoning inflation targets, instead shifting the focus towards Growth, a move mirroring the priorities of the Federal Reserve. Janet Yellen has been given the the nod by another big spender Obama. Stuck within the confines of academia and Government agencies she makes a good choice to a leader who has not attempted to tackle the deficit and whose legacy will be a disaster for his successor.

The Eurozone still has too much debt, the plasters continue to hold but like any temporary measure are making the problems worse. America continues to raise the US debt ceiling as though it has validity. If they keep raising it at will then how can it be called a ceiling. Cuts from all corners of the Globe are hypothetical.

Fundamentals, as always, are key. A panic can reside but the fundamentals always come back into the picture. Golds bull market is not over, its just on its next leg, like it has been over the past decade plus with various ups and downs just like any Bull market. Governments can't defy economic reality of spending money they don't have - bond markets, currencies, commodities - will all catch up with their reckless spending. Running budget surpluses is hard work for Governments only when a party feels they require to obtain economic credibility from the electorate does a political institution follow such a path. With all parties in the UK promoting spend-onomics there will be no immediate return to that concept.

I never believed this current Government would sort the mess and they are doing what I thought they would, dodging the real issues, tinkering on the fringes with little progress to show for it. Expect more short term polices. Tackling long term issues are no good for politicians precious votes. Ironically the short term Tory boom will please Keynesian's who will proclaim our troubles are over. In reality the problems continue to compound. 

The Euro, Past, Present and Future

“Our role as central banks is to guarantee price stability in the Eurozone. I’m convinced that the future of the euro is fundamentally linked to the support of the population, and that this support depends on the confidence Europeans have in the stability of their money.”  

“The mandate is deeply rooted and stems from the lessons learned during the seventies and eighties," he said. "It’s when a central bank ensures price stability that it contributes the most to durable growth.”  

“Governments must take on their responsibilities and not subcontract them out to monetary policy.” 

Jens Weidmann, Bundesbank President (article)

The persistent Euro crisis has garnered much media attention in the aftermath of the credit crunch. With benefit of hindsight many have concluded that the Euro was always doomed to fail from the start, with both sides of the political spectrum fervently believing they were correct all along. In Britain, right wing thinkers always believed that 'Brussels' never had a solution and should stay out of Individual Nations affairs. The left initially thought the Euro to be a good thing, seeing old currencies as symbols of Imperialism, but would later object to the Austerity imposed on member States. The left during the seventies were opposed to the common market, while the right were in favour. When the European Exchange Rate Mechanism was in use it was the right who were generally in favour. After the pound was ejected the left could claim it was a disaster made by the Tories; after the event had occurred.

You can see the confusion and schizophrenic nature from both ends of the political spectrum. History has shown both camps to support one form of monetary union, but then to oppose another. There has never been a thorough discussion on the Euro in mainstream politics with either end of the spectrum unable to rationally determine what the real issues are. 

Claims have been made that "You can't have monetary union without political union" or "A Nation and its Government should always have control of its own money supply", to "You need the power to devalue in order to regain competitiveness". All are stabs in the dark, as these were never raised as issues back when the currency was created. Only when catastrophic events have transpired do these so called shortcomings come forth. Like all events in history, it is never a simple yes or no, and requires a rational look of what caused the current situation to arise.

During Bretton Woods I, when the US was on it's quasi Gold Standard, they pegged the dollar to gold allowing only foreign central banks to redeem their dollars for gold. With increased deficits by Kennedy and then by Lyndon Johnson this spending had to be paid by someone, therefore the government does what it usually does, it printed money to pay the difference. When the Bretton Woods agreement was created the Keynesian's proclaimed that redeemability of the dollar for gold would cause no issues as institutions would never need to claim. Unfortunately for them they didn't count on Jacques Ruff advisor to former French president Charles De Gaulle. 'They run deficits without tears', thus Ruff advised De Gaulle to call the Americans bluff and trade in the paper promises for something that the American Administration couldn't create out of thin air. Others followed suit.

The rest as they say was history. Bretton Woods I was abandoned, in which we moved to the current global monetary system we still have now. The erratic fluctuations of the currency markets during the seventies accompanied with widespread financial turmoil prompted many European nations to look for solutions to stabilise trade, thus the chaos became one of the prime reasons for the single monetary currency created two decades later. (Taken from a previous post)

After the post war era Western Europe progressively moved towards economic integration. Many reasons exist, to combat American dominance, to unify against Eastern Europe, to enable greater trade - it was always a strength in numbers philosophy. 

Prior to the Euro, Europe had the ERM which attempted to tie the various currencies on the continent to the German D-mark; which at the time was one of the hardest currencies in Europe. It was doomed from the start as fixing currency exchange rates is a foolhardy scheme. It was price fixing and like any attempt to fix market prices it fell apart in the end. The principle however was to maintain low inflation among member nations and to stop political pressure to devalue in a race to the bottom. The right wing in Britain joined the ERM under Majors Government, despite the Majority Conservative Euroscepticism we see now. 

When the Euro was created nations who had an association with soft currencies clamoured to obtain membership. Its easy for complaints to be made towards the Euro now when austerity is imposed, but when the single currency was introduced it was seen as an economic boon by such countries.  Nations such as Spain, Greece and Ireland benefited greatly from the introduction of the Euro. Inflation fell, interest rates stabilised, capital investment spending increased. The whole point of the Euro is to ensure inflation is kept low by borrowing inflation credibility from the old Bundesbank who had a long history of doing just that. Interest rates fell across Europe in part due to this factor. Bond markets could therefore ask for a lower rate of interest on Greek or Italian bonds as Monetary Policy had been handed over to the more competent Germans. Historically Mediterranean countries would erode the value of their bonds with expansive monetary policy, but when these powers were absolved to the ECB, markets lowered prices for such Government debts.

A similar mechanism happened here the United Kingdom, whereby monetary automonoy was taken out of political hands. In 1997 the new Labour Government gave interest rate decisions to the Bank of England, a supposed neutral organisation. The idea was to take such decisions away from politicians who had in the past set interest rates to create inflation, and/or economic booms during election times. Both sides of Parliament, agreed that this was a good policy. The rest of Europe did something similar to the above, it handed monetary policy over to the Bundesbank. Another example of the contradictive nature of mainstream thinking.

