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When the lights went out

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Those readers old enough to remember the seventies will recall that one of the consequences of the power cuts of early 1974 was the ubiquity of paraffin lamps which suddenly appeared in many homes. These were recognised as a superior alternative to the candles to which most people had instinctively turned to once the lights started to go out on a regular basis, as electricity was denied to the domestic market in order to allow manufacturing industry to continue to operate – albeit only for three days a week.
 
The cause of the black-outs was a strike by the National Union of Miners, who faced down the then Prime Minister Edward Heath, leading to a General Election in 1974 which Heath duly lost. This ushered in the Labour government of 1974 to 1979 under Harold Wilson and then, after Wilson’s resignation in March 1976, under Jim Callaghan, who was latterly supported by the Liberals during the Lib/Lab pact.
 
The middle classes, as they unboxed their paraffin lamps in 1974, probably thought things could not get worse. We now know how wrong they were. Wilson, assisted by his Chancellor Dennis Healey, embarked on a couple of years’ worth of radically redistributive economic policy. There were huge increases in state pensions and other benefits; rent controls and even food subsidies. The top rate of income tax on earned income was 83% and, on unearned income, an eye-watering 98%. The really rich emigrated in droves, which benefitted the Los Angeles property market at the expense of the UK Exchequer. Those who were sufficiently well-off to be stung by the taxation, but not so rich or mobile as to be able to up sticks, suffered the most. The real incomes of the middle classes fell, as inflation (which peaked at 26.9% in August 1975) outstripped salary growth. Those who worked in unionised industries fared much better as strike action, or the threat of it, tended to support real wages.
 
By 1976, the chickens had come home to roost. With sterling in freefall, the UK, now under Callaghan, was forced to apply for an IMF loan of USD 3.9 billion – at the time the largest ever IMF loan and equivalent to USD 26.3 billion today on an RPI-linked basis. Although the mere agreement of the loan meant that the pound quickly stabilised, so that the loan was never fully drawn, this was a watershed moment. Out of necessity, the focus of policy quickly switched from full employment and social welfare to the control of inflation and expenditure.
 
Callaghan limped on until 1979, at which point Margaret Thatcher came to power. The middle class breathed a sigh of relief and the paraffin lamps were consigned to the attic. Thatcher immediately stockpiled coal, destroyed the miners and their communities – and substantially deindustrialised the North. It is often said that many would not have voted Tory in 1979 had they bothered to read the manifesto, such was its radicalism. However, Thatcher correctly calculated that after a period of high inflation, endless strikes and social experimentation, the electorate was prepared to accept pretty much anything as long as it was politically well to the right of what had gone before.
 
Like financial markets, politics in Britain tends to revert to the mean but in doing so, again just like financial markets, very often overshoots. As Thatcher followed Callaghan, so Corbyn now seems poised to follow May (or the next Tory leader, depending on the party’s discipline). It is not necessarily that the voters want a radical socialist government reminiscent of the seventies, but that they want a better deal for themselves. Given ever hazier memories of the past, Corbyn seems, to many, to offer just that.
 
It is interesting that Shadow Chancellor John McDonnell has admitted to already ‘war-gaming’ scenarios such as a run on the pound in the event of a Labour victory. If he has any sense, he will stick to a laissez-faire policy in this area, as intervention – as demonstrated in 1992 when the Bank of England attempted to support the pound within the ERM – is likely to be useless. Nonetheless, his fears are justified. Sterling still reacts to politics, as demonstrated by the FX market’s negative reaction last week to May’s conference speech and the ongoing apparent impasse over Brexit negotiations.
 
At 6/1 Corbyn is this morning no longer the bookie’s favourite to be the next Prime Minister, with that accolade falling to Boris Johnson. Nonetheless, ‘people’s QE’, i.e. outright money printing is a real possibility. Indeed, one way or the other, inflation looks to be on the cards. The threat to the independence of the Bank of England is also real as ex Treasury Select Committee Chairman Andrew Tyrie and others have recently pointed out, although John McDonnell has gone further than most in simply stating that a Labour government would remove the Bank’s independence. This would threaten the perfect inflationary storm under the clouds of which, à la seventies, Chancellor McDonnell could award huge pay rises to the public sector, put the benefits system on steroids and debauch the pound. QE (people’s or otherwise) has a nasty habit of favouring the rich through asset price inflation but a few judiciously-placed wealth taxes would soon see to that.
 
If this all sounds far-fetched or unfair, the fate of the miners should always be remembered. In the early eighties, as Thatcher set about smashing the NUM, there was little sympathy, except amongst the hard Left, for the fate of these men and their families. It was they, after all, who had done such damage to the country in the seventies, was it not? It is not too difficult to imagine a similar lack of sympathy amongst the general electorate for those who have benefitted from QE, ultra-loose monetary policy and associated asset inflation, along with cheap, imported labour.   
 
When it comes to inflation, it has been the distinct lack of wage pressures that has kept a lid on the general price level all over the world. Last week’s US labour market data was, therefore, particularly interesting. Despite a disappointing non-farm payroll number of minus 33,000, the unemployment rate fell back to 4.2%. Crucially, however, average hourly earnings rose to 2.9% year on year in September, while August’s rate was revised upwards from 2.5% to 2.7%. Barring exogenous price shocks, it is hard for inflation to take root without wage increases but, now that wages are moving upwards in the US, a major factor in suppressing global prices is being removed. Perhaps we should not be surprised that the Fed remains so committed to rate normalisation. If the US starts to inflate, as night follows day, so will the UK.
 
The consensus amongst market participants is that it will be the next financial crisis that leads to another huge bout of global QE and that this additional QE (in the absence of central banks’ ability to meaningfully cut rates) will be the catalyst for a sustained rise in the global price level as measured by fiat currencies. However, robust wage growth in the US has the potential to derail that theory. With inflationary expectations and bond yields still so extraordinarily low, the biggest shock imaginable to markets would be labour cost-push inflation led by the United States. Yet, after so many years of capital’s gaining at the expense of labour, such a swing should be less of a surprise than markets suggest it will be. Time to dust down the paraffin lamp? 
 
This week is not a big one for data. Tomorrow sees UK industrial production and manufacturing output – expected +0.9% and +1.9% respectively. Friday sees US inflation, with the increase in CPI expected to have been 2.3% y/y in September – up from August’s 1.9%. All the scope for surprise and upset is to the upside.

All views expressed here are the Author’s own and are based on information available at the time of writing.

 

AUTHOR SPOTLIGHT

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