Labour’s borrowing binge is the road to ruin

Hang on, what is this? Sajid Javid, a Conservative chancellor, promising to spend like a drunken sailor, doubling the annual deficit to £55 billion by next April?

If you want to know why what Sajid Javid is proposing is quite sensible, relative to the challenges we face, let me introduce you to two new fashionable economic buzz words: “investor strike” and “reversal rate”.

If you want to know why his Labour counterpart John MacDonnell’s plan is very dangerous you must, by contrast, think from first principles.

Let us start with the buzz words. Investors, when it comes to Britain, are on strike. Private sector investment has gone off a cliff. There are almost no flotations happening on the stock market. Bank lending is flatlining and companies are actually saving money. They have a record 38% of GDP in cash on their balance sheets.

The lack of private sector investment comes in the wake of a similar shortfall in public sector investment. In order to balance the books, George Osborne slashed investment and we are still living with the consequences.

What is particularly peculiar about this investor strike is that it comes at a time of near-record low interest rates. Take a look at mortgage rates, for instance, or the 10-year gilt rate, currently 0.7%. These are rates even lower they were in William Gladstone’s time.

This leads us to the second buzz word. The reversal rate. This is the level below which a fall in interest rates becomes counter-productive. Banks can no longer lend profitably. Businesses and consumers, fearing the worst, hoard cash on deposit or under the bed, thereby driving interest rates down further.

Central banks, like the Bank of England, see economic growth come to a standstill and reach for the traditional lever of cutting interest rates to stimulate the economy, only to realise that will only make things worse. If monetary policy is exhausted, the only option is to reach for fiscal policy, in other words, tax and spend, the remit of the Treasury at the other end of town.

This is what Sajid Javid is proposing. He is intending to balance the current budget, on day-to-day-spending, but to borrow £60 billion a year to invest in infrastructure. Given the paucity of other opportunities, investors will be only too delighted to fund such much-needed stimulus. And if interest rates go up a tiny bit, so what? It will be a relief.

No doubt there will be plenty to quibble about how Mr Javid would spend the money. I would personally prefer far greater focus on tax cuts, including the abominable stamp duty, and cutting the payday interest rate on student loans. Prepare, instead, for “investment” in public sector pensions. But with Britain near the bottom of the OECD league table for investment in recent years, his approach is surely a sensible one. Critically, it is also compatible with continuing as a commercial, market-based society where property and individual rights remain intact.

Which takes us to John MacDonnell. His spending proposals require borrowing of circa £150 billion a year and there is no way the market can digest such a gigantic flood of gilts being issued by the British Government. To finance his spending he is going to have to make the Bank of England print more money and force the banks and pension funds to co-operate. Negative interest rates, made worse by an investor strike, are very likely.

His tax proposals are likely to cost a middle-class family thousands of pounds a year. The wealth tax will be especially pernicious, as everyone with any meaningful assets (a house, a pension, life insurance policy, ISAs, jewellery), will have to file an annual wealth statement and pay a fee of circa 0.5% to 1.5%.

When people wake up to what that means in practice, assets would start to leave the country and sterling plunge. The only way Chancellor MacDonnell could respond while keeping his programme intact would be to impose exchange controls, limiting what individuals can take out of the country. You don’t believe me? It has happened before under Labour Governments, in 1947 and 1966. Exchange controls were finally abolished by Margaret Thatcher and Geoffrey Howe in October 1979.

That is the thing with proper, red in tooth and claw socialism. What is billed as few reasonable tax rises on the rich, for the common good, not only damages your wealth and makes society poorer, it is actually supervised by a pernicious bureaucracy which fundamentally overturns the relationship between the citizen and the state, replacing the spontaneous co-operation of a market based system with centrally administered coercion. It never ends well.

Sajid Javid’s programme is intended to address the demands of the times, to stimulate ordinary economic activity and put us back on track as the shockwaves of the 2008 financial crash are still felt. John MacDonnell may claim to be doing something similar, but in the end will result in us forming pathetic queues outside banks and supermarkets.

As Adam Smith wrote in Book II of the Wealth of Nations: “The statesman who should attempt to direct private people in what manner they ought to employ their capitals, would not only load himself with a most unnecessary attention, but assume an authority which could safely be trusted, not only to no single person, but to no council or senate whatever, and which would nowhere be so dangerous as in the hands of a man who had folly and presumption enough to fancy himself fit to exercise it.”