For 25 years, and especially since the financial crisis, the global economy has taken a catastrophic wrong turn for which we are about to pay a terrible price. In one of the greatest intellectual mistakes since communism, many of the world’s smartest people thought they had discovered the secret to perpetual prosperity. Forget about hard work, delayed gratification, battling post-industrial wasteland or even earning a living by designing, building and exporting: there was an easier way.
Encouraged by politicians, central banks have kept interest rates low, favored borrowers over savers, printed money with abandon, and engineered an artificial boom in house prices, tech company stocks, cryptocurrencies, bond markets, art and more. This ersatz “wealth” was supposed to encourage spending and investment, tax revenues would fund a generous welfare state, low rates would increase public debt, and there would be no need for difficult conversations about the ageing, science, taxation, competitiveness, incentives or productivity.
It was, however, a Potemkin economy, a facade, a swindle. Much of the “growth” and wealth was not real. The UK was stagnating, not booming. House prices have “enriched” the haves while infuriating the have-nots. It was a bubble at best, and a Ponzi scheme at worst, keeping zombie projects alive and fueling obscene misinvestments. Edward Chancellor’s The Price of Time is an excellent introduction to this tragedy.
This crazy experiment is ending now, killed by an overdose of Covid money printing, the supply-side dislocation that accompanied the virus and the attempt to send the economy into a coma, and Putin’s war , all of which sent consumer prices skyrocketing. The necessary transition from cheap to rational money will be traumatic and could trigger a brutal global recession, rising unemployment and bankruptcies. Long-term mortgages are already at 7.1% in America as the old order crumbles and financial markets boil over the world.
This is the context of the punishment inflicted on Britain. The readjustment that all other countries will also undertake – in particular much higher borrowing costs – has happened in an accelerated fashion in the UK, triggered by the ridiculous reaction of the financial markets to the budget. The pound fell disproportionately. Some pension funds were caught off guard, forcing the Bank of England to intervene.
It is easy to understand why the Chancellor did not anticipate such a response. Regarding the budgetary impact, the overwhelming majority of announced policies had already been abandoned and the cost of the energy bailout seems much lower. Spending is already slashed because inflation is depressing public sector wages and the fiscal slowdown continues to do its dirty work.
It was an ideological and visceral reaction to a government that the financial institutions do not fully understand. Elite mood music in 2022 is defined by leftist American economists and hysterical Twitterati who hate Truss, Brexit and the supply economy. It is therefore extremely important for a government which rightly wants to break orthodoxy to be much more proactive in explaining how it is going to grow the economy and stabilize public finances, and how central England is doing will wear better.
Kwarteng and Truss broke many taboos: they dared to criticize the Bank of England during the campaign for being too slow to raise rates, which made for a softer version of my argument above. Markets agree that the Bank has been useless, especially relative to the US Federal Reserve. But prejudiced by their incorrect reading of Brexit, they listened to those who deliberately twisted Truss’ powerful analysis by claiming that she was not concerned with controlling inflation, a despicable lie.
This situation was compounded by the Bank’s inexplicable inability to raise rates further last week and its obtuse decision to start selling gilts. Traders have also chosen to interpret Truss’ supply-side tax cuts as suggesting she doesn’t care about the national debt, another absurd misunderstanding.
My assessment of the policies in this budget has not changed: they are excellent. Every idea announced is positive for growth. The same goes for all the other deregulation and tax initiatives the prime minister is working on: they need to be enacted. It is possible to increase the trend growth rate. A corporate tax hike would have been a disaster. Reducing high marginal tax rates is great. We need to build many more.
Truss is exceptional in realizing that false growth on the never-never ends, and true bottom-up capitalism is needed instead. She wants to reduce the current account deficit by energizing the City, increasing energy production and sucking up businesses. It is therefore outrageously arrogant of the IMF, a fanciful and hypocritical body that should have been abolished years ago, to demand a reversal. The focus on a tiny part of Truss’ tax cuts – the elimination of £2billion from Gordon Brown’s top tax rate – proves he is now explicitly aligned to the left of Joe Biden and should be boycotted by sensible governments.
The excuse for this blatant interference by the IMF, led by Kristalina Georgieva, European Commissioner for six years, was that Truss’ tax cuts would increase “inequality” and, presumably according to the fashionable drivel, would reduce growth . It is a shameful confusion of market outcomes with genuinely bad inequality (like that which exists under feudalism or corrupt kleptocracies) and ideology disguised as science. The main driver of inequality in recent years has been the bubble theory endorsed by the Davos Consensus. It is absurd to claim, as the IMF has also done, that you cannot tighten monetary policy while loosening fiscal policy.
The Prime Minister must keep his cool. His vision is entirely appropriate for managing the transition to a post-Brexit economy based on sustainable expansion, rather than debt-fueled mirages. Hopefully the Bank’s late intervention will stabilize the markets and give it some hedging. Andrew Bailey, the governor, needs to start doing his job properly.
The big danger is that the left will try to turn our soaring interest rates into an ‘ERM II moment’, blaming the Prime Minister’s tax cuts, when in fact the end of good money market would have happened anyway, although more gradually. The stakes are extremely high and there can be no back-pedalling. Conservative MPs must support the Prime Minister all the way.