The principle in keeping inflation low is a good thing. This spurs capital investment and production so that citizens can obtain better living standards. The more stable a moneys purchasing power is, the better off its people will be. The faster a currency devalues over time, the poorer its economy and people will be.

Many of the countries however still worked under the spend now, act later mentality. Government and consumer debts kept rising along with off the record liabilities. The European Welfare state was supported by this illusion, along with heavy Government corruption, rigid regulation or absurd employment traditions. The Credit Crunch was just the spark to highlight all these underlying issues to the market that has since demanded the bankrupt countries get their house in order. Markets have been trying to do this by asking for higher rates of interest on bonds; increased risk means the return an investor requires should be higher. This is the markets price mechanism trying to force bankruptcy/spending reform upon the political system. Without this dynamic the old political system tricks people to believe that an easy fix is within sight, allowing Government spending to get out of control. The problem is whenever these prices have been raised, a bailout fund is announced in an attempt to bring these prices back down. Initially the markets predictably put money on the new policy but not for long as markets know the underlying issues are only compounding.

The quotes taken from the Bundesbank President are exactly the reason the Germans have such a strong reputation in financial markets for running a sound currency during the Post War Period. It also highlights cultural differences between the Germans and the Mediterranean countries, who historically had Governments that pursued high inflation for their political failings. The periphery countries want all the benefits that accompany the common currency, low inflation, low interest rates, real terms capital investment, while at the same time oppose the fiscal constraints that help foster such benefits.

The simple problem with the Euro, or any money controlled in a monopolistic manner, is its openness to abuse. Money should be provided, like all goods and services, by a free market, competition, consumer sovereignty and choice. Thats the real issue behind the Euro and the solution not just to its ills but all problems that will arise with Government controlled money. 

We are witnessing the end of the Euro as many analysts/pundits/commentators are proclaiming, who state it should never have been created (usually these were the same people who were saying the UK should have joined, or were selling their Dollars and buying Euros a few years back). It is impossible for any commentator to predict what Governments will do, however I believe the Euro has the potential to prosper from recent events, only if the Germans maintain a hard line. This will entail Government defaults, bank collapses, members leaving, but if they decouple the currency away from political pursuits it will be a sound currency relative to others.

The real crisis will be if the Germans do not uphold a hard line. Many are distracted at the crisis occurring in Europe but are unaware of the crisis building up in nations who are overstretched, but still have monetary autonomy. Countries like Japan, the UK and the US are the ones who will have real problems. Their spending is also out of control, but the politicians are just using monetary tools to mask their problems. Interest rates for Government bonds are low in such countries because the market knows they will just monetise their debts if there are no buyers. Its certainly not because they are any more creditworthy. However this postpones any reforms that need to occur, with the situation getting worse. Look at Japan. Its debts are astronomical and will no doubt have great problems during the decade.

The Euro, if it is managed correctly, will be a strong contender to challenge the Dollars world reserve currency status. If this occurs, contrary to popular opinion, I believe the UK will eventually join as we continue to mismanage pound sterling. 

As mentioned in previous posts, I believe the 21st Century will be a great Century for liberty, individual freedom and human innovation. Statism, Monarchies, dictators have all had their time in the West. Such nations will increase individual freedoms as the states role diminishes over time. It will be an evolutionary process, not revolutionary. I also believe that the Euro may be a step towards the abolition of Government control over money. Its a pseudo gold standard that has the potential to stop endless devaluations for political means. As the state shrinks, people will realise the state is not required to help run our lives with money also falling under a similar observation, we don't need our Government to issue money. The Euro may well be run by Government officials, but its not tied to a single nation or a unified political system. Therefore the Euro, to some extent, decouples political affairs from monetary policy. We are a long way from free market money, but the Euro could be the start of a long path towards such a goal.

We have no Solutions Yet

"Don't be fooled. Don't fall into the government's trap. Lenders and debtors will sit at the same table, having agreed to skin the people alive."

Aleka Papariga, Greek Communist Party Leader

The ECB and IMF have yet again decided to lend Greece more money in order to 'avoid' contagion which would lead to a tsunami of defaults across the financial world. The Greeks can't pay but who cares, I don't think any Western Government can. 

'Tough talking' British Prime Minister Cameron told Ed Milliband during this weeks PMQ's Punch and Judy show that if Labour were in power, then we would have a Greek crisis. Yet what is the current Governments approach? Inflation is rising. The BoE have now admitted they don't give a monkeys about Inflation. Despite it being more than double their official target they have stated that more QE (money printing) may be 'required'. The rate of inflation is now predicted to stay above target for the next two years. Of course, what they don't say is they plan for it to stay around for the whole decade.

David Cameron is a showman, all talk and no action, a modern day Ted Heath, as I previously said before he came to power. He has been in power for over a year, yet the Government continues to spend more money, 

"During April and May, the first two months of this fiscal year, the Government borrowed £27.4bn according to figures released last week, up from £25.9bn during the same months in 2010."

The majority of people are wrong that Cameron will solve our problems. A valuable lesson in life is that people are not able to see trends. They see the current time-frame, and extrapolate. When Cameron talks of 'austerity' and 'cuts' the public believes we will be back to boom times again soon. Cameron is no Thatcher. The Governments loose monetary policy may inflate tax receipts, but spending will rise as costs always catch up. Thatcher raised rates, lowered spending and let business go to the wall. Until this happens, then the current rhetoric is all fluff.

History is repeating itself again. Britain in the 1970's had some of the highest inflation in the developed world. Fast forward 40 years and its the same again, we are world leaders in the Western inflation league table. Germany meanwhile has less than half our inflation rate, and their earnings, unlike ours, are rising in real terms,

"Real earnings, that is, the price-adjusted gross monthly earnings of full-time employees, rose by an average 2.0% in the first quarter of 2011 on the same quarter of 2010. As also reported by the Federal Statistical Office (Destatis), nominal earnings increased by 4.1% in the first quarter of 2011 compared with the first quarter of 2010. Consumer prices were up 2.1% in the same period. The increase in real earnings was the second highest since the beginning of the time series in 2008, while that in nominal earnings was stronger than ever before in the given period."

