The demon is out there

Tuesday, 1 February, 2000, 22:44 GMT

The demon is out there

Oil: The single biggest driver of inflation in the 1970s

By the BBC's Rodney Smith

Inflation is bad. We all know that. Do we? Some people, like a colleague of mine, a prominent broadcaster, remembers what happened in the 1970s and 1980s with nostalgia.

Like many of us, she is an inadequate saver, and a consummate borrower.

She remembers how large-looking loans dwindled away, while the only significant asset she owned, a house, shot up in value.

She is not among those whose savings are destroyed, or whose employers are forced out of business, by galloping inflation.

So it is worth considering that the inflation we thought dead, and whose return some might welcome, may be about to escape again.

Oil prices

The single biggest driver of the inflation that plagued most of the world during the 1970s and into the 1980s was the huge increase in oil prices by Opec producers after the Arab-Israeli War that started on 7 October 1973.

The effect of expensive energy invaded all industries, all business, all aspects of modern life. Almost all prices were affected by it.

When pressures on individual incomes became too great, already powerful trades unions argued for and won wage increases that compounded the problem.

Inflation became built into expectations, became planned for and became a structural part of economies.

It was only beaten by the very harsh treatment that invariably produced unemployment.

It could happen again, because the world economy is wide open to attack from high oil prices again.

Euro effect

This is made potentially made worse by, of all things, the euro.

The weak euro, at 97-cents US or 95-cents - some think it could even lower - mean that essential imports will rise in price in Europe.

And poor old Europe is wide open to attack. Everywhere there are signs of incipient inflation, not much, but an uptrend, creating a fertile field for other forces like weak currency and high fuel costs.

It's happening already. In Germany, import prices rose 1.6% last month, the third increase of more than 1% in four months. Why? Oil and the euro. These numbers are being repeated among other European Union member states.

This highlights another highly unwelcome development.

Pay settlements of 3% -plus demanded by powerful German industrial trades unions, principally the engineering union IG Metall, are a huge new threat to stable prices in the principal anti-inflation European economy.

One effect you can bet on - the Bundesbank is piling on the pressure for the European Central Bank to raise interest rates at next month's meeting, and by at least 0.5%.

But back to influences the ECB and European governments can't control. Some commentators in the oil market are saying world reserves have been hugely overstated; that high oil prices could be here to stay.

More likely, say others close to Opec, the oil cartel is a differently composed, more economically sophisticated organisation than it was 25 years ago.

It represents a wider spread of interests geographically than it once did, and its supporters reckon it would open the taps at or before $30 a barrel.

Even at that level, that's three times what the price was at the start of 1999.

The Western economy is much less sensitive to oil prices than it was a quarter century ago. But the impact will continue to be felt indirectly. Base metal prices are rising already. Higher oil prices will emphasise that.

Goldilocks should start to worry.

-- Old Git (anon@spamproblems.com), February 07, 2000

Answers

link

-- (kb8umw.@yahoo.com), February 07, 2000.

(I put the link at the top :) This one doesn't have one because the Telegraph is a subscription e-newspaper.)

ECB boosts euro by lifting interest rates By George Trefgarne in Frankfurt

THE European Central Bank took action to boost the fortunes of the troubled euro yesterday when it raised interest rates by a quarter of a point to 3.25pc.

The move helped the euro recover 0.78p against the pound to 61.39p and by more than a US cent against the dollar, rising from $0.9724 to $0.9840.

Wim Duisenberg, ECB president, gave his strongest signal yet that the recent decline of the euro is causing growing alarm within the bank. As the currency falls it is triggering price rises of imports to the euro zone, igniting inflation.

Mr Duisenberg said: "Developments in the exchange rate are becoming a cause for concern and could have effects on price stability. It is one of the factors which could have a lasting effect on price developments in the future."

The most recent bout of weakness in the euro began after Christmas when Greece announced it would apply to join EMU in the spring. It gathered pace as revelations emerged of the corruption scandal in Germany, involving former Chancellor Helmut Kohl. The allegations include a secret slush fund to pay for pro-EU campaigns in France, Italy and Germany. The success of Jorg Haider in Austria has also alarmed investors.

Mr Duisenberg admitted these political problems had hit the euro. He said: "In modern financial markets political factors cannot fail to have an impact on the exchange rate."

Yesterday's move was the second rate rise from the ECB in the last three months. In November it raised rates by half a percentage point to 3pc. Mr Duisenberg denied the euro had a credibility problem. He said: "This was not a panic reaction."

The fall of the euro to below parity with the US dollar has unfortunately coincided with a massive jump in the oil price - from about $10 a barrel to $26 a barrel in the last 13 months. As most European countries import oil this is pushing up energy costs and caused inflation in the euro zone to blip last month from 1.5pc to 1.7pc.

