Why the "Mini-Budget" Doesn't Matter a Jot
Following the end of another summer break for the UK parliament, we have – superficially, at least – a change in leadership. Liz Truss, as is customary for any new Prime Minister, has undertaken a cabinet reshuffle, at the forefront of which is new Chancellor of the Exchequer, Kwasi Kwarteng, having just made a fresh set of fiscal and economic promises widely being termed a "mini-budget".
Predictably, the usual mud-slinging has broken out amongst the mainstream media minions: Kwarteng's stated intentions amount to a "declaration of class war" if you're inclined to The Guardian's views, whereas other outlets highlight Kwarteng's admission that such tax-cuts are "a gamble" to steer the UK away from choppier waters ahead by stimulating economic activity.
We will not labour over the specifics here, because, as we explain below, the nit-picking and squabbling over the difference of a few percent here or there between Labour and the Tories is utterly irrelevant in the context of the global economy.
No matter where you look, there's chaos all around:
- Sterling, the Euro and a whole host of other major currencies losing ground to the US Dollar – "the least dirty shirt in the laundry," as some have coined – and no sign of the trend averting in the foreseeable future;
- inflation continuing to rise, with official figures approaching 10% in most western economies, despite the statistician masseuses doing their damnedest to induce a more relaxing number;
- huge upheaval in global supply chains, China having more or less closed the port of Shanghai owing to its fallacious zero-Covid policy; and
- continued economic self-harm by western governments in their bid to spite Russia over its Special Military Operation – soon surely to be pronounced officially as a full-scale war.
Without wishing to play down any of the aforementioned, the fundamental reasons behind the West's reeling economies of today amount not to what we see around us nowadays, but rather they are an inevitable consequence of what Western governments have been doing for as long as 50 years. Simply put: fiat "money", currency that has nothing tangible and objectively valuable as its underpin, has always wreaked havoc on any civilisation at any time in history. Today is no different.
Currently, central banks create currency out of thin air, and its corresponding government forces its public to accept this as legal tender. Previously, while far from entirely free of manipulation, the link of a currency to gold, i.e. legal money, always kept central banks, and by extension governments, in some sort of check: for each banknote or bill circulating represented an opportunity for a holder to redeem for a given quantity of gold (or, more traditionally, silver and copper). While banknotes, a representation of bank credit, could be printed to infinity, the gold supporting this credit is most definitely not infinite. Hence, only within reasonable limit could banks create and lend credit.
Doing away with the link to gold, as US President Nixon did in 1971, the currency no longer had an anchor, but, crucially, no restriction on its quantity. Naturally, western politicians, looking to curry favours and win votes in the here-and-now, have been taking advantage of this by running up enormous spending and debt with which to fund this. Essentially, we've had 50 years of a government mindset which seeks to consume today (through borrowing) at the expense of tomorrow.
While there are many dire consequences to such a monetary system, the most crushing of these to ordinary people is inflation. Put aside the CPI, RPI or any other arbitrary metric which is open to manipulation and all sorts of other statistical hocus pocus; we need instead to think about the concept, how it works and what it ultimately means in terms of human action. As we have written previously, inflation by its classical definition is an increase in the money supply. When we see economists and other media figures talk about inflation, they are almost always referring to the effect of inflation on general prices. When some Keynesian on Sky News cites a CPI of 8.1%, say, the instant impression is that prices across all the economy are up more or less evenly by such an amount.
This, however, is to mask how inflation really works: newly-created currency does not magically appear into every household's bank account overnight, but instead it goes to particular groups, industries or markets first, before eventually making its way into the general economy with time. Those who are at the front of the money queue, so to speak, have the benefit of being able to act (spend or invest) prior to everyone else, before prices in other markets respond to the introduction of the new money. Moreover, the effects of price inflation might be more strongly felt in, for instance, the petroleum industry, whilst the cost of a smartphone may barely have budged. The picture could perhaps change again in a relatively short time, with food and produce prices increasing much faster than petrol, and so forth.
It has been argued that, since the Financial Crisis of 2008, we never saw widespread inflation and so this concept is rendered obsolete. By some measurements, certain prices did not swell as they are doing now, but quite often people fail to consider which industries experienced inflation during the years following 2008: if newly-printed money goes to financial institutions first, then it follows that inflation will occur in the stock and bond markets rather than at the petrol pump – initially, at least. With time, we begin to see prices more generally going up, albeit at varying rates depending on other factors within each particular industry.
Now, against the backdrop of chaos as described above, the chickens are finally coming home to roost; the public now sees the effects of decades of debauched currency in everyday goods and services. It is already pushing households and many small businesses over the edge into the chasm of bankruptcy, and at the current pace, not many will avoid such a fate.
In defiance of the economic reality, governments still continue to spend money which they do not have, i.e. they take on new debt to repay old and fund new extravagant spending bills. To facilitate this fantasy, central banks are encouraged to kept interest rates low, lest the cost to government of servicing its debt become too burdensome.
But, central banks typically have a mandate to control inflation (2.0% in the case of the US Federal Reserve), and the only weapon they have with which to achieve this is the interest rate. Upping the interest rate increases the cost of borrowing, and a higher cost of borrowing results in lenders being more scrupulous over whom they lend to. For example, a startup business looking to raise capital would need to be much more economically viable with an interest rate of 10% than it otherwise would with rates at 1%.
If we now apply this to governments, even a fairly modest rate increase is proving catastrophic insofar as the cost of servicing its debt. In the US, at current values, an interest rate of 4.0% would mean around an additional $400 billion in servicing payments alone, per year. With a UK national debt of circa £2.7 trillion, you can begin to fathom what a similar interest rate would mean here.
Thus, we come to ask: how do Truss and Kwarteng expect to grow the UK economy? Whatever the promises of this latest mini-budget, there is no escaping the underlying economic reality. Higher interest rates to combat inflation would put the UK government into insolvency, yet lower rates to support a further ballooning of government expenditure would lead inflation to roar with even more ferocity – and ultimately render the Pound to kindling within a not-unimaginable time frame.
The Bank of England, albeit more cautiously than its American counterpart, is beginning to realise that inflation is spiralling, having recently risen its base rate to 2.25%. But, the Bank is falling far behind in its race with inflation, even if, being charitable, the latest year-on-year CPI at 8.6% is to be believed. (Do well to recall the basket of goods and services which make up the CPI has changed somewhat since the 1980s, so the CPI by its 1980s standard is thought to be much higher – perhaps double.) The Bank ought thus to be considering a much higher base rate, above that of the CPI to start with, to have any chance of taming the inflationary inferno.
However, with pressure from the UK government to keep rates as low as possible, owing to its obligations to debt interest, it is quite probable that inflation will not subside any time soon, and, if Truss and Kwarteng are dependent on yet more borrowing to fund their mini-budget promises, the consequences for the Pound could ultimately be apocalyptic.