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It never rains but it pours

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The UK government has lost its lead in the polls for the first time since the general election last year.  Despite the many mistakes made in handling the Covid-19 emergency, the government had maintained a lead of some 6 to 9 points over the Labour opposition.  But an Opinium poll for the Observer at the end of August showed Labour and the Tories running neck and neck at 40 points.

With more than four years before the next election, and cushioned by an 80 seat majority, this lone poll ought not to be cause for concern.  But these are far from normal times.  A largely absentee prime minister – who may well still be recovering from his own encounter with SARS-CoV-2 – has left his ministers to score a series of own goals, such as the recent exam grades debacle, the failure to produce a viable track and trace system, and the abolition of Public Health England.  Meanwhile, despite desperate attempts to get the country back to work, the absence of a treatment or a vaccine means that an unofficial partial lockdown is likely to continue into next year.  As the BBC reported yesterday:

“A senior Bank of England official has cast doubt on the government’s drive to get workers back to the office as coronavirus curbs are eased. Alex Brazier, the Bank’s executive director for financial stability, said a ‘sharp return’ to ‘dense office environments’ should not be expected…

“The law firm Linklaters, Lloyds Banking Group, NatWest, Fujitsu, Capita and Facebook are among those who plan to allow much more flexible working in the future.  Meanwhile, 50 of the biggest UK employers questioned by the BBC said they had no plans to return all staff to the office full-time in the near future.

“One of the main reasons given for the lack of a substantial return was that firms could not see a way of accommodating large numbers of staff while social distancing regulations were still in place.”

It is against this backdrop that Chancellor Rishi Sunak met with backbench “red wall” Tories – whose seats will be the most vulnerable at the next election – to reassure them that he is not about to impose “a horror show of tax rises with no end in sight.”  This though, suggests factional disagreements behind closed doors in the Tory Party as it seems to contradict anonymous Tory sources over the weekend claiming that big rises in fuel duty, corporation tax and capital gains taxes are on the way.  In fact, tax increases are the least consequential clouds in an increasingly stormy post-pandemic sky.

The problem with attempting to analyse government thinking at this point is that it is far from clear whether they truly believe the “magic money tree” myth that they pedal to the public; to what extent they intend using it as a cynical cover for another post-2008-style transfer of wealth from the people to the elites; or whether we can trust Johnson and Cummings when they pledge no return to austerity.  Surveys by the campaign group Positive Money found that 85 percent of MPs are clueless about where currency comes from; mistakenly thinking that the government creates all of it.  Most also wrongly believe that government has to raise taxes before it can spend money.  After the experience of 2008 however, it is doubtful that senior Bank of England and Treasury officials are as deluded.

The overwhelming majority of the currency in circulation – some estimates put it as high as 97 percent – is spirited into existence by commercial banks when they make loans.  Governments could create far more currency directly to distribute via public spending (which would favour ordinary people) but conventionally borrow currency by issuing bonds (which favours the already wealthy).  It doesn’t have to be this way, but this is what governments of all colours have chosen to do for several decades.  Indeed, one of the less well reported developments during the pandemic has been for the Bank of England to spirit currency out of thin air to lend it directly to the Treasury.  Technically, this counts as debt.  But in reality it is one arm of government owing currency to another arm of government – a bit like transferring money from a savings account to a current account; at the end of the day nobody is going to demand repayment.

With the various government schemes which have supported the economy during the lockdown coming to an end in the next few weeks, Britain faces a recession far deeper than any in living memory.  The loss of demand from workers whose jobs were not protected was sufficient to accelerate the retail apocalypse; with tens of thousands of jobs lost despite the availability of state support.  The ongoing social distancing laws, which effectively halve the number of consumers a business can accommodate, is set to cost hundreds of thousands more jobs in the autumn.  In such circumstances, raising taxes and thereby removing even more demand would amount to economic suicide.

This though, is just the beginning of the government’s woes.  One of the few places that government had believed it might levy some taxes (which has to be done to reassure investors that government debt is still safe) was on various online platforms like Amazon, Facebook and Google.  This was to be presented as a means of levelling up the playing field with the high street (notice how governments never lower the cost of doing business).  Unfortunately, online retail is the one sector of the economy that has continued to grow during the pandemic.  With platforms like Amazon replacing more than 10,000 of the jobs lost from British high streets, government will not want to be seen to be stifling the one sector where newly unemployed workers might find alternative employment.