Yet Germany imports every drop of oil, and the majority of food, just like the UK. UK wages in real terms continue to decline,

"Average pay rose at an annual rate of just 1.8% a year in April, according to the Office for National Statistics (ONS), while the consumer prices index was running at 4.5%."

Inflation is a monetary phenomenon. Keynesian's will point to the symptoms of Inflation and tell the public that these are the causes, for example increases in workers wages. Government friendly economists state that if wages do not rise, then inflation should be subdued. It doesn't take an economist to work out this is just plain illogical thinking. The above clearly disproves the theory. German wages are rising twice as fast, but the inflation rate is half as much. By any scientific measure this Keynesian law wouldn't even hold at primary level education. 

Now is a time to reign in loose monetary policy, but not for the UK, its time to print more. If history is a guide the UK will have negative wage growth and high inflation for a long time, just like in the seventies. Worse still, we will accept it. Its a culture thing. Similar to the Greeks, as the quote at the top of this article reads, believing their problems are inflicted by others, when in reality it is all their own reckless doing. They wasted money for years.

The rise of union strikes have also become more prominent. So rather than lacing up our boots to go work, like the Germans, we decide not to turn up to work, compounding inflationary pressures, eroding our global market competitiveness and lowering real term wage growth. Marvelous! I believe people are free to do as they please. Strikes however are always a waste of time and do not raise peoples living standards. It seems to me that their living standards are already quite cushy compared with many,

"The calculations show that a mid-ranking teacher on £32,000 a year will receive a final salary pension that is the equivalent of having built up a £500,000 pension pot. This is 20 times higher than the average private sector scheme, according to figures from the Office for National Statistics."

Rather than sulk, how about they spare a thought for future generations. State pensions will be non existent, despite the fact we pay National Insurance, the greatest ponzi scheme in existence and the new pension standard is to be put on a private contributory scheme (if you are lucky) that is no where near as previous non-defined schemes. 

Previous generations fought a war, underwent rationing during the 1940's and 1950's, left school at 15, worked for 40-50 years and got a paltry state pension, if they lived that long. Meanwhile many boomer's were the first generation that got a free University education, gained greatly from credit booms from substantial asset inflation in items such as houses and to top it off were given gold plated pensions. A generalisation, of course, my mum left school at 15, never went to University and won't have a gold plated pension, but for many of her generation this was not the case. However this is how economies should work, the next generation has it better.

Subsequent generations now have to pay for their University education. They will never see their state pension as it keeps riding on further into the sunset. Private pensions are minimal in comparison. This is not how the next generation should have to live. But hey, that's governments, they take money from the future to buy off present day votes.

Circumstances will improve, the free market will see to that. As the Government creates more problems the only way to solve them will be to expand the price system and allow free markets further reign over the economy. It always happens. The end of this current age of stagflation will result in further moves towards free markets. Just like the last stagflation. In the current climate I see no solutions yet, just more compounding of our current problems. The solutions will come, just not quite yet.

BoE 'Inflation, Thats Our Job'

"The MPC's chosen approach has been to accept a temporary period of above-target inflation, rather than seeking to hold inflation as close to the 2 per cent target as possible at all times."

Charlie Bean, Member of the BoE Committee

News it may be to many, but for readers here this is not news. This is how Governments work. Goalposts move. Targets change. Inflation is always present. People looking for action on Inflation from Central Banks are looking in the wrong direction. These people create inflation, not control it. With private and public debt out of control they are 'secretly' creating inflation.

When I have mentioned previously of interest rates going to double digits during the decade this may seem scary in the current time-frame. But by that time  debts will have been drastically erroded by the damaging effects of inflation over the years to come. Negative interest rates, where inflation out paces the savings rate is here to stay for some time. When interest rates hit 10%, expect inflation to be at least twice that rate.

The central banks primary function is not to fight inflation, or to sustain economic growth. Its job is to prop up the whole fragile fractional reserve banking system. Its aim is to ensure financial collapse does not occur. This means re-leveraging the system back up and and trying to inflate their troubles away. It takes a while for people to become sick of inflation. Britain had terrible inflation for over a decade during the seventies. No one did anything as the public didn't feel strongly enough over the issue for some time. Its going to be the same again. Inflation is here, 4.5%, double the targeted rate, but no one in the public wants to do anything about it. Most people are so heavily in debt, they want it.

The Bank of England's comments will worry no one. The words may even reassure people. The deflationists are wrong, as they have always been since the post war era. With Central Bankers running a monopoly on the printing press, how can we ever have deflation?

Where is the deflation?

"The Chinese government is expecting its economy to expand around 8% of gross domestic product in 2011, same as in recent years, but it has raised its inflation target to around 4%, indicating Beijing isn't willing to sacrifice growth even though fighting inflation is a top priority.

State television reported the new numbers Tuesday, citing Zhang Ping, the head of the National Development and Reform Commission. Next year's inflation target is a full percentage point higher than this year's target of 3%."

News that China will raise its Inflation target

If you were to believe the experts it is deflation we have to fear. Its just round the corner. Its a battle we must win. A depression must be avoided which apparently is caused by deflation. In the real world people are seeing costs rising all the time. Not just in the West but in emerging economies also. The Chinese authorities have raised their inflation targeting metrics in order to keep their bubble, sorry growth, moving up. A rule of life is governments always bend the rules. Its sets them. Free markets allow people as individuals to set the rules. Participants mutually trade with one another under an amicable agreement. The state takes at will and by force. Inflation is one such example, it benefits no one in society in the long run, only the government over the short term.

The fact that the target has been moved upwards should not be a surprise. This is what's going to happen everywhere, across the globe. Here in the UK our Inflation has risen yet again. Its now been above the target for over a year now and what are the "inflation fighters" (that is Mervyn King and his MPC comrades) doing about it, Nada. Zilch. They have already raised their inflation targets, they just haven't told the unsuspecting public. There's more price increases in the pipeline:

The increase in VAT from 17.5% to 20% that will come into effect next month will be used to "mask" more extensive price rises according to accountants at KPMG.

They claim almost two thirds of retailers and consumer product manufacturers plan to increase their prices by more than the planned VAT hike in January.

Martin Scott from KPMG told the BBC why he believed retailers would raise prices by more than just the VAT hike next month.

