Not everything is Gordon’s fault

Jun 25 2008 by Ian Shepherson for The Journal

I NEVER thought I’d say this, but I almost feel sorry for Gordon Brown. Almost. And my sympathy extends only as far as acknowledging that the surge in food and energy prices, which is contributing mightily to the gloomy national mood, can’t fairly be blamed on him.

The trouble is that when things are going wrong, the man in charge gets blamed for everything, fairly or not. That said, the single biggest problem, the catastrophic bust in the housing market, is a reasonable candidate for the Gordon’s Fault label, at least in part.

Housing busts follow housing booms, and booms are based on free-flowing credit. The then-Chancellor’s role in the credit explosion of recent years was his stubborn unwillingness to acknowledge that households’ debt burden had reached monstrous proportions and could not possibly be sustained.

Economists and others who highlighted the problem were dismissed as Cassandras, but they, like Cassandra, were right in the end.

The direct trigger for the end of the credit boom was the massive losses incurred by global banks in the US housing market, and the PM can’t be blamed for that. But the crunch in the UK, including the Northern Rock blow-up, was inevitable, and the US banking crash merely brought forward the timing of the bust here.

We’ll never know, but if Mr Brown had used his pulpit to address the issue of excessive debt growth, and if the FSA had had a stronger mandate to prevent lenders overstretching their balance sheets, and if 125% mortgages had been at least discouraged, then maybe we wouldn’t now be staring into the abyss.

It is Mr Brown’s misfortune that the hole is being made deeper by the sustained increase in commodity prices. Oil prices have been rising since late 2003 but this year they have jumped far above the 25% per year trend in place since then. Had that continued, prices would now be at about $95 per barrel, not $135.

The very first thing you learn at economics school is that prices are determined by the nexus of supply and demand. Global demand for oil has risen, but the rate of growth has slowed markedly over the past three years, averaging little more than half the pace of the previous three years.

Supply has increased too, though it seems likely that this year there will be a very small shortfall in global production. This cannot possibly explain the surge in oil prices, though, and I have to believe that speculative excess is playing a big role in the story. It will end in tears, eventually, but predicting the timing of the bursting of a bubble is a mug’s game.

Food prices are a different story altogether. The shortage of supply in world grain markets is real; the US government reckons world inventories, relative to consumption, are at their lowest level in more than 50 years.

A variety of forces have generated this mess, including the huge diversion of corn production for biofuels, the growth of demand for animal feed from the emerging economies, and the sustained drought in Australia.

Together, the rise in food and energy prices makes us worse off. And there’s nothing we can do about it. The great lesson of the seventies is that we cannot get around a commodity price shock simply by paying ourselves more. Down that road lies real inflation in everything, not just food and energy.

Ian Shepherdson is a former Wall Street and City economist now living in Newcastle. ishepherdson@hotmail.co.uk