Determined to avoid the deflationary panic of the Great Depression, policy makers in the UK and the US spent the best part of half a century adopting a growing policy of government interventionism and a more mixed economy. This was done to prevent unemployment spiking to unsustainably high levels, by ensuring all who wished to work and who were fit and able would be employed in good time.
Full employment was the motto of many governments in the UK during the golden age of the UK’s so called post-war consensus era between 1951 and 1979. For a generation, however, low productivity and other issues led to rising inflation which would not be rectified until more radical anti-inflation policies were ultimately pursued under the Thatcher government and its successors.
As we emerge from the COVID-19-induced recession, the signs suggest inflation is unlikely to spike, but scratch beneath the surface, and a more volatile future could be in store for us, pushing prices higher and potentially boosting the attractiveness of inflation hedges such as gold.
The return of inflation
Ask anyone born in the post-war years about the economy from the 1960s until the 1980s and there’s a good chance they will find some point to drop in the word ‘stagflation’ – an amalgamation of the words stagnation and inflation. Economic theory had held previously that prices rose faster when the economy was booming or overheating. However, as the stagflation era showed, it was possible that one-off factors could depress growth and simultaneously allow inflation to rise to high levels, suggesting a decoupling of the two.
The UK found itself increasingly outcompeted by rival economies such as West Germany and Japan, who were able to produce more goods at cheaper prices thanks to more efficient workforces and greater use of high-tech solutions. The UK faced increasing pressure to devalue the pound on multiple occasions, culminating in politically incendiary devaluations in 1967, 1976 and again in 1992. Inflation ate away at the hard-earned savings of millions, requiring the Bank of England to raise interest rates to a high of 17 per cent in 1979.
High inflation forced policy makers to act to cool down the increase, but by hiking rates, the economy was stifled even further. Loans became costly to repay including mortgages, making the housing market more volatile for first-time buyers. High inflation also made the price of everyday goods and services costlier over time, eroding the value of disposable income, forcing employers to pay higher wages. In the absence of rapid productivity gains, higher wages simply fed into higher inflation, and so the negative spiral continued.
The link was eventually broken, but only after more than 30 years of deindustrialisation and mass unemployment in many communities. In the meantime, the price of gold had effectively priced in the volatility and lost purchasing power, surging in value remarkably, especially between 1970 and 1980. The decision in 1971 for the US to sever the link between a fixed gold standard for the US dollar opened the floodgates to an era of higher prices not just in general, but for gold as well.
Since the 1980s, inflation targeting has been the mantra for policy makers, in place of full employment. Tighter monetary and fiscal policy have been enforced numerous times to keep a lid on inflation, all to ensure that prices only rise between one to three per cent on an annual basis for the foreseeable future, with a specific two-per-cent inflation target as outlined by the Bank of England. Since the 1990s, the UK has more or less managed to achieve inflation close to two per cent, but this didn’t prevent the global financial crisis of 2008 from occurring.
Inflation has seemingly remained inert, but the last decade or more of economic turbulence has been changed in a radical way, suggesting that, without careful consideration, prices would start rising faster in the coming years. Inflation was once thought to be a slain dragon but could actually return as a phoenix from the ashes, ready to cause more mayhem in the coming years.
The wrong metrics
In its quest to quell inflation, the Bank of England was blind to the bubble forming in the economy, especially in consumer spending, over the course of the 1990s and the 2000s. When the bubble burst in 2007, bank runs ensued and a credit crunch led to the worst crash since 1929, threatening to pull the UK, the US and the world economy into a new Great Depression. Fortunately, a co-ordinated fiscal stimulus from leading world economies plus loose monetary policy helped facilitate a recovery of sorts from 2010 onwards.
Since the new millennium, in the meantime, gold has been a recognised safe-haven as buyers sought a place to protect their money. The inflation of the 2000s, the financial crisis of 2008, as well as numerous other moments of economic instability such as the COVID-19 pandemic have helped push gold prices to new highs up until as recently as last summer. It’s almost as if gold is acting as a metric for gauging the success of recent policies and where inflation could be heading.
Fiscal stimulus such as furlough and other measures to support businesses, plus low interest rates and money printing in the form of quantitative easing are pumping billions of pounds into the UK economy. Fortunately, there are signs of a recovery gaining strength, allowing for more job creation and higher wages. Policy makers should now take note not to repeat the mistakes of the early post-war years, of stop-and-go or boom-bust policies. By making policy too loose during downturns, bubbles risk forming, allowing inflation to creep up, forcing sudden tightening moments.
The post-COVID recovery could easily devolve into a stagflationary episode, meaning higher inflation, a weaker pound, higher interest rates and higher unemployment. In the meantime, gold could stand to benefit, as it did in the 1970s and over the last 20 years or so. An unwelcome return of inflation could offer a golden opportunity for you to enter the bullion market, and see what UK Bullion has to offer, as prices rise higher.