One of the unfortunate consequences of the 44-day Truss/Kwarteng economic experiment is that there is now almost certainly going to be an overreaction. It was fit and just that the free-marketeers were brought down by the markets they believed in. The irony of it! But the danger now, with all this talk about the black hole in the nation’s finances, is that in its efforts to restore “credibility” the Sunak/Hunt economic experiment could well be taking risks with the country’s social fabric, while not necessarily retaining credibility in the markets.
To put it bluntly: when the central banks of the Group of Seven are on the warpath, deliberately fomenting recessionary forces to fight inflation, there is a danger of a recurrence of what, in the early 1980s, I termed “sado-monetarism” – as if the sado-Brexiters were not enough.
A little diversion, which is not entirely irrelevant. At the International Monetary Fund conference in Belgrade in 1979, your correspondent was happily conversing with a US Federal Reserve governor, Henry Wallich, when we were interrupted by the Fed chair, the redoubtable Paul Volcker, who said: “Stop talking to journalists, Henry. I need you.”
The rest is financial history. Volcker flew back to Washington to put interest rates up, and up, and up. There followed what his enemies called the “Volcker recession”. He was fighting an inflationary spiral set off by the second oil crisis of 1979-80. Higher interest rates, while causing a domestic US recession, also drove the dollar up. This posed difficulties for many developing countries whose debts were denominated in dollars.
It also threatened trouble for the British economy because it drove the pound down towards parity with the dollar in January 1985.
This was embarrassing for prime minister Margaret Thatcher, who enlisted President Ronald Reagan’s help. The Americans intervened to support sterling in the foreign exchange market, and the pound recovered. It might have fallen to below $1 at those usurious airport exchange desks, but the official rate stayed – just – above a dollar: an economic virility symbol. Yes, Thatcher liked to say “you can’t buck the market”, but she succeeded on that occasion.
Which brings us to the latest sterling crisis. The disavowal of the Truss/Kwarteng economic experiment helped the pound to recover from another “down to $1” scare; but former Bank of England governor Mark Carney is right to remind doubters that there was a dramatic devaluation after the 2016 referendum – some 15% – as market operators immediately assessed the extent of economic damage in store from Brexit.
As the former Treasury permanent secretary Lord Macpherson said recently in a lecture: “Before Brexit, the Treasury was always perceived as the most Eurosceptic of departments; since Brexit, it has been seen as the most Euro-enthusiastic.”
His lecture, entitled Treasury Orthodoxy: Fact or Fiction, organised by the Strand Group at King’s College London, was a fine riposte to the Truss/Kwarteng attacks on the institution. I like the way he talked about “the Treasury’s obsession with frameworks designed to save the government [under either party] from itself”.
He was suspicious of fiscal rules that were jettisoned when “the political price of keeping them became too high”, because “regularly breaking rules damages credibility”.
By the way, it is interesting to find the Treasury’s former top official noting that the Sunak/Hunt regime “has gone to extraordinary lengths to demonstrate its commitment to sound public finances”. (My italics.)
More rules waiting to be broken? The government should listen to Jagjit Chadha, director of the National Institute of Economic and Social Research, who says it makes little sense to commit to strict rules “in a world where we have been hit by such large shocks as Covid, energy and Brexit”. He warns: “There is a danger that we end up with tighter fiscal policy than actually is appropriate given the shock that many households are suffering.”
But it seems that after a decade of George Osborne’s woefully misconceived austerity policies, we are in for more. I wonder how this government thinks this is going to encourage the business investment we need. As for public sector capital spending, as Macpherson observed, during the 1976 IMF crisis this “did fall off a cliff and has never really recovered”.
Yet there are reports of more cuts to public investment coming in this week’s autumn statement. “Whom the gods would destroy, they first make mad.”