And now for the homeopathy of economics - price controls
In the increasingly-desperate global political scramble to tame inflation, the yellow jersey is currently held by Belarus’ President Alexander Lukashenko after he simply ‘prohibited’ by decree any further price rises last week1.
How he thinks this is possible is unclear. Perhaps it is muscle memory from his time in the Soviet regime where he was director of a state farm. The USSR never had inflation - it didn’t even record the data as all the prices were set by a central planning committee (Gosplan), with predictable consequences. By the time the Soviet Union was finally dissolved in 1991, the economy had pretty much collapsed into a mix of hyperinflation and kleptocracy.
Price controls are slightly different to a planned economy, but have an equally ignoble history, and one which stretches back to the ancient world. Following a century of currency debasement, in 301 AD the Roman Emperor Diocletian issued a series of price ceilings or maxima to limit profiteering and speculation. The subsequent slow, final decline of the Roman empire in the west is very much a story of internal strife, much of it due to the economics of inflation from monetary debasement.
Yet even when Rome was a glorious Republic, the issue of inequality saw politicians on-the-make bravely push for price controls. In 131 BC and again a decade later, the Gracchi brothers (Tiberius and Gaius) used the office of Tribune to push for popular reforms, including the division and distribution of public lands to the poor, as well as sales of corn below market prices (ie price controls). The aristocratic reaction to these populist tendencies did not end well for the Gracchi - Tiberius was beaten to death with a stool-leg and later his brother Gaius was killed, decapitated and his skull filled with lead2.
It is through the lens of populism that the political urge towards price controls should best be understood. Diocletian’s maxima were a response to inflation, itself a problem caused by monetary debasement. If one looks at the proximate cause of the current bout of inflation in the developed world, the urge to impose energy price-caps can be seen in part as a response to a similar bout of monetary debasement in 2020 and 2021 caused by central-bank debt monetisation to fund lockdown-related fiscal largesse, a problem now compounded by the privations of war. Plus ça change.
Economics would suggest that the cure for high prices is high prices. What this means is that higher prices reduce demand, and this in turn moderates further price rises. On the supply side, higher prices also create the opportunity for higher profits, meaning investment increases, increasing supply, and this in turn causes prices to normalise in the long run. But electoral politics is never a matter of the long run. The current cost-of-living crisis is an unhealthy combination of monetary inflation and also supply shocks caused by sanctions on Russian energy exports due to the war in Ukraine, demanding action now.
The problem with the policy-driven move to energy price controls is that demand is propped up as a means ameliorating the immediate effects of a sharp economic downturn or recession. Demand stays artificially high, delaying the ‘natural’ economic adjustment. The funding bill is huge - the UK has budgeted £150b, France €100b and Germany a monster €200b (on top of prior bailouts for the energy industry), a figure so big that it is drawing harsh criticism from the Eurozone’s have-nots. Not exactly one team one dream in Europe this winter, or not yet at least.
Much of this will be paid for through deficit financing. Without the central banks buying the debt, these fiscal deficits will have to be funded by national savings or from abroad through foreign bond-buying, with the former likely to divert investment from elsewhere in the economy and the latter likely leading to currency weakness, itself a further source of inflation. If central banks do step in to monetise the debt, then markets will respond with higher inflation expectations, raising bond yields and also weakening currencies further. If windfall taxes are implemented (as they seem to be about to be), then the energy industry will be stripped of the capital needed to invest in more plant; this reduces supply growth, which again prolongs the inflationary trend. Populist short-termism 101, or simply a compounding of poor policy decisions upon one another?
In France, where strikes at fuel refiners are causing increasingly-painful shortages at the pumps, President Macron appears to be about to requisition the refiners themselves - basically a short-term nationalisation of key industries. If one needed to be made even more aware of how the war in Ukraine is becoming more overtly an economic war with Russia, Bloomberg reported on the 11th October that at least one French department, Alpes-Maritime, is going to start rationing petrol to 30 litres for cars and 120 litres for trucks.
Possibly the most controversial potential price-control move is the attempt by Europe and possibly the US in imposing a price-cap on Russian oil. Not only does this risk disruption to energy investment in the medium term, but it also risks antagonising OPEC+ even further, based on the idea that if it’s Russia today, it might be us tomorrow. It might be going too far to say there is a new risk of 1970s-style oil shock repeating itself, but there is only so much meddling that markets can take before something goes badly wrong.
As a medium of exchange and payment, money functions due its convertibility. Money can be converted from bank deposits into notes (cash). It can be converted from cash to goods and services. It can also be converted through foreign exchange via the importing of goods or as investments in securities or deposits held abroad. Money functions best when this process is not inhibited by the state. Indeed, one could argue that it only functions when it is not inhibited.
When one goes down the road of price caps and rationing (ie limiting money’s convertibility into goods and services), one can legitimately start to wonder, should the domestic economic or financial situation deteriorate sufficiently, whether bank withdrawals or even capital controls might end up being imposed at some stage. During its banking crisis in 2013, Cyprus imposed a €300 per day limit on cash withdrawals. Banks in Lebanon appear to have frozen domestic accounts held in foreign currencies altogether.
While talking in these terms might seem like absurd fear-mongering, one has to think about our recent experience of government intrusion into the private sphere, notably during lockdown where individual liberties were curtailed to a degree almost unthinkable prior to the Covid-19 pandemic.
One might think once bitten, twice shy, but the tone in the media at present is becoming increasingly frenetic. Take an article by Ben Marlow in the Daily Telegraph on 14/10/2022 as an example - ‘Turning down the thermostat will help beat Putin and it is patriotic to say so’ [emphasis added]. The emphasis is on ‘advising and educating’ consumers rather than actually ordering them to do anything, hence it not being like another lockdown-imposed diktat. Notwithstanding this, restrictions on energy use are clearly far more explicit in Europe than in the UK at present. Let us not also forget Oscar Wilde’s observation about patriotism being the last refuge of scoundrels.
One general observation about financial markets is that one should look at them in terms of what is happening and likely to happen rather than what one would like to happen. One can have a moral stance on the war in Ukraine and on the methods Russia is using to pursue it. As an investor though, one has to be mindful of the consequences of the economic policies which are being implemented in the West in response.
The strategy of price controls, rationing and the like which affect money’s convertibility into goods and services can also lead to limitations on its convertibility elsewhere, as outlined above. War, if only economic war, is one of those catch-all situations which can permit governments to take more control over the economy. We are clearly not in a Soviet, Gosplan-like situation in the West, but policy is clearly trending in a direction which would have been unimaginable even just a few years ago.
Belarus bans consumer price rises in bid to tame inflation, Reuters, 06/10/2022.
Tom Holland, Rubicon, Abacus, 2003, p29.