Instability follows inflation as night follows day

Both the Tories and Labour will be wrecked by the cost of living crisis.

Inflation sucks. You don’t need me to tell you that of course, but it really, really does. This is because the cure is almost as bad as the disease yet once inflation gets out of control, as it has in the UK, there’s no harmless way to eradicate it. Everyone pretends this isn’t the case, but they all know it is.

Inflation is rather like cancer. Chemotherapy kills cancer cells by using toxic chemicals that kill healthy cells too, but just a little more slowly. I’m not sure the Bank of England, which is largely responsible for the current inflationary sickness, has the skill to deal with it without killing the patient.

Successive governors have pursued reckless monetary expansion for nearly two decades through around a trillion in quantitative easing. Everyone knows what happen when you print money on this epic scale: it erodes the value of the currency. Has done since the late middle ages when the import of gold and silver from the New World caused hyperinflation in Europe.

On top of that we have government spending at epic levels. Government debt has increased to more than GDP for the first time since the post war years in the 1950s. This spending is partly a legacy from the Covid relief schemes and partly increased spending on pensions, NHS pay awards sickness benefits and other welfare costs.

Inflation in democracies rapidly becomes self-perpetuating. Workers understandably demand higher wages to compensate them for inflationary price increases. Firms pass this on to prices and so it goes round like a dog chasing its tail.

At least, this is what the Bank and the National Audit Office say is happening in the UK. If you strip out the contingent price increases caused by the disruption to energy and food markets following the invasion of Ukraine you are left with core inflation of 7.1% - the highest since the early 1990s. This inflation is linked to the similar rise in average wages. It also becomes the benchmark for the next pay round – and so it goes.

The conventional response to inflation is to shut down the economy, force people to accept that they are a lot poorer, and try to restore the balance. It’s a bit more complicated than that of course, but it’s basically what the Bank of England is doing: creating a recession by increasing interest rates. That makes people poorer by increasing housing costs and makes firms less willing to invest by increasing the cost of borrowing. Firms shed labour, house prices collapse, people accept lower wages and so inflation falls. At least in theory.

The Bank can’t really say this is what it’s doing so it uses a suite of metaphors to disguise the reality. Cooling demand, putting on the brakes, slowing the economy. But the objective is to create a recession and break the wage-price spiral. However, I’m not entirely sure they can get away with it this time.

In the 1980s, governments dealt with a similar inflationary disease by fiscal contraction on an epic scale. Paul Volcker the head of the Federal Reserve increased interest rates to nearly 20%. Twice. This led to two deep recessions in which unemployment reached 7.5% in 1980 and 10.5% in 1982. Housebuilding all but ceased, hundreds of thousands were thrown out of work, and unemployment rose to 7.5%. But inflation was beaten, though at immense human cost. By 1987 when Volcker left the Fed, inflation was down to 3.4% from 10% and it broadly remained low until the 2010s.

In Britain, a similar policy was pursued by Margaret Thatcher’s Chancellor, Geoffrey Howe – though they called it “monetarism”. That created two major recessions, three million unemployed and the destruction of Britain as a manufacturing power. Thatcherism also began the process by which Scotland detached itself from the Union via the Scottish Constitutional Convention in the 1980s. Rising demand for a Scottish parliament was largely a response to mass unemployment and the disintegration of Scotland’s industrial base. Inflation always leads to political instability.

Neither the Tories nor Labour are prepared to go through that again, and even though the Bank of England is nominally independent there seems little likelihood that the ‘hard knock’ approach to inflation will be repeated this time round. This means we are likely to have inflation around for quite some time.

The Tories have already been largely destroyed by the cost of living crisis, which is the other name for inflation. Though admittedly they have made it massively worse by their incompetence, divisions and successive failures of leadership. The belated increase in interest rates later this year will slaughter many Conservative MPs in English marginal seats where the numbers of households facing up to £3,000 on their mortgage costs is greater than the Tory majority.

Labour will almost certainly take over in 2024/5 and will also be destroyed by inflation which will be getting its second wind. It is unlikely that Labour will try to rein in its spending instincts, whatever the shadow chancellor Rachel Reeves says, and nor will it try to resist public sector wage demands since Labour is still heavily financed by the trades unions. This means that both major parties are liable to be wrecked by inflation.

European countries like Italy and Finland have already moved sharply to the right but Britain is unlikely to see a similar development here. This is partly because of the First Past the Post electoral system that prevents outsider parties gaining influence. So there will be much turmoil in Westminster, much as there was in the 1970s, but it should largely be contained within the big parties as they alternate in power.

This is good news for the SNP who have highly inflationary instincts but will be able to play at being innocent bystanders to the chaos in Westminster and the collapse of the establishment parties. If the SNP escapes from its current difficulties and manages to find another leader with the populist charisma of an Alex Salmond, it could be the end for the Union. Though erecting a regulatory and trade border with England is unlikely to lead to economic recovery in Scotland in the short term. Unionists will warn that independence will more likely lead to a flight of funds, investment and people as the Scottish government increases income taxes and struggles with a devalued currency.

It’s not a very bright prospect, I have to admit. But there is a consolation here. Even though Britain’s economy has been lagging Europe since Brexit, there is still a good deal of wealth around. People will get poorer but it won’t be like the 1930s or even the 1970s when people often faced destitution when they lost their savings or their jobs. The productive forces of the economy are immensely greater than in the last century. Innovations like gene editing, AI, and supercomputers will push on and the global drive to decarbonise the environment should generate an industrial recovery, so long as it is properly managed.

But fasten your seatbelts because we are in for a bumpy ride.