All this inflation is causing Government bond prices to stay high. Well I say high, but we haven't seen anything yet. They will go double digit over the course of this state induced disaster. Double Digit may seem high in today's environment buts that's what you would have thought when Interest Rates were single digit back in the seventies. In the US they eventually went above 20%. Ouch!

Well at least the banks are ok now. They were small fry. We have moved on to more impressive bailouts like, err, countries? Ireland, Portugal - what about when Italy and Spain need assistance? They in turn get bailed out by Germany or France or even the UK. Hang on, aren't we bust also? Yep. Fractional reserve banking, fiat state monopoly money, you have to admire it. The Governments legalised ponzi scheme. No one has the money for any of these bailouts. Deflation will never happen because Governments know this would be the end and a collapse of the system. Therefore they will print money. They will raise inflation targets. They won't even tell people they are doing this. Oil is at record high once more. Just like with any unwarranted inflation, peoples living standards are falling. Prices rise and real wages don't keep pace. 

Through all the bailouts and enlightened interventions, nothing has been solved. Its worse than before the crunch. Its the quiet before the storm, just like prior to the market collapse of 2008. Everything was fine until it happened. That's the problem with economic collapse caused by government mismanagement. You can't predict it, you just know it will come. And when it comes its always too late to act. We won't hit bottom until the market is allowed to cleanse itself, but that isn't going to occur. Until then, just know that inflation will always be there, always rising, even when it may seem its not. Deflation is just the Governments smoke screen.

Inflation - The Governments Free Lunch

"While our case has been aggravated by the illegal sanctions imposed by the Western powers, rising food prices are a world phenomenon because of the use of biofuel"

Zimbabwe's Finance Minister, Samuel Mumbengegwi 

Recent figures for inflation have been released for the UK yesterday and it doesn't make pretty reading for the Government. CPI up to an annualised rate of 3.7% with RPI standing at 5.3%. Again Mervyn King blames the increase on VAT, the fall in the pound or the rise in oil prices. Hate to break it to him but these are just symptoms not causes. The causes can be laid directly at the Governments monetary policy, that is printing money, record peacetime deficits and artificially low interest rates. Thats what he should have told the new Chancellor George Osbourne. Scepticism amongst the city seemed to be the other part of the story, that is they are not buying the above reasons anymore. How long will it be before the general public cottons on that inflation is going to be a real problem going forward. The only way inflation is going to come down, as the Governer would have us believe, is if the government stops printing money, hikes interest rates and gets their books in order. But none of this will occur.

Continued debates regarding which algorithm to use have resurfaced. RPI-X, RPI, RPI-Y? What about using a tool we all know works, the free market. Supply and Demand. Prices. But that would be all too easy. The Keynesian witch doctors couldn't promote their economic religion of the 20th Century. 

There are a lot of common myths surrounding inflation in most instances, the symptoms are portrayed as the causes. Symptoms such as unions, 'overheating', OPEC, speculators - the list goes on. In a nutshell inflation is actually created by making more money, its that simple. Zimbabwe hasn't got inflation because of their stock market or the Unions or OPEC, its got price problems because Robert Mugabe ran out of money and turned to a printing press instead of balancing the books. Of course he lists the same reasons as all governments do. Zimbabwe shut down their stock market recently by stating it was helping to cause runaway inflation. The best stock market in the world is there, along with the best housing market, gains we could only dream of. However there is a catch. The Zimbabwe dollar, in which these assets are valued, is worthless. Same policy as our current Governments are pursuing only with more moderation.

Excess Capacity? Now theres something Zimababwe knows about. But yet the well versed lines we are told is that we can't get inflation because of this excess capacity. People can't demand pay rises, again a symptom, because of this fact. When in history did a country sucumb to high rates on inflation when their economy was strong? Excess Capacity exacerbates inflation, it doesn't dampen it. So while the deflationist scream 'excess capacity', I say 'look at history' (Remember Stagflation?). Incorrect lessons are learnt, fallacies are drawn from history. By the same logic, Zimbabwe should have solved their inflation problem. I have been tracking events there from around 2006 when their inflation stood at a 'mere' 1,000-2,000%, and continuously there has been more and more slack in the economy but yet inflation has gone through the roof, it can't even be measured anymore. People stopped turning up to work because the price of the bus fare was more than they got paid at work. People get confused that the unemployment caused during Thatchers Policies in the early eighties helped dampen inflation when in fact all she stopped doing is spending money the Government didn't have and buying her way out of trouble like previous Governments had. She let market forces take over which lowed consumer prices, and let inefficient state entities fail. It wasn't excess capacity, it was a combination of market forces and the relative restraint of money creation.

Oil keeps going up and up. It does in Zimbabwe. So much so that they put price controls in place. Mugabe blamed oil speculators or OPEC, again the symptoms. It was caused in exactly the same manner as we have now, excessive monetary expansion. Supply and demand issues will occur at some point in the future as we hit peak, but not now. Global demand is weak and people are struggling to buy as much of it. So that price of £1.22 a litre in the UK, we can thank our MPC and our government. Not the oil companies as the Government would have you believe.

Unions or the lack of them. We won't get inflation because we don't have unions due to the wage price spiral they cause, again its a symptom. As more money gets created the publics demand for money becomes greater as it takes more money to buy the same goods and services. However pay demands can equally occur in the free market, for example people move jobs similar to India where they have greater inflation expectations as their Government is weak thus creates too much money. People can just as easily drive up their own wages. We will see more unions and strikes in the future, but don't confuse this with a cause of inflation. I disagree with the concept of unions but there is one point I agree with them, they don't cause inflation, they just play catch up to rising prices caused by weak incompetent Governments. Suggestions of public sector pay freezes does not bode well for future industrial relations, when inflation is on the rise.

In 1997 when Labour granted 'independence' to the BoE for controlling interest rates this was hailed in the city and by many economists, but I disagree. Their targets are still set by the Government. It's laughable that the BoE is independent with it's main remit to target inflation however this figure is now nearly twice as high as what they target, it's not even within their bounds. The 'recovery' or 'it will subside' are reasons given to not take action, but the bank doesn't have a remit on these issues. Its aim is to take steps once inflation goes outside its bounds of 1-3% that the Government dictates. So while Mervyn King and Co. sit on their hands it won't be long before the creditability of the central bank is called into question. A year ago the bank predicted that inflation would now be 0.7%. A 3% margin or error is quite large if you ask me. The record reads quite clearly - it didn't take until 2011 for inflation to rise above 1.2%.

