Part 1 – Idiocy repeated

Any catalogue of economic legends would of course include the 2008 visit of Queen Elizabeth to the London School of Economics, when the country was experiencing an unprecedented housing market bubble based on the irrational belief that house prices would just keep on rising.

[Note for future reference: when enough people believe something, no matter how palpably daft, others will follow, thinking “I’m obviously missing something - I don’t want to be left out!” Contemporary examples abound.]

As ever, reality struck. The housing market collapsed under the weight of defaulting mortgages originally secured on “liar-loans”. This led in turn to a liquidity crisis and a fall in bank lending. Numerous bankruptcies followed with Lehman Brothers and Bear Stearns leading the way, while a mountain of uncollateralised international debt created the perfect storm – indeed, we were confronting the near-collapse of the world’s entire financial system. 

It was in this context that the Queen enquired “If this thing is so big, why did no-one see it coming?” Skip 13 years and read the headline in last Tuesday’s Business News: “BoE under fire: why did it fail to anticipate inflation?”, and the sub-heading “How central bankers were caught off-guard by rapidly rising prices”.

Although posed 13 years apart, the answer in both cases is the same: they didn’t see it coming because they caused it! “Caught off-guard” indeed – ten years of printing money like there is no tomorrow, and they didn’t anticipate inflation?

In 2008 a group of eminent economists attempted to salvage something useful from the wreckage by explaining, in a letter to The Times, what went wrong. They wrote: “The causes of the credit crunch were extremely complex”, and represented “a failure of collective imagination” and other platitudes - but the nearest they got to what really went wrong was to blame the “psychology of denial” by which they had been “collectively afflicted”; and to which they could offer no cure. Proof of which is the re-enactment of the same psychological malaise we are witnessing at this very moment!

It was self-inflicted

Last time round, banks overextended their already bloated loan portfolios, and had to rely on compromised rating-agencies, auditors and purblind regulators to legitimise their feverish game of passing on their parcels of uncollateralised IOUs, sliced-and-diced to meet fake criteria.

Their collective madness destroyed every shred of entitlement to be returned to the ranks of licensed players: they did this to themselves - unaided and uncoerced. There should have been no taxpayer-funded rescue. Yes, there would have been wailing and-gnashing-of-teeth aplenty - but would we not, now, be in better shape if, as happened with Lehman, all that financially and morally toxic dross had been cleared out?

But rather than letting them burn in the furnace of their own afflictions, the government decided to bail them out with newly created debt. This was the devil’s pact between the US Fed and the Treasury – and thus was “quantitative easing” (QE) launched.

There is no “temporary”

QE was heralded as a “temporary” device to be deployed only as long as the emergency lasted. Yet here we are, a dozen years later, and the Fed is only now beginning to taper its bond-buying from a high of $120 billion per month. Such is the appeal of QE to governments living on the never-never that every central bank in the world has embraced it as a free-for-all ride.

But a debt-fuelled economy can function only so long as interest rates are suppressed. The central banks of Sweden, Denmark, Japan and the ECB have been well-entrenched in negative interest territory, and others will follow. But, to reverse a well-worn adage: what comes down must go up. There is a limit to how long savers can be robbed with impunity, or for how long industrial budgets can credibly use zero for pricing the cost of working capital. At the sovereign level the annual cost to the UK exchequer would now approximate £22 billion for every 1 per cent rise in the interest rate.

A clear principle emerges: in economics, as in life, applying a false remedy will assuredly beget the next crisis.

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Part 2 – Public and private sectors: understanding the difference

In “Through the Looking-Glass” Humpty Dumpty tells Alice: “When I use a word it means just what I choose it to mean—neither more nor less."

Humpty’s subjective approach to verbal meanings is of little relevance in the field of economic writing – although you would be forgiven for concluding that the highly-qualified economics correspondents employed on BBC news programmes are alumni of the Humpty Dumpty University. Only this week a friend sent me a clip from BBC’s educational video on the subject of Inflation – which, as you know, I was at pains to define in my last essay.

The BBC’s accompanying workbook defines it: “Inflation is the rate at which prices are rising. If the price of a bottle of milk is £1 and it rises by 5p, then ‘milk inflation’ is 5%.”

The BBC is in standard macroeconomic territory here: it cites inflation’s effect as if it came about by magic, with no reference to its cause.  But this is apt enough in the upside-down “Looking-Glass” world, where cause and effect are what Humpty chooses them to be, neither more nor less.

To inflate is literally to blow up, as we might do to a balloon or a tire. But it can also mean “expand” – such as the number of people paid out of taxes.  In the year to September 2021, their numbers swelled by 250,000 to reach a total of 5.7 million people employed in central and local government, the NHS and the civil service - compared with 27 million working in the private sector.

Taxation provides the funds needed to pay for public services, and the private sector generates the wealth from which those taxes are levied. But how are taxpayers able to assess whether they are receiving good value for their money? Without a reliable measure it’s impossible to assess the reasonableness of public sector wages, or claims for an increase. What we know is that wages in the public sector increased over the pandemic while wages in the private sector, where productivity provides a measure, decreased.

The pandemic has been good to people paid from the public purse and it is not surprising that they (and their unions) have consistently favoured more and more restrictions on our behaviour. These restrictions may ruin children’s education and put hundreds of small firms out of business – but civil service jobs, pensions, retirement plans and privileges, immune from economic consequences faced by the rest of us, remain secure.

Absence of economic calculation

To repeat what I have pointed out many times, government expenditure is not susceptible to economic calculation. Senior public sector officials have no need to think about such prosaic matters as commerce, competition or productivity. The terms of public sector employment are wonderfully generous for one reason: there is no commercial reason for them not to be! There is no compulsion, no pressing need for 5.7 million people to recognise that that nothing comes from nothing, and money needs to be made.

So twisted is government thinking that no one in had the foresight to see, for example, that energy price-cap legislation would cause energy prices to rise; and that all “do-good” schemes like “help-to-buy”, “buy-to-let” and stamp duty relief would cause house prices to rise. Simply put, the effect of well-intentioned, but blind, meddling is always the opposite of what was intended.

The chancellor is now desperate to slash spending - so why are local authorities squandering money without restraint? Do borough treasurers think their funds come from somewhere else? The imperative that drives them is that if they don’t spend this year’s budget it will not be renewed next year. The result? Congestion caused by temporary traffic lights when no road-work is taking place; or a Town Hall focus group tasked with thinking up new ways of blighting citizens’ lives: low-traffic neighbourhoods with blocked roads and secret cameras at every intersection.

Or this North London classic: an entire building encased in scaffolding and plastic sheeting while every window is replaced.

But here’s the thing: next year’s budget includes the cost of demolishing the whole building.

[I am not making this up]