Christopher Snowdon: Liz Truss didn't break the economy, it was like that when she found it.

Christopher Snowdon writes how the market response to the Truss/Kwarteng emergency budget showed that the emperor has no clothes, and it is a sign that the era of big borrowing is at an end.

Some choice quotes:

Long before the pandemic began, I was troubled by emergency economic policies - ultra-low interest rates and money printing - being in place for a decade without any emergency to justify them. This led to a great deal of inflation, but since the inflation had mainly affected the housing market and stock exchange and had made the rich richer, it didn’t seem to count. Then, in 2020, we had an actual emergency which seemed likely to push us over the edge.

The so-called "libertarian" budget included massive subsidies to cap the price of energy.  The cut in income tax and reversal of a rise in national insurance were hardly enormous measures, and freezing corporation tax (rather than implementing a rise that was indicated under Boris Johnson) is also hardly libertarian, but the word has stuck. 

Of course there should have been measures to liberalise the economy, and none eventuating except a removal of the ban on fracking - a measure that wouldn't achieve much for some time. 

Some saw the mini-budget as an invitation to the Bank of England to raise interest rates. If so, it was an invitation that was declined. Some thought the mini-budget implied that there would be spending cuts, but Liz Truss insisted that there would be none. Instead, Kwasi Kwarteng took to the airwaves to announce that he intended to make more unfunded tax cuts.

Previous governments had at least paid lip service to balancing the books. The Truss administration didn’t even bother pretending. The bond markets, seeing no plan for growth and no sign of an interest rate rise, naturally demanded a greater return on their investment. 30 year yields nudged toward 5 per cent. The pound fell to a low of $1.07. Pension funds that had been making what the Economist describes as ‘obscure derivatives bets’ found themselves short of liquidity thanks to higher gilt yields - although they insisted that they were not short of capital - and so the Bank of England stepped in to lower yields by buying gilts....

Liz Truss was dealt a bad hand and played it badly, but despite the broadcast media spending a fortnight treating every day as if it were Black Wednesday, she did not ‘crash the economy’, as the Labour Party has claimed. The economy was already in pieces and there is much worse to come. Goldman Sachs has already taken 0.6 per cent off the UK’s GDP forecast for 2023, partly because of the rise in Corporation Tax.

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Interest rates have existed for thousands of years for good reason. They are, to quote the title of Edward Chancellor’s excellent book, the price of time. Or, if you prefer, the cost of impatience. They should provide an acceptable return to lenders and should certainly be above the rate of inflation. The international experiment with very low interest rates has, unsurprisingly, led to governments, businesses and individuals becoming heavily indebted. As people take on more debt, they become increasingly vulnerable to interest rate rises. This leads to a doom loop in which central bankers are reluctant to tackle inflation because interest rate hikes will make people poorer and so inflation persists, making people poorer.

Even in the absence of inflation, interest rates couldn’t be raised because it would ‘wreck the recovery’. An economic recovery so feeble that it cannot withstand an interest rate of one or two per cent barely deserves the name. The economy had become like an alcoholic. Every drop in interest rates and every bout of money-printing made it feel better in the short-term, but they made the addiction worse and was slowly killing it. It was hair of the dog economics.

The left have already started wailing about ‘Austerity Mark 2’, but they are now going to have start telling us which taxes they want to increase to pay for their spending priorities. They may find that they get a rough reception. It is notable that almost the only thing left from the mini-budget is the scrapping of the Health and Social Care Levy. Even Labour didn’t want to keep it. It’s unpopular. Fine. But if you can’t get the public to support a tax specifically earmarked for the NHS - the one thing that normies say they are happy to pay more tax for! - good luck raising taxes for Net Zero and foreign aid.

The MMT loonies will say that the recession could have been avoided if the Bank hosed us down with one more burst of QE. Everything looks like a ‘political choice’ if you ignore trade-offs and consequences, but the number of practical options available have narrowed considerably. As Janan Ganesh says in the FT today, Labour are not going to enjoy governing without a magic money tree to shake.

Hair of the dog economics has had its day. The era of big borrowing has come to an end. We have run out of road. It would be unfortunate if Liz Truss has given economic growth a bad name because it really is our only way out of the woods....