The troubles do not end there either.  Government tax and spending policy does not take place in a vacuum.  Because most of the currency in circulation is created by commercial banks, the most sensible role for government is to act as a counter-weight to the private sector.  To understand this, think of money as flowing through circuits.  The government circuit starts with government departments spending new currency into the economy and ends with the government removing that currency via taxation.  The bigger circuit however, begins with commercial banks creating new currency when they make loans (which are then also spent into the economy) and ends with households and companies repaying their debts. 

The flaw in the system – which is responsible for almost all recessions – is that the currency loaned into existence comes with compound interest attached.  This means that if every borrower – including the state – were to attempt to repay their debts at the same time, all of the currency would disappear long before the interest had been repaid.  We are not, of course, going to try to do this; and they wouldn’t allow it even if we tried.  Nevertheless to cause a major crisis does not require that we do anything so dramatic.

The reasons that economies are not in a permanent crisis is that new loans are made even as old ones are paid off.  And so long as the rate of growth in borrowing keeps pace with the compounding interest, the economy will continue to grow.  But in the event that the rate of new borrowing slows, the drop in the amount of currency in circulation is sufficient to send the economy into recession.  Governments can compound the crisis – as they did between 2010 and 2015 – when they seek to run budget surpluses (by some combination of spending cuts and tax increases).

There is only one form of borrowing that households engage in which is big enough to make an impact.  With the average UK house price just shy of a quarter of a million pounds, hundreds of millions of pounds per week are pumped into the economy through this route.  It is for this reason that government ministers will have recoiled at this morning’s news that:

“Low-deposit mortgage deals available to borrowers have plummeted in recent months as lenders play safer during the economic fall-out from coronavirus. 

“Borrowers able to offer 10% of the value of a home as a deposit could have chosen from 779 deals at the start of March, data from Moneyfacts shows. Six months later, the choice was now down to around 60, the financial information company said.

“Lenders are being stricter about who they lend to amid fears of defaults.”

Fortunately, mortgages pale when compared to corporate borrowing.  By pumping billions of pounds into corporate bailouts during the lockdown, ministers will hope to generate the mystical “V-shaped recovery” as the economy opens up again.  Unfortunately, lost demand, the slow return to workplaces and the accelerated retail apocalypse all point in a different direction.  As John Llewellyn at the Financial Times pointed out in August:

“The spending component that is hit hardest in recessions is investment. It is an easy item to cut: which chief executive would go to their board amid a deep recession to argue that now is the time to expand capacity? Thus, in the second quarter UK business investment fell by more than 30 per cent.

“Unfortunately, this really matters. Not only is vital investment forgone but also — and particularly in this recession — changing patterns of demand render parts of the existing capital stock prematurely obsolete, even though they remain physically sound. Think of all those long-haul aircraft, years from the end of their physical lives, yet unlikely ever to fly again. Or the cruise ships, convention centres and high-rise office buildings standing empty.”

Thus the two primary means by which new currency is loaned into existence – corporate investment and mortgages – are falling like a rock.  The question before government, then, is whether it is going to go suicidally insane by cutting spending and raising taxes or whether it will be prepared to act as an investor of last resort.  As Llewellyn argues:

“With the private sector having temporarily lost its investing mojo, there is a clear case for public investment to fill the hole, not least in infrastructure. Such investment is not a direct substitute for private sector capital formation. But it is a most useful complement that does much to enhance an economy’s productivity in the long term. Hopefully, as the UK government eases back on income support it will switch progressively towards investment support.”

The depth and duration of the coming depression will depend to a large degree on two factors – one economic, the other political.  On the economic front, much will depend upon how far Bank of England and Treasury technocrats remain wedded to the failed neoclassical economic doctrines of the pre-2008 years.  On the political front is the question of whether a political party can reinvent itself while it is in government.  If – perhaps aided by a new generation of more enlightened technocrats – the government can shed its austerity skin and learn to be an economic counterweight to the private banks, then we may face a shorter and less severe recession.  But if government chooses this moment to unleash another round of austerity, then those who didn’t survive Covid-19 may turn out to have been the lucky ones.

As you made it to the end…

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