Frustrated savers sit and wait, questioning the policies officials take. Of course its one great moral hazard and the Central Banks are masters at setting up future disasters. The reason savings rates are so low is because commercial banks can lend from central banks for virtually nothing. Unlike genuine savings (capital) this is just pure inflation, so why pay retail savers with real capital more than the central banks rate? The commercial banks can then take this money and lend it for the long term, a common trade is to borrow short term at 0.5% and take this money to buy long dated bonds, say 10 year gilts, which have a higher return (inflating the bond bubble). The difference becomes the profit, money for nothing. Of course the problem occurs when Central Banks have to raise rates. How will the banks deal with this sudden shock to funding? Bailout Mark II? Private Banks then lend to the public and the Government at higher rates because of inflation and default risks in the future. So unless the Government and Central Banks step into the place of private banks then they will never ultimately set market interest rates. 

Media types will have you believe that this is not a plan, that is to inflate away the debts, and its Central Banks believing that inflation will subside. Don't believe everything you read in the news, like I mentioned above there is a remit on the bank which they are quite clearly ignoring. Much damage will be done by trying to inflate, its not just a case that the prudent among society are punished to bailout the irresponsible. The prudent peoples savings erode, incentives are lost to save and capital begins to flee, into foreign assets or Precious Metals. Keynesian's would have you believe we have a liquidity problem, when it fact its a capital deficiency issue. If you have a printing press liquidity is never an issue, so by inflating all officials are doing is adding gasoline to the fire. It compounds the problem. I think people are aware something is not quite right with the monetary system, printing money, giving away free money, people are asking "isn't this what Banana Republics do?".

I warned that we can't devalue our way out of trouble, making the point that prices always catch up with you. The UK is now beginning to find this out. Companies and individuals get lazy but when prices come back to bite, suddenly that purchasing power has gone. Capital gets eroded, saving rates come under pressure as people's demand for money rises to buy the same goods for more - two building blocks for prosperity. Peoples inflation expectations grow. Capital becomes harder to form as prices rise and people struggle to forgo consumption. Company profit margins come under pressure. A vicious cycle can occur without action from a strong Government. Could we have a fall in inflation? In the short term I don't dispute this, when cuts are enacted we could have some slowdown but we won't go the distance and take our full dose. If we couldn't take the pain in 2008 why do you think our leaders will take it going forward with the economy in worse shape. 

There is only one trend and that is expect more inflation, but not the relative calm inflation we have seen over the previous decade. Over the new decade inflation will get out of control, the policy makers will go to far. With the same deflationary market forces relatively subdued it's going to get messy. Inflation, its historically the Government great free lunch.

"Inflationism, however, is not an isolated phenomenon. It is only one piece in the total framework of politico-economic and socio-philosophical ideas of our time. Just as the sound money policy of gold standard advocates went hand in hand with liberalism, free trade, capitalism and peace, so is inflationism part and parcel of imperialism, militarism, protectionism, statism and socialism."

Ludwig Von Mises

Strike!

"The banks are fucked, we're fucked, the country's fucked."
Anonymous Cabinet Minister speaking in regards to the UK

"The last time we built up this much debt was when we were fighting ... half of Europe. This time we've done it on our own. It's quite a chilling thought. This is my worry is that it's like the man in the casino has lost it all on red and you know ... what's to stop Gordon putting it all on red all over again?"
William Buiter ex MPC member on recent events

The first UK Gilt tremors were felt this week. It was the first failure to sell non-inflation linked (regular) government bonds since 1995, with only 93% coverage. Back in 1995 it was 99%, which shows the significance of this event. Comments made earlier in the week by Mervyn King, the Bank of England's Governor in regards to worrying levels of government debt and how he may not wish to print as much money as first anticipated spooked the market. So how significant is this event and what does it mean for Britain in general? Is this a sign of things to come for many Western Governments? Many commentators may dismiss what happened as a one off or just a fact of bond auctions, however this would be very naive. It would be correct to state that this is only one failed auction, however context is key. This is not 1995.

Estimates for the following years budget deficit has come in at around £150bn - £200bn, which for a small nation such as Britain is a huge amount of money that the government needs to raise. Along with the shrinking economy, with last quarters contraction revised to -1.6% GDP, giving an annualised figure greater than -6% GDP, these billions listed above could turn out to be even worse, as Britain begins the path towards bankruptcy. The fact that a Gilt auction has already failed this early on, and by such a large margin, should be of great worry. As mentioned before on the blog, the governments bond markets are a classic bubble as market forces are being tampered with, along with irrational investment behaviour. Will the Government let market forces burst the bubble now? I doubt it. Like all bubbles it will continue to grow, going against all market fundamentals.

The other day, bond yields went up as the government struggled to sell them. This is market pricing in supply and demand where there was a lack of demand, therefore the government has to raise its returns for potential investors in order to attract buyers. The market forces where yields go up should be allowed to happen. In the Euro zone recently there is now a large divergence on the returns given to hold say German bonds, to say Greek bonds. Greek bonds are now having to offer far higher returns to compensate for the fact that there is more risk in the country, specifically default. Despite what the Greeks may say regarding the Euro, or their wish to have control over monetary policy the current situation is actually beneficial to the Greek public. It ensures the Greek government can not print money to buy government debt, thus artificially reducing short term rates on government debts. This of course encourages the Government to take on more debt as they can print money, thus holds the rate of interest artificially low over the short term so they can increase spending thus piling up more debt. However there is a cost to all this. Specifically this is how massive inflation begins, by the governments spending getting out of control thus printing money to pay for it. If the Greeks still had the Drachma, this is what would happen leading to high inflation and in Greece's case probably currency destruction.

As they are on the Euro, they consequently don't have this control, rather it seems to be the more traditional hard money countries such as France and Germany that have greater control. German officials and the Bundesbank understand the problem, and they know printing money can not help along with huge government spending in the long run. These ECB hawks know we have to take the medicine now allowing market forces to work and ensure real capital is used for government debt, not this 'new' money. This is the problem Britain finds itself in now, however Britain has the pound so it can do what it likes unlike Greece. It still has full autonomy over the printing press. The recent lack of buyers now casts doubts over the governments ability to raise the £200bn or so in money over the next 12 months. And not only the next 12 months as Government deficits are going to be a feature for a very long time, even with huge spending cuts all the other governments debts that are yet to be felt will be coming into play over the next 5 - 10 years. So where does this leave the Government?

