This week, I have changed my mind on the economic outlook, partly, but not entirely, due to the health and social care levy announced in Britain. I expect it will be repeated in other countries.
I have been super-bullish when it comes to the economic recovery from Covid. My thesis was that most economic activity during the pandemic was deferred, not lost, and when reduced restrictions combined with the huge stimulus from central banks, we would experience perhaps the biggest boom for a generation.
In addition, I would take it further; rapid innovation brought forward by the pandemic, a surge in investment and drastically remodelled business plans means that far from “economic scarring”, there will be “economic muscling” from Covid. Productivity and growth will be faster than before the virus struck.
This thesis has been entirely vindicated by the evidence. There is a boom going on.
But now we must change tack. It is time to ring the warning bell.
The Covid economic muscling will go to waste unless the economy is taken off the steroids and put on a sustainable, long term recovery regime soon.
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There is a growing risk that Western governments and central banks are charging headlong into a crisis in 2023-24, when a belated rise in interest rates will combine with big tax rises, inflation and sloppy regulation to cause a massive fall in real take home pay and potentially a severe recession.
To see this, you have to understand the institutions and how they operate. I take Britain as the exemplar of these risks partly because I know it best but also because it seems now to be leading the charge into a potential crisis.
The Bank and inflation
First, let us start with the central banks, the great purveyors of monetary protein shakes. The ultra-low interest rates and quantitative easing they have sensibly provided have, unfortunately, been accompanied by an apparent change in ethos and mindset at the behest of outside interest groups. There is even a campaign led by the Democratic Congresswoman, Alexandria Ocasio Cortez to stop Jay Powell, chairman of the US Federal Reserve, being re-appointed in February. She wants him replaced with someone focused on, “eliminating climate risk and advancing racial and economic justice.”
The Bank of England, for example, has abandoned monitoring its own money and credit figures; it has omitted to scrutinise worrying developments in the energy market – such as record natural gas prices – despite having a new duty to support net zero; it has embraced stretching social objectives for its own staff in relation to diversity targets (the intention is admirable but a more flexible approach would be better) and working from home a full five days a week (it should be setting an example of hybrid working at least); and the Governor Andrew Bailey has got himself into a peculiar row with Parliament as to whether “addiction” is an appropriate word to use in relation to quantitative easing.
Simultaneously, and perhaps because of this new mindset, the Bank has repeatedly underestimated inflation. Many independent forecasters reckon it will be over 5 per cent by the end of the year, twice even the Bank’s most recent estimate. This is particularly relevant when it comes to asset prices, with stock markets and house prices galloping away. That is good for the wealthy and the older generation with assets, but not younger or less wealthy people. It is hard to see how inflation, a bubble in asset prices and the risk of a bust advance racial and economic justice.
Next, let us head over to the East End, where the offices of the Financial Conduct Authority are largely empty. This, during a great speculative boom, when all kinds of bezzles are presumably emerging in the system. Its major investigations are prolonged, it recently presided over an astonishing miscarriage of justice in the Forsyth case, and it is reportedly suffering a high turnover of staff and morale issues. In my experience, customer service and efficiency have declined alarmingly across the consumer financial services industry. Presumably this is partly because too many white-collar workers are following the example of the Bank and the regulator and are at home, not in the office and eschewing even hybrid working. If people are going to work at home, many companies have invested insufficiently to do it properly.
The FCA has such extensive powers, regulated companies and individuals are too scared to criticise it publicly and it has insufficient accountability to the Treasury or Parliament.
Downing Street and the Treasury
Finally, let us go back across London to Westminster. The Prime Minister’s appetite for both spending and tax increases is the most gargantuan since the early 1970s. Although, in fairness to Boris Johnson, he has been right to be optimistic about the outlook. His problem is he seems to have insufficient sympathy with entrepreneurs, the private sector, or younger workers. This week’s announcement on National Insurance and the health and social care levy, from which retirees are exempted, is a classic example of the generational inequality he is hard-wiring into the system.
Meanwhile, the Treasury and the chancellor Rishi Sunak may have performed well during the pandemic, but they are now making two errors. The first is to fail to account for pandemic and recovery spending as a one-off item, to be paid off over 100 years, and the second is to be trapped by Treasury orthodoxy (and the gloomy forecasting errors of the Office for Budget Responsibility) into trying to balance spending with tax rises over the next few years. Not only does this make no financial sense, it snuffs out any long term plan for recovery and growth.
The big squeeze coming
These institutions, of which the central bank is the most critical, might be thought by an observer to be pulling in opposite directions. But the reality is they are all pulling in the same direction: a punitive combination of inflation, global interest rate rises and significant tax rises from 2023 onwards. I fear the mistakes may be replicated across advanced economies.
The result could be a huge fall in take home pay and business investment and a deflationary bust in a few years’ time. That would be bad enough, if it was not also accompanied by windfalls for some people: the wealthy and retirees with substantial appreciating assets.
Not much fun in Canada
The powers-that-be need to accept the world as it is – which is observable both in the data and the experience of ordinary people up and down the country – and change direction. Otherwise, they may find themselves suffering the fate of Justin Trudeau in Canada who, having called a snap election about the handling of Covid three weeks ago, instead finds himself behind in the polls as voters say the biggest issue for them is actually the cost of living. As for investors, riding a wave of monetary and fiscal expansion, beware that once they withdraw the shakes and supplements, the economic muscle could turn to flab.
George Trefgarne is CEO and founder of Boscobel is an independent strategic communications firm, providing clients with bespoke financial PR & public affairs advice.