Finally we have official deflation in the country. Now, in terms of economy and jobs and money, deflation is not really a good thing. It means wages will start being cut and we may even see a drop in the minimum wage if things get really bad.
In the short term however, for at least a couple of months, people will have relatively higher wages and things will cost less. Until contracts get renewed and companies push through wage cuts, the Real Wage Index will be a little higher. Unfortunately this will not last for very long because wage cuts will probably be fairly severe. There are two things that people can do in this situation, they can either spend their extra money and boost the economy by reinvigorating the normal supply and demand processes, or they can save their money for when things get bad. The British government tried to boost consumer spending by cutting the VAT before Christmas. Initially this worked, but due to the extensive media coverage, people are actually less inclined to part with their hard earned cash. Similarly, the Bank of England has also dropped national interest rates to 0.5%. This should, in theory, mean that banks can start lending money to each other. The problem is that a bank may be more inclined to borrow money because the repayment is less, but are they as willing to lend the money to other banks if they make less money on it? The drop in national interest rates is also bad for small business owners and pretty much everyone else. Whatever savings we have are not earning us any money and with people losing their jobs, whatever money they did have stashed away is being used up.
It certainly could be argued that by lowering interest rates, the government was trying to encourage people to spend and borrow instead of to save. However, like before, there is a problem with this. Banks are not willing to let people borrow money at lower interest rates, unless it is a mortgage, which is less risky because banks are guaranteed access to some sort of asset, whether it be monetary or not. The biggest problem with this is that banks end up with 'toxic' assets, which is a nightmare for the housing market. A 'toxic' asset usually comes in the form of property which has been repossessed due to an inability of people to pay off mortgages, which in turn is caused by unemployment. Banks can't really do anything with an empty house, which means that the housing market is being flooded with repossessed houses and flats. However, due to the unusual , lengthy and risky way that repossessed properties have to be handled , and of course due to people not being able to afford mortgages, banks are losing even more money. This is a problem that President Obama is currently trying to solve by pumping lots of money into banks and to encourage them to just get rid of their 'toxic' assets. But if people aren't buying, then banks can’t really sell these ‘toxic’ assets.
The ‘Credit Crunch’ is also very much alive. Even with cuts in national interest rates, credit cards still have huge interest rates because the banks are not confident in the customers ability to pay back the money. Which makes sense considering that unemployment is on the rise because there is less demand for goods and services and keeping people employed just wastes money. But if we’re now entering a period of deflation, surely interest rates on credit cards should drop, right? The problem doesn’t really lie in how much stuff costs but rather the difference between how much stuff costs, and how much people can afford. If prices drop, and wages drop, the ratio will stay relatively the same. What we need, therefore, is a bigger gap between what things cost and what people can afford. This can only be achieved by either letting prices drop and keeping wages the same, or artificially inflate the economy and to increase wages at a higher linear rate. Borrowing money only really works if people don’t need to do it, but rather do it out of choice. The cost of living in the UK is too high and people are being driven to borrow money and ridiculously high interest rates of necessity.
Sounds confusing, right?
Well it is. It's all very circular and I have certain doubts to whether the government, or any government anywhere, is able to restart any form of normal economic activity. A article by a Prof Lyons from the University of East Anglia suggests that we should temporarily nationalise all banks, reform the economy from within and then when it's all fixed hand it back to the share holders. In theory it's a nice idea, but you can't force the economic machine. Not to mention that the strength of the Pound will drop even further because people will not be willing to invest in an economy which is essentially communist.
So what should we do? If we all started spending money like crazy the economy would do better. The more money that businesses have, the more money they can pay us. It also means that people need to borrow less money in the long term, which means interest rates are put up and banks can start making money again. Which is good for us, because we get more money, spend it on more stuff and the world goes round. But, for this to happen we actually need to give up nearly all our savings. We need to spend everything that we earn on things that we probably don't need. Nationalising banks certainly won't achieve this and it is unfair to expect our governments to take the blame, or for the banks to take the blame. It is actually the media and people who profit from all of this who should take the blame. There are certain bank managers who profit, but at the end of the day they are all being totally ravaged by the media and are being forced to resign.
In historical terms we are entering some very uncertain grounds. Pretty soon people will start saying this is the new 'Great Depression'. I suppose in certain ways it is a 'Great Depression', but it is far from being identical. Our governments are slowly being forced to adopt more liberal, and in some cases socialist, political ideologies to deal with our problems. Had the world economy kept going throughout the US Presidential Election, I doubt that Obama would have felt as secure of imminent victory. It is without doubt that Obama is the best thing that happened to the world since Clinton, however it is worth considering to what we owe this fortune.
Final Thought Byte : At the end of the day, no one really knows what’s going to happen, or what has happened already. It will be decades before historians will be able to look back upon this period and comment on it without some sort of overriding emotion. Certainly it is probably bad practice for me to write this, considering I am studying to be a historian. But, sometimes, there are more important things in life than our chosen profession.
Tags : Banks, Deflation, Economy, Great Depression, Money, Obama, RWI, Toxic Assets, VAT cuts