Unlike the Bank of England the ECB keeps the proceedings of its governing council secret. There have been rumours of a split between countries like Germany, which do not want interest rates to rise, and Ireland, which wants to calm its booming economy.

Mr Duisenberg said no vote was taken on the 15-man council yesterday, and claimed: "It was a consensus decision. Of course, we discussed the size and moment of the increase, but there was no discussion of the direction. It was decided by consensus that we should act today rather than later."

He hinted that more rate rises could be on the way, saying: "Recent developments in the exchange rate cannot be ignored." He said growth is picking up in Europe more than expected. One beneficial side-effect of the falling euro is that it has boosted exports, by making them cheaper.

However, Mr Duisenberg made clear his frustration with governments which are being slow at putting through economic reforms. He issued a powerful call: "Governments must enhance their structural reform process to strengthen the economy. Such reforms would increase investment from abroad and will lead to the strengthening of the euro."

The ECB president also stressed that he believes the euro will start to rise against the pound and the dollar. He said: "It has strong upward potential."

ECB boosts euro by lifting interest rates By George Trefgarne in Frankfurt

Monetary policy decisions [3 Feb '00] - European Central Bank European Central Bank The euro: Now in business - HM Treasury The euro - Europa [EU web site] The Bank of England and the euro - Bank of England Department of Trade and Industry Business for Sterling Britain in Europe

See City Comment

THE European Central Bank took action to boost the fortunes of the troubled euro yesterday when it raised interest rates by a quarter of a point to 3.25pc.

The move helped the euro recover 0.78p against the pound to 61.39p and by more than a US cent against the dollar, rising from $0.9724 to $0.9840.

Wim Duisenberg, ECB president, gave his strongest signal yet that the recent decline of the euro is causing growing alarm within the bank. As the currency falls it is triggering price rises of imports to the euro zone, igniting inflation.

Mr Duisenberg said: "Developments in the exchange rate are becoming a cause for concern and could have effects on price stability. It is one of the factors which could have a lasting effect on price developments in the future."

The most recent bout of weakness in the euro began after Christmas when Greece announced it would apply to join EMU in the spring. It gathered pace as revelations emerged of the corruption scandal in Germany, involving former Chancellor Helmut Kohl. The allegations include a secret slush fund to pay for pro-EU campaigns in France, Italy and Germany. The success of Jorg Haider in Austria has also alarmed investors.

Mr Duisenberg admitted these political problems had hit the euro. He said: "In modern financial markets political factors cannot fail to have an impact on the exchange rate."

Yesterday's move was the second rate rise from the ECB in the last three months. In November it raised rates by half a percentage point to 3pc. Mr Duisenberg denied the euro had a credibility problem. He said: "This was not a panic reaction."

The fall of the euro to below parity with the US dollar has unfortunately coincided with a massive jump in the oil price - from about $10 a barrel to $26 a barrel in the last 13 months. As most European countries import oil this is pushing up energy costs and caused inflation in the euro zone to blip last month from 1.5pc to 1.7pc.

Unlike the Bank of England the ECB keeps the proceedings of its governing council secret. There have been rumours of a split between countries like Germany, which do not want interest rates to rise, and Ireland, which wants to calm its booming economy.

Mr Duisenberg said no vote was taken on the 15-man council yesterday, and claimed: "It was a consensus decision. Of course, we discussed the size and moment of the increase, but there was no discussion of the direction. It was decided by consensus that we should act today rather than later."

He hinted that more rate rises could be on the way, saying: "Recent developments in the exchange rate cannot be ignored." He said growth is picking up in Europe more than expected. One beneficial side-effect of the falling euro is that it has boosted exports, by making them cheaper.

However, Mr Duisenberg made clear his frustration with governments which are being slow at putting through economic reforms. He issued a powerful call: "Governments must enhance their structural reform process to strengthen the economy. Such reforms would increase investment from abroad and will lead to the strengthening of the euro."

The ECB president also stressed that he believes the euro will start to rise against the pound and the dollar. He said: "It has strong upward potential."

-- Old Git (anon@spamproblems.com), February 07, 2000.

The trouble is, I know that my salary won't be increased as fast a prices, so I'll probably be in a net loss situation (or at least lagging seriously). The same is true even for the Union members who have multi-year contracts...

On the other hand, having my loan payments be a smaller part of my annual salary wouldn't be too bad...

-- Mad Monk (madmonk@hawaiian.net), February 07, 2000.

Inflation almost invariably helps the salaried, hurts the investor. Check the history. A healthy economy requires a balance of the two interests.

-- tim phronesia (phronesia@webtv.net), February 07, 2000.

Just got home, and saw the gas prices jumped by .10 today. Now 1.399 for unleaded regular.

Gene, in IL.

-- gene (ekbaker@essex1.com), February 08, 2000.