History repeats itself; the first time as tragedy, the second time as farce. Marx told us that. Karl, that is; even if the line feels more like Groucho, should you want to relate it to the fun and games involving the launch of Trussonomics onto the UK’s economy.
Whether we’re at the stage of tragedy or of farce isn’t wholly clear. It might depend on whether last week’s budget was the first attempt to repeat the Barber Boom of the early 1970s. If so, it would be tragedy, even if a dollop of farce looks like it’s mixed in. Either way, it won’t be pretty. It might signal the end of Trussonomics before it has even begun. Alternatively, it might not be quite the disaster pundits are lining up to predict.
Superficially, stage 1 of Trussonomics, last week’s mini Budget involving maxi amounts of tax cuts, bears an uncanny resemblance to the start of the Barber Boom, named after Tony Barber, chancellor of the exchequer in a Conservative government elected in 1970. Much like Truss’s unelected government, this one was obsessed with stirring the UK’s economic growth. It rested on the idea that, if an economy is stoked with sufficient demand, somehow supply will follow; perhaps like a dog being dragged by its lead, like it or not. Thereafter, however, supply and demand will mysteriously slip into a virtuous unison; the two of them, master and mutt, trotting along side by side. If only.
True, economic growth did materialise following Barber’s tax-cutting budgets of 1971 and 1972. But inflation followed even faster and had soon overtaken it. Then events – in particular, the effect of 1973’s Yom Kippur war on oil prices – overtook both of them. Yet even before then, the Barber Boom had been put out of its misery. A good old sterling crisis wrecked it, taking Rolls-Royce with it, or at least into nationalisation. Thereafter, free-wheeling Barberism was replaced by price commissions and pay boards, the sort of devices that seem inconceivable for a Conservative administration to introduce – until they are.
So Trussonomics also assumes that if enough adrenalin is pumped into a corpse, it will get up and dance. Yet there is a crucial difference between the two that may make life intolerable for the Truss version. At least Barber was in control of the UK’s monetary policy, or as far as it’s possible for a government to be. Thus in 1971 he introduced the so-called Competition and Credit Control banking regulations, though these might have been better labelled Competition and Lack of Credit Control. The new rules freed up banks to lend more aggressively. As a result, and in the best traditions of the UK economy, rather than growth they fuelled a property-market bubble which ended in a banking crisis that almost claimed an earlier corporate incarnation of NatWest.
But the point is that at least during the Barber Boom the UK’s fiscal and monetary policies pointed in the same direction. Today, Trussonomics starts off from a point where the two have never been so diametrically opposed – monetary policy as tight as a clergyman’s dog collar, fiscal policy as loose as a swinger’s morals.
Sooner or later perhaps this is what happens when central banks have independence and, true, it matters less today if fiscal and monetary policies look in opposite directions than it did in the early 1970s. Those were the closing days of the Bretton Woods agreement when the world’s leading currencies – at least unofficially – were still linked to the dollar, so exchange rates needed to be defended. Today there are no such obligations.
That hardly means sterling’s exchange rate is irrelevant. Sure, there will be some twisted knickers if the rate falls below parity with the US dollar. But a rate of $1.00 has no more significance than any other neatly rounded number, like $1.50. Yet clearly it does have consequences – benefits but mostly costs.
To understand the costs, take a look at the chart and recall the words of Mark Carney, the previous governor of the Bank of England, who, a few years back, took a famous line from A Streetcar Named Desire, the best-known Tennessee Williams play, to warn that the UK’s economy relied too much on “the kindness of strangers”. He referred to those nice people overseas who were willing to fund any shortfall in the UK’s current and capital accounts and, especially, to lend to the UK government via gilt-edge stock.
As the chart shows, these folk always show up, playing a vital role in feeding the nation’s appetite for debt. Their share of lending is picked out in the black part of the bars – one for every year – that show how the UK’s borrowers and lenders net out. Meanwhile, the UK government’s share (almost always of borrowing) is, appropriately, shown by the red part of the bar.
Red is getting redder and – both necessarily and ominously – black is, as it were, getting blacker. Necessarily because increasingly in the developed world voters expect their governments to step in as lenders of last resort when the going gets even moderately tough. But ominously because there are limits to what even the government of an affluent and stable state can borrow. Based on the data for the 36 years up to and including 2022, on average overseas lenders have funded the UK’s spending overshoot to the tune of 2.8 per cent of national output (GDP). In today’s money values, that would be about £65bn a year.
Yet that will be as nothing compared with the demands that Trussonomics is about to put on them. Last week’s maxi-budget in a mini wrapper delivered the biggest package of tax cuts in 50 years “without even a semblance of an effort to make the public-finance numbers add up” in the caustic assessment of Paul Johnson, the director of the Institute for Fiscal Studies (IFS). After adding in £60bn to cover the likely cost of the government’s Energy Price Guarantee for the coming six months, the public sector borrowing requirement for 2022-23 is likely to balloon from £100bn (the most recent estimate from the Office for Budget Responsibility) to £190bn, according to the IFS.
No prizes for guessing who’s likely to be tapped for the lion’s share of that extra £90bn. In the first quarter of 2022, overseas lenders funded UK debt worth 8.4 per cent of GDP (an annualised amount of roughly £190bn). And, as the chart shows, they were pretty well the UK’s only lenders. The household sector, normally a net saver of varying amounts, suddenly has nothing to spare. The corporate sector usually comprises borrowers looking to build productive assets, but is also absent. So now somehow overseas lenders are expected to cough up maybe an extra £90bn.
Thus it becomes crystal clear why sterling has been plummeting and Andrew Bailey, the Bank of England’s current governor, is sweating. Those nice lenders from overseas were not really nice at all. When it comes down to it they are as tough as Stanley Kowalski, the poker-playing anti-hero of that Tennessee Williams play. So, yes, they can supply the readies that the government so desperately needs. But if it means swapping decent quality currency for an IOU denominated in something that looks increasingly like funny money, the price has to be right. Small wonder, therefore, that the price of 10-year benchmark gilts has dropped almost 40 per cent in a month and, correspondingly, their yield rose from just under 2.7 per cent to just over 4.3 per cent prior to the BoE's intervention; or that sterling has lost 8 per cent of its buying power against the US dollar in the same period and, at $1.08, is 36 per cent below is 10-year high.
All of which is another way of saying that, by the time you read this, the bank rate, the interest rate that underpins the Bank of England’s monetary policy, might be higher than the 2.25 per cent to which it was raised just last week. Bailey is already doing his tough-guy act saying that the BoE won’t hesitate to raise its key interest rate if need be. Of course, that’s a bluff. It will hesitate. Trussonomics forces it into a horrible position and the markets will test its resolve. In a game of poker between Bailey and the markets in the shape of the young Marlon Brando, who established his reputation playing Stanley Kowalski on Broadway, I know who I’d back.
We shall see. Meanwhile, there will be extra inflation to contend with. Trussonomics will see to that. Sure, generous subsidies of energy costs will restrain inflation’s rise in the coming months, but only at the cost of sustaining it over the longer term. Similarly, there is all that extra inflation imported via sterling’s weakness to contend with.
Ultimately the benefit for UK investors is that UK assets – especially gilts – will be cheap. They must be to persuade overseas investors to buy, even if that means prices must become cheaper still. Ditto company share prices. If US predators could buy lots of UK plc with their dollars a few months ago, think what they can buy now. True, that thought offers scant consolation today, but its time will come.
