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The UK's Economic Spiral Towards Zimbabwean-Style Monetary Policy

When that fails, what will the Government do then? It will do a Mugabe, rip up all the banknotes and start again with a new form of currency. What could possibly go wrong?
Chris Radburn/PA Archive

In Zimbabwe, where worthless $100 trillion (80.36 trillion pound) notes serve as reminders of the perils of hyperinflation, President Robert Mugabe is printing a new currency that jeopardizes not just the economy but his own long grip on power.

Six months ago, the 92-year-old announced plans to address chronic cash shortages by supplementing the dwindling U.S. dollars in circulation over the past seven years with 'bond notes', a quasi currency expected at the end of November." Reuters.

The good thing about being a dictator is that you can simply invent new money, wipe the slate clean, and get the economy working again. All you have to do is tell the Governor at the Central Bank to turn on the printing press and all your problems are solved. Except they aren't; the currency will collapse, people will starve and you will be ejected from power.

For money to be worth anything it has to be backed by something. It acts as a medium to be held temporarily while goods and services are exchanged. The farmer sells his crops in return for money, which he then in turn exchanges for household items and capital goods when it is most efficient and appropriate for him/her to do so. In order for the system to work, the currency must have a reasonably static value, and a political system that guarantees this value. The currency is based upon these pillars. If the currency loses its static value then the trade in goods and services becomes chaotic, and the trust is broken.

Once the trust is established, money itself becomes a traded good subject to the same rigours of supply and demand as all the other goods and services. This trade in money comes in many shapes and forms including credit and insurance. The money markets become competitive in their own right, and the levels of interest or premium required fall, allowing the farmer to enjoy lower running costs. The key is the static value of the currency.

For many centuries money came in the form of gold and silver coins, both metals being rare and expensive to mine, yet still globally available. The supply of the coins was restricted by their scarcity, and so the value as a token of exchange was stable. Some people trimmed the coins and smelted the shavings to mint new ones. The 'coin clippers' were taking minute pieces from a multitude of coins to make new ones. The problem was that they were increasing the money supply, meaning that there were too many coins chasing too few commodities, food prices rose, and instability spread. The issue was so bad that in 1278 some 300 'coin clippers' were arrested and executed at the Tower of London.

The problem, of course, is when the Government, like Mugabe's, embarks upon its own 'coin clipping.' Governments, however, tend to clip coins on a grander scale. They switch on the presses and shower people with the new currency and hope for a return to stability, having wiped out the value of anything denominated in the old currency, like savings. Having seen the Government behave in such a reckless fashion terrifies the heck out of foreign investors, who pack up and never return. Or if they do return, it is at mind boggling interest rates.

Modern day coin clipping by the Governments comes in two main forms - debt accumulation, and Quantitative Easing - and a third 'Helicopter Money' is on the horizon.

Once the UK Government is unable (politically) to tax more, it borrows from the banks and the collateral is, of course, future tax revenues. The more it borrows the higher the interest rates charged by the banks will be. But the money that is lent by the banks is not money taken from deposits - it is new money (possibly 'backed' by around 3-5% deposits), and thus, the amount of money in circulation (the monetary base) increases. The more money in circulation, the higher prices will go. Yet this is in the interest of the Government, it actively seeks this inflation. It has debts set against a fixed rate of interest and the greater the money (or the higher the cost of money) in the market, the quicker it pays off its debts. But if the debt does not pare down the real value of the debt as planned (like 2008 onwards) it taxes more - typically on consumption, rather than income.

Once this fails, the Government invents new money (just like Mugabe) and tells the Bank of England to print new money. Since the onset of the financial crisis £430 billion in new 'money' has been created. Cynically the Government used this money to buy back its own debt, effectively lending to itself at zero interest rates, and reduce its interest payments (by about £10 billion a year) and make the public finances look better. This new money is recycled to the electorate in the form of mortgages, driving up house prices, or other consumer credit expanding, once again, the monetary base and driving up inflation. But it has driven down the real value (purchasing power) of the currency meaning that people become poorer in a more expensive world.

This Quantitative Easing, and it represents almost one third of the public debt, which has been put away on a shelf to be forgotten about. There are no plans ever to repay this debt, its sole aim was to 'stimulate' the economy, which really means make things become less affordable.

And inflation did bite making things less affordable.

We have all read the stories of house price inflation as prices for accommodation surpassed levels that caused the financial crisis.

Other basics like food also outstripped wage increases. Price increases for food ran up to double digits with the onset of QE, and hovered around 3-6% from 2010 until Q2 2014.

But wages did not match these cost increases in necessities, with wage increases barely ever reaching 2% according to the ONS.

How was this all paid for? Debt of course. Consumer credit has increased to almost £1.5 trillion in order to close the gap between wages and the cost of living. This means that there is now is 44% more money in circulation chasing the same amount of goods - most of it locked into mortgages or credit cards.

So the income inequality has actually been created by Government policy, aided and abetted by the Bank of England, as it has flooded the economy with money to pare down its debts. House prices, and other basics have gone up (household energy bills have also soared), but wages have stagnated. So, what is left for the Government to do? It will print even more money, of course.

The Scottish Government is considering issuing more 'money' into every household (as has been trialled in parts of the Netherlands and Finland) to stimulate demand. Everybody will get freshly printed notes and be instructed to go off and add to aggregate demand, i.e. spend. This is known as 'Helicopter Money'. Of course, the problem of too much money chasing too few goods as the coin clipping takes steroids, and prices will soar again, across the board. But because we will not actually be making anything new, it will not be matched by real economic growth.

When that fails, what will the Government do then? It will do a Mugabe, rip up all the banknotes and start again with a new form of currency. What could possibly go wrong?

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