It has already embarked on the policy of QE, printing money to buy government Gilts with an initial figure of £150bn mentioned by Mervyn King to buy this debt, with statements when this policy was implemented that this figure could rise. So this is where we come onto how the Government always distorts the markets. The statement that they made sent a signal out to the market, "If there are no genuine buyers of government debt, then we will buy it". Hence the first market bond sale after this statement was made saw huge amounts of buyers with the auction being oversubscribed. The market is now playing the governments game, a game of the last one to hold the debt will get burned, and the market is thinking that will be the Government. In the future all Bonds will be bought by the Government, with all other sellers rushing to sell. It's a classic Ponzi scheme, where the whole pyramid exists on the premise of selling to the bigger fool.

Many nations are embarking on this path, America, Japan even the traditional hard money country Switzerland has followed this route. QE will just blow this bubble up further causing more damage in the long term, as this will become a vicious cycle if it is not stopped soon.

At the moment inflation is not a concern so the bond investor does not demand huge returns. With the Stock market in the tank, other assets falling in value and deflation on many peoples minds Government Bonds look like a good bet, a steady income stream 'sheltered' from the financial dislocations. Therefore people have piled into Gilts. However as government debts have been growing in certain nations, contracting economies and huge economic imbalances in these countries, market forces are trying to set higher returns, specifically for nations with these risks. However with the new intention for expanding the money supply to "combat" deflation, QE is now monetising many of these bonds, in effect creating artificial buyers. Similar to the recent housing bubble, real demand was never there, it was just people flipping houses to one another with artificial cheap money as the driver. The market anticipates this new QE artificial demand, by lowing rates as there is less risk on default as more buyers have entered the market - seemingly increased demand, limited supply. This is where the real trouble begins, the point we find ourselves in now. The UK money supply has actually been expanding over the past few months even more than during the credit boom, which is highly inflationary under an environment such as this. This will eventually feed through to the economy into consumer prices. With the currency devaluing (inflation) there is a decrease in the demand for bonds that are not inflation linked as the future becomes more uncertain. Usually under this environment yields would rise to attract buyers, however with the Government becoming increasingly strained just paying the interest payments (and with the fear of no buyers thus in effect bankrupting the government) they wish to try and keep these yields down. This in turn means the government has to buy more, creating more artificial demand. This in turn feeds back and increases the money supply, thus creating more inflation with investors demanding even higher returns of compensation. With the monetary base getting ever more out of control it leads to investors fleeing Gilts even more, thus eventually leading to no genuine buyers, with the only buyer being the Government. Such a cycle feeds back on itself, creating an even more desperate state of affairs, and worse economic conditions.

We are only in the early stages of the above. In theory, this could be stopped now with the Government abandoning QE, but I doubt it. Not with the huge deficits to come and the lack of Global Capital. The above describes the very process of how the Central Banks believe they can beat the market. However they can't, as the above details, they can only make it worse and the longer they try to 'beat' the market the worse they make the situation. In the event that things go to far they will destroy the currency, the lifeblood of the economy, thus impoverishing us all. Prices are there for a reason. Economists will tell you that when yields come down, that the Central Banks have saved us and proclaim that QE has worked. It can never work and is doomed to failure. The longer they try and hold the short term price down, the higher it will shoot up eventually and the longer it will stay there. Just like any market price, it's there for a reason - basic supply and demand. Kings new hard line will not stay for long. He will keep the QE program on track, with the initial £150bn just a foot in the door. There seems no political will to scale back Government spending or accept the terms of an IMF loan just yet.

The basic process described above is how all governments go broke. It begins with a little, but eventually takes over the whole market similar to Zimbabwe. With statements continually made that they will be able to "turn off the tap" or "mop up the excess", this is simply not true and misleading for many members of the public. Countries like Ireland, Italy, Greece etc may complain with the hard line the Germans have took, but they are doing them a favour in the long run, some tough love. We may well see the EU take exactly the same route described above, I do not discount that. However at least we have witnessed some rational opinions expressed again by the Germans, many whose Great Grandparents and Grandparents lived during the Hyper-inflationary Weimar period. The UK should let their Gilt Prices rise. This puts a check on excessive government spending by the market rationalising on who is solvent and which countries are sound. If there are no buyers, let there be no buyers. This will either stop government spending altogether or let the country go bankrupt. The short term pain would be far better than bankruptcy by the printing press, drawing out the process and leading to a much worse collapse.

The Currency Wars

A new world currency? Russia and China have expressed their recent concern over the Dollar monopoly of reserve status and have mentioned the possibility of an alternative, not associated with any nation - a new world currency. The Austrian School of economics predicted this back in the 1960's, along with the creation of a European Common currency that would supersede this step. We saw the Euros creation back in 1999, are we about to witness the early stages of the Global Currency? The Austrians said this would be the ultimate desire of Governments, the ability to inflate with no apparent currency fluctuations occurring masking the debasement. Timothy Geitner put his foot in it, and contradicted Obama by saying it would be a good idea. The Euro will probably fragment at some point in the future. Nations such as Greece may opt out, thus regaining their autonomy over their currency with the ability to inflate once more. We will have to see. Back around six months ago I said currencies will disappear or merge, with the Icelandic Krona the first victim, there will no doubt be many other interesting twists and turns over the coming decade.

More Carry trades will continue unwinding over the year. The Yen carry trade that we witnessed unwind last year, causing the collapse of the Icelandic Krona, the fall in the British Pound and the spectacular rise of the Yen, should still unwind some more this year, as more of these currencies come under pressure along with the increasing scramble for cash. The Eastern European Debts have been unwinding too, with these debts bought in Euros, Yen or Swiss Francs beginning to undo as the hryvnya, Forint or Zloty have devalued. There will be lots of civil unrest to come in these countries, Latvia and the Ukraine will not be the last to succumb to protests. We will continue to see more gyrations of the worlds currencies, as "beggar thy neighbour" policies continue and carry trades continue to unwind.

