30 years on from Black Wednesday | Could it happen again?

Norman Lamont, with his chief economics advisor David Cameron

Maggie Thatcher once memorably claimed

“the problem with socialism is that eventually you run out of other people’s money”

During the credit crunch we discovered that deregulated free market capitalism had exactly the same problem, just on a much bigger scale.

This week is the 30th Anniversary of Black Wednesday when HMG raised interest rates to 15% and sold off chunks of our gold reserve in order to stop a run on the pound.

The pound is now at a historic low, lower than it was during Black Wednesday, so it seems like a good time to ask whether we are heading towards another Black Wednesday or whether HMG is a risk of running out of other peoples money.

First the boring bit:

Public finances are divided into 2 categories: The Departmental Expenditure Limit (DEL) and Annually Managed Expenditure (AME). DEL is planned expenditure like the NHS budget, AME is in year spending on things like benefits or interest on government borrowing

Last year before the current crisis started there was a massive increase in AME spend – it rose by over £100bn from £375bn to £498bn. This is the biggest leap I can remember. 2 thing are behind this; firstly. the country is getting a lot poorer and more and more is being spent on benefits, secondly Boris kept on borrowing loads and loads even after Covid, and the costs of servicing that debt has increased too.

There has been another massive leap in AME spend this year – interest payments alone went up by a record £20bn in June alone. It won’t be that bad every month, but this is terrible news.

To put this in perspective in 1976 the then Labour Government had to borrow $3.9bn from the IMF. Inflation was at 24% and the pound was losing value. The Government was worried it would fall below $2.

That $3.0bn is worth $18.6bn today – less than the increase in AME in June.

Obviously this means that there is little, or no, scope for tax cuts. The Government has little credibility right now, and yet is asking to borrow more and more money from financial markets for unfunded tax cuts – markets will want HMG to pay a lot more for this borrowing, which only makes the AME problem worse. There has been a lot of talk about financial markets losing faith in HMG (usually aimed at future Labour governments), but Truss has a weak team, big holes in her financial plans and a real risk of losing the confidence the people she needs to buy more and more government debt.

She risks running out of other people’s money

But this also creates a massive cash problem for Government. The only way the Government can fund increased AME payments in year is to print more money. You don’t have to be Milton Friedman to know that printing loads of cash during an inflation crisis is a bad thing to do – it makes the problem loads worse.

UK money supply has been high since the credit crunch – an affect of quantitative easing. Since 2020 and Covid there has been another massive leap in printing money – June and July this year were the highest months of record for £M2

So could this end in another Black Wednesday?

Lots of people are still angry that Gordon Brown sold the gold- but there is a massive upside to what he did – by changing how we hold our reserves (more foreign currency, less gold) we were better able to withstand pressure on the pound – that’s why. we haven’t seen an attack on the pound since, despite Brexit and other shocks, the regular sterling crisis that dominated the post war era haven’t effected the UK since.

Given the Governments massive fiscal problems we might be about to find out exactly how robust Brown’s strategy was – it withstood the Brexit shock – can it withstand a full on run on the pound?

That stable bit of consistent currency values and stable exchange rates? That’s Brown selling the gold

The Conservatives came to power in 2010 claiming that the UK was at risk of becoming like Spain, Portugal, or Greece; too much debt, unstable property market, unaffordable spending commitments in particular state pensions

In the 12 years since they have increased debt to record levels, created an unstable property boom, and introduced the triple lock, making pension commitments massively more expensive while everyone else has struggled.

Successive Conservative PMs acted pro-cyclically – they pushed austerity when the economy was struggling and then increased spending when the economy was already over heating. They should have acted counter-cyclically; delayed any cuts until the economy had recovered fully from the credit crunch, and they should be cutting not spending now.

Johnson, and his successors, have left behind the most ruinous financial position of any out going PM in history.

A better historical comparisons might be with the 1970s – an energy price shock, a Government that increased spending not cut it in response, and industrial unrest. Just like Black Wednesday there was a currency crisis – the 1976 IMF bailout.

We now face a massive economic crisis without the tools we need to fix it – we need to cut not spend more, but the legacy of bad policy and too much historic austerity has made that impossible. The Bank of England will raise interest rates to try and curb spending, the but the traditional relationship between spending, investment and interest rates has broken down (12 years of low interest rates and low investment) and the sources of our inflationary shocks are exogenous anyway.

The Governments big increases in spending and tax cuts can end 1 of 2 ways: Either the economy will grow and inflation will stay under control, or inflation will take off and strangle growth.

Which outcome we get depends on whether there is slack capacity in the UK economy – if there is slack capacity we will get grown, if there is no slack capacity we get inflation.

The latest Labour Force Survey shows a fall in unemployment to a record low. This is a good thing. But it also shows a fall in employment as well. The Labour force in the UK is shrinking – we have lost 0.5m workers since Covid, lots of them leaving the workforce in their 50s due to ill health or the need to care for relatives. This is on top of the huge contraction in the workforce post Brexit.

It is hard to see a lot of slack in those figures.

There are however some parts of the UK economy where there is lots of slack- high street retail. This is where the story is very different.

There is still hope – if demand for labour grows and wages grow it might become attractive for people to move back into the workforce. I am actually confident about the real economy of shops and restaurants, more than I have been for years. Lots of the empty shops in my town are filling up again, often with good quality local independents. New cinemas and hotels are opening. Shop fitters are busier than ever. It may be that Durham is bucking the trend – we have 12 new openings in retail and leisure this year, and 5 more to come.

If tax cuts and £100bn of extra spending can help retail and other parts of the UK economy fill their slack capacity we could still flourish

But I worry that the current Government are no longer acting like a party that expects to win an election and stay in power. It feels drained, out of touch, lost. It is spending money as if they don’t expect to have to pay the bills when they come due. Exiting power leaving behind a mess that will limit an incoming Labour minority Government from doing anything meaningful.

And that is what worries me the most – a Government that doesn’t want to accept the consequences of their own actions.

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https://www.gov.uk/government/statistics/public-spending-statistics-release-may-2022/public-spending-statistics-may-2022

https://www.ons.gov.uk/economy/governmentpublicsectorandtaxes/publicsectorfinance/bulletins/publicsectorfinances/june2022#:~:text=This%20month%20the%20interest%20payable,the%20impact%20of%20the%20RPI.

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