Time for some economic optimism again
There is not much point in writing notes of this kind if you just agree with what the purveyors of received wisdom are saying. So here goes, I am going to stick my neck out: the worst may be over for the economic outlook in Britain and I don’t think there is going to be a recession. Or at least not a deep one.
This makes a change. I first circulated a note “Time to ring the warning bell” last September and have been arguing since then until I bored even myself that inflation was coming and our catastrophic energy policy, made worse by Vladimir Putin’s invasion of Ukraine, but also the antics of central banks and the financial sector, was going to cause a crisis.
Here are five reasons it is time to be more optimistic:
1. The appointment of Liz Truss as UK Prime Minister
I do not know Liz Truss at all well, so cannot really comment on her as a person. But her arrival plainly brings to an end months of uncertainty in Britain, made worse by the interminable Conservative leadership contest. It also brings an end to the disastrous Boris Johnson era dominated by a philosophy copyrighted by him, Cakeism (“I am pro cake, and pro eating it”) but actually advocated by every lobby group in town, whether it to be Environmentalists, Brexiteers, Modern Monetary Theorists, the Woke brigade, you name it. Do as we say, they would cry, it won’t cost anything, will have no disadvantages and make us all richer.
It turns out they were all wrong and this change in the Zeitgeist to a more realistic, sober one – not without optimism – is to be welcomed. In that regard, the new Prime Minister’s somewhat clunking speaking style is a relief. Every time Boris cheered you up or made you laugh, as he still can, fiasco soon followed. I look forward to his return to journalism. Her first Prime Minister’s Questions were noticeably more accomplished and reassuring.
2. An energy package is coming to the rescue
The media has spent weeks, rightly, working the country up into a lather about the impact of high energy prices on household budgets, but also inflation. The previous administration essentially did almost nothing about this, an odd example of being against cake and not letting us eat any. Eleven months on the CAKE26, COP26 conference looks more and more like an unreal gathering intent on economically patronising the commonality. The only person missing was Meghan Markle.
Before everybody gets on their high horse, this is not to say climate change caused by human activity is not happening – it evidently is – but that we must be realistic and practical how we deal with it. Adapting to it, while trying to halt it, may be critical. Above, withdrawing and curtailing investment in hydrocarbons, especially natural gas, before reliable and cost-effective alternatives are in place has been a folly with terrible consequences. The pathway to Net Zero has been unrealistic and inflexible.
The new Government’s energy policy (to be announced on 8th September), in common with other Western nations, is likely to be dramatically different, covering part of the cost of the energy price rises for businesses and households but, more significantly, enhancing investment in natural gas, including fracking, the North Sea and long term Liquid Natural Gas contracts. They are not going to be alone in this as non-Russian gas production in America, the Middle East, Africa and Asia all comes belatedly on stream in coming years. In other words, gas prices are likely to come down dramatically even if there is no ceasefire in the Ukraine (though I expect that too in coming months).
3. Fiscal expansion
It ought to be a heresy at a time of high inflation to advocate an increase in deficit-funded public spending and tax cuts, as we will see in Britain and elsewhere. However, this is to miss the fundamental point that we are effectively at war. Covid was a once-in-a-generation emergency, akin to a war and the Ukraine situation is, well, an actual war, with shooting. It is certainly true that Governments could have been better prepared or had better energy policies or that it would have been preferable if the Conservative leadership contest had concluded weeks ago, enabling time to design a carefully targeted package. But we have to deal with the world as we find it and Liz Truss has no choice but to embark on yet another round of social support. It is just necessary, like having to order more Spitfires or rebuilding the East End.
We are, in fact, very lucky to live in societies with deep and liquid capital markets, functioning public finances, a floating exchange rate, relatively low unemployment, robust banking systems and savings accumulated during the pandemic. It is precisely for crises like the current one that the modern nation state and its institutions were created to manage in the first place. As it happens, the national debt is not very high by historical comparison, being less than half the proportion of GDP it was in the prosperous 1820s or 1950s.
What is more, when all is said and done, the net cost of the energy intervention is not going to be anything like the £150 billion widely reported. This is because economic growth will be higher, tax revenues will be stronger and a social and economic collapse avoided. Furthermore, by reducing the headline rate of inflation it will reduce the financing costs of a quarter of the national debt which pays out to investors on an inflation-linked basis.
4. Sterling and Perfidious Albion
Another cause for optimism is that the fall in sterling, to $1.14 against the dollar and its lowest ever level on a trade-weighted basis according to Bloomberg, may have run its course. If economic growth is going to be strong but the Government issues more of its own debt via the gilts market, it follows that interest rates are going to be higher than expected just a few weeks ago. Indeed, financial markets are already pricing that in.
Just about the last organisation to notice will be the Bank of England which, contrary to speculation, is not at risk of losing its independence. The Governor of the Bank of England, Andrew Bailey, can expect continued criticism in Parliament and, potentially, an independent review by the Court of the Bank into forecasting errors.
All things being equal, closing the interest rate differential with the United States will underpin sterling.
Another risk to sterling will also be lifted when it becomes clear that Liz Truss is not actually going to trigger the Article 16 dispute mechanism with the European Union. Instead, she is going to exercise a policy of perpetual strategic ambiguity, threatening to trigger the dispute but not actually doing so. This is a reversion to a traditional British policy in relation to Europe, otherwise known as Perfidious Albion. The EU will also respond in the traditional form, with indignation, while actually turning a blind eye to minor rule-breaking on the Irish border and in the Irish Sea.
5. Victorian interest rates
It is too early to say that interest rates have peaked or Brexit is resolved or Russia defeated. But we ought to be able to imagine that we are inching towards a more familiar time, a post-Brexit, post-Covid, post-War era which, frankly, might be a bit dull. Some of us have had enough of “Boris gets the big calls right” and would prefer there were no big calls to be made at all. We might even aspire to the Victorian era, when interest rates fluttered around 3% for decades.
A word of caution
Finally, I have to admit that I have a tendency to be over-optimistic whenever a change of Government has occurred (“A new dawn has broken, has it not?”, Tony Blair, 1997). So you might want to add a pinch of salt of your own to this analysis. For instance, the related energy and Ukraine crises may get worse not better. Another issue which we should consider is the culture wars in the US, but also here, which continue to rage. As far as I can tell, Liz Truss is tone deaf to these sort of issues and is not an especially cultivated person. I confess to being disappointed that Kemi Badenoch is not education secretary.T he heady fumes of freely available drugs and firearms, the thrashings of Donald Trump over the January 6th hearings, political lawfare and the extremes of wokery and the burblings could yet waft over us all and reduce us – and her – to a more vulnerable state.
George Trefgarne is CEO and founder of Boscobel & Partners, an independent communications and political consultancy; specialising in financial communications, strategic advice and analysis.
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