UK Bubble RIP

"The City of London is pretty much finished ... and if you're alarmed by the recent slump in sterling, you ain't seen nothing yet. In a decade, you're going to be importing oil again - what's going to hold sterling up when you're a net importer of oil? You've already got a balance of trade deficit. I've sold all of my sterling ... there are no fundamentals to support sterling as far as I can see"
Jim Rogers, Chairman Rogers Holdings

"But if investors no longer think the UK's banks are at risk of collapse, they then look at our other vulnerabilities - such as public sector borrowing which is rising very sharply because of the costs of the bank rescues, dwindling tax revenues and the need to spend our way through the economic downturn ... If international investors fear our credit isn't what it was and are selling pounds, we should hardly be surprised."
Robert Preston, BBC Journalist

Since the end of the First World War, Britain had been in a state of terminal decline. Recently, however, the worlds financial markets were loosing confidence in Sterling as the Treasury could no longer balance the books, with ever increasing government spending that could no longer be paid for. By Autumn the pound was plunging, inflation was rampant and the Prime Minister was trying to keep his party together after just recently obtaining the job. The year was 1976. The UK in the end had to go cap in hand to the IMF to avoid economic collapse, the first Western Nation to do so, and only Western nation up until Iceland's recent decline. It ushered in a wave of right wing Thatcherist economic policies which prevailed up until the present day and changed British politics and society forever. The Labour party after the crisis subsequently split between the old left who remained, and the Social Democrats, who later abandoned the Labour party and joined forces with the Liberals to form the Liberal Democrats. Labour also morphed in subsequent years, from the early eighties the 'loony left' politics of Michael Foot, all the way to 'New Labour' a 'Third Way' led by Tony Blair, who won power in 1997 and for the first term emulated Tory spending plans.

Without North Sea Oil and Gas as the seventies came to an end, the UK could have become an economic wreck, and Margret Thatchers monetarist policies in all probability would have failed putting the final nail in the coffin. The UK's trade of balance would have collapsed without the support from the Oil and Gas revenues. In the end, the UK experienced a renaissance and shook itself out of the terminal decline it had found itself in. However in 2008, the UK again showed strains with investors questioning a new generation of Labour Politicians, wondering if history was repeating itself again. Expansive fiscal measures had been announced, with huge government deficits being forecast and the balance of trade in once again, a perilous state. The UK bubble had burst and with it, she resumed her long decline after the illusionary reprieve of the last 25 years.

Over the past 11 years the Labour government has won successive elections, which no other Labour government in history could achieve. Tony Blair won a historic third term and with it, the party had gained the trust of the people regarding economic affairs. It was no surprise that there was a reversal in opinion regarding the economic competence between the Conservatives and Labour which had once favoured the former, now favoured the later. 'New' Labour was nothing more than a Thatcherist project, one that the Iron Lady herself would jokingly remark was her greatest achievement. Labour had increased the Plutocracy that was seen under Thatcher, with little change in the social apparatus of the country. They continued with Tory Policies, such as PFI, the selling of state assets or Privatisation and the push towards the services industry, in particular the over zealous belief in financial services. Yet this 'Third Way' obtained some false perception among the British public, that social responsibility or progress was greatly enhanced under 'New Labour policies', even though it was evidently Thatcherism but under these new false social pretensions. Of course like all socialist governments they were tied to their socialist dogmas, with the incessant need to 'help' people under the guise of the states apparatus. Their spending deficits became more prominent after the honeymoon period, with needless spending and increasing bureaucratic waste. As the global economy began its historic downturn, the government was now exposed for all its true colours. Relative poverty was as bad as ever, hospital deaths from new super bugs had increased with some of the worst standards in Western Europe. The decline in state pensions had not been reversed since Thatcher pegged them to CPI rather than average earnings, which had now become officially the worst in Western Europe. No real social progress had been made, and the economy had become even more imbalanced with government finances in a dire shape with all the one time privatisation cash cows now all but gone. It would soon be 1976 all over again.

So why did the UK have such an extraordinary post 1970's renaissance? The biggest free gift which gave a healthy revenue stream was the North Sea Oil and Gas that had been discovered during the Sixties. This in effect saved the UK from a perilous plight. It enabled Thatcher to follow in the lead of Federal Chairman Paul Volcker and implement Monetarist Policies in order to contract the money supply and cut government spending, suppressing inflation that was causing havoc in the UK's ability to conduct trade. Without the Oil and Gas revenue stream it is very hard to say if she would have been successful, as even with this, there was still huge unemployment and civil unrest. With sound monetary policies Thatcher could then next turn her attention to the Unions who had held successive governments to ransom during the stagflationary seventies. A move towards a more dynamic workforce was critical in positioning Britain for the global challenges that would evolve over the coming decades. The battle against the 'Shock trooper' Union, specifically the miners lead by Arthur Scargill, was subsequently won by Thatcher and meant that the Unions were subdued. The reformation of tax, meant external capital was once again flowing back into Britain, fueling further economic expansion. With tax cuts came the problem of raising sufficient government revenues and Thatchers solution was privatisation, the selling of state assets for dirt cheap prices giving the government a once only large cash flow. Without getting into the flaws or the advantages of privatisation, this is what happened in the UK, but it is a once and once only money machine. The state was slowly selling off its family estate. In 1986 the 'Big Bang' policy deregulated the financial markets and in came the all conquering US Investment Banks, along with further external flows of capital. Thatcher had begun reinvigorating London as the financial center of the World once more, like the bygone age of British hegemony at the turn of the century.

Manufacturing was in solid decline, indeed recession, for the subsequent two decades. The turn towards services was deemed to be Britain's area of strength after the fiasco of Nationalising the Car Industry during the seventies which ended in disaster. An age of retail had begun, consumerism ruled Britannia, with Marks and Spencer becoming the darling of British Retail. Margret Thatcher had a very conservative childhood with strong family values and thrift. Ironically she presided over Britain's largest credit boom of its day, a new consumerism had taken over the nation. Of course all credit induced booms end in bust and this was no different. After unpopular polices such as the Poll tax, and mutiny within the party, Thatcher was ousted and replaced by John Major. As the bust continued Sterling collapsed as it was ejected from the ERM. The subsequent years of 'Tory sleaze' and their old tired public image lead to the publics rediscovery of the opposition. Under Tony Blair Labour had become 'respectable' once more and with amendments to the party manifesto, mainly the abolishment of Clause IV regarding nationalisation, and a pledge not raise income taxes, Labour were voted in on a landslide.

Once in power Labour initially adhered to the policies of Tory tax and spend. They continued with further privatisation of state assets. They ramped up the PFI projects they had once opposed while in opposition, with further increase in off book government debts. During their time North Sea Oil and Gas reached its peak production, with the UK exporting it in ever greater quantities. With the abandonment of Coal during the political clashes of the eighties, the UK drew more of its power now from Gas fired power stations rather than turn to Nuclear options like the French. While in Norway they kept a substantial portion of their Oil and Gas revenues in the Government Pension Fund, for future generations to enjoy and to smooth out the coming decline, Britain in typical Anglo Saxon consumerism spent it all. Debt began its exponential climb upwards as the UK reached its economic peak, as people racked up further debts just at a time the UK would be ill equipped to pay them in the future. More external investors flooded the island with capital, from Russia the Middle East or Asia, London was the nations financial artery, directing more money into a heavy debt laden economy. This further fueled more credit expansion, with the need for less internal savings. The financial liberalisation of the 1980's from the Big Bang came to a pinnacle as British banks expanded more and more, with traditional conservative Building Societies moving into the realm of risk. Northern Rock, with 125% mortgages, or the 'Together Plan', became the dynamic dynamo of London, what would soon be the Enron of the UK.

During this time the Labour government had been increasing spending ever more, running continual budget deficits, with ever more rosy growth projections from the 'prudent' chancellor Gordon Brown. As Oil and Gas production began to decline and with ever increasing reliance on imports, Britains trade of balance deteriorated further. Warning signs were there, but few wanted to acknowledge them. This was after all the new dynamic Britain, who its people believed had become a strong economy with solid foundations. However as the American housing market bubble began to unwind, so did many financial instruments and institutions. Britain had uniquely positioned itself precariously reliant on finance, only Iceland had an even more foolish model. With the global slowdown, came a collapse in the main British Industries, finance, housing and retail. The service economy where we could all become sales people, skills and trades had been outsourced, with everyone getting cuts and no real value being created, was beginning to unwind. Sterling was beginning its decline. Unfunded government borrowing was beginning to occur once more. The UK was not bankrupt, but began on the path towards it.

Just like the seventies where key manufacturing industries were nationalised, the UK government had once again made the same costly errors, this time with the Banking system. RBS, Bradford and Bingley, Northern Rock and further shareholdings in other banks will paralyse the sector for years to come. Without the luxury of being the worlds reserve currency or a major currency such as the Euro, Sterling can't afford to be exposed the way it has. Even with Sterling falling week on week the politicians continue to make more mistakes, recently with the policy of paying the nations mortgages if there is personal loss of income. This will Compound the issues with the battered banks they have nationalised. More money will be needed to pay peoples mortgages and as the banks can't liquidate their assets, will need further government capital injections - a double disaster as the economy tailspins out of control. Indeed, the UK is even beginning on the road to loosing its triple A credit status. It will just be a matter of time before it does. External capital flows are drying up, with Sovereign Wealth Funds questioning their Investment strategy in the once 'dynamic' island. Rather than waiting for the Pound to collapse, Gordon Brown has begun looking for alternatives to try and shelter the UK from the coming decay.

The current government, just like the populace, are in a state of denial. Over optimistic growth forecasts are continually used, with Growth projected to rebound sharply to 2% at the end of 2009. A quite fundamentally flawed figure. I'm not sure the leaders truly appreciate the risks they are currently running with increased government debt, and a further deteriorating economy with no credible plans to reverse these current conditions. The suggestion that they won't be able to balance the books until 2016, shows what a mess we are in, as it uses these optimistic forecasts. With ever decreasing options the Bank of England has begun with suggestions of the nuclear option, namely the printing press, as the options addressed above used by previous governments have all been exhausted. The media are under the illusion a Japan like scenario could occur, however we are not the worlds largest creditor nation like Japan was then, and do not have a trade surplus. Japan tried to inflate like we are now, but failed due to these reasons. We however will succeed and face years of stagflation once again, just like the seventies. The governments are continually propping up the private sector, but no one is asking the real questions. Who will prop up the government? Even mainstream commentators understand the implications, as Robert Preston states just before the Nuclear Option was announced,

"Some analysts see this as the start of the money printing-presses being turned on with a vengeance, a deliberate attempt to stoke up inflation to reduce the real value of all those excess debts. I'm not sure we are there yet - though it's probably only a matter of time."

UK Government debt is set to explode over the next few years, with off book debts being realised as unfunded pension liabilities, Bank Loans, PFI and declining energy revenues further impair Britain's finances. Central Banks and governments have begun explaining the false dangers of deflation, however they know perfectly well they are preparing for inflation, one that will make the seventies mild in comparison. The reduction of interest rates is further evidence of this, by giving no incentives to save, just the further encouragement to spend and upkeep the velocity of money. Victorian thrift has long gone.

Of course there are no economic fundamentals to support the UK, as the quote at the start states. All of the above, PFI, nationalised finance, unfunded government spending, privatisation, pension liabilities and off book debts, will now go into reverse. Just as they exacerbated the boom on the way up, they will exacerbate the bust on the way down, all compounding with one another over the coming decade.

However, when history is examined Britain has a long and successful functioning liberal democratic system, one that was able to survive the excessive debts obtained during the wars with France, and with it rose as the global power. With debts in excess of 200% of GDP, the UK did not default like many other nations did. It instead paid all the bond holders even in a period of extraordinary deflation during the pioneering phase of the Industrial Revolution. She rose to become the greatest creditor nation the world had seen, spearheading what we now associate as modernity. As Europe succumbed to Fascism during the crisis in capitalism throughout the 1930's, Britain maintained its traditional liberal democracy. These historical factors alone won't prevent the decline of Britain. It involves a painful transitionary period, which politicians are notorious for preventing. Even with this there are no guarantee's as Britain is not what it once was in 1815 and the world is a much different place. We may have seen a high in the UK in our lifetimes. We may be witnessing the beginning of terminal decline.