Opinion An early lesson in the British pound’s free fall
If there’s a broader lesson to be gleaned from Britain’s economic crisis, it’s this: Beware politicians glibly promising that they — and they alone — know better than the experts.
Prime Minister Liz Truss and her allies promised that when she came into office, she would fix the economy by ditching “the stale economic orthodoxy” and “so-called abacus economics.” This sort of rhetoric has become common among populist politicians — including in the United States — who portray themselves as freethinkers by bashing the ominous-sounding “establishment” or “elites.”
Or, you know: those annoying, bean-counting, possibly on-the-take experts.
Since Truss unveiled a mini-budget Friday, Britain’s currency has been in free fall, with the pound hitting an all-time low against the dollar Monday. Markets clearly don’t believe the Conservative government’s stated commitments to get inflation under control, and they doubt Britain’s ability to make good on its debts.
That’s partly because economic conditions outside the government’s control are genuinely challenging. But there have also been a lot of unforced policy errors.
Sometimes an economic policy has previously been ruled out not because leaders lacked the ingenuity or moral courage to propose it before, but because it’s already been tried and repeatedly failed. Unfortunately, that’s the flavor of “unorthodox” that Truss and her party have been adopting — and that some American politicians are proposing, too.
Among Truss’s supposedly bold and brave ideas is seeking to stimulate the economy’s way out of an inflation crisis. Her government announced a series of tax cuts, which bear more than a passing resemblance to the kinds of trickle-down policies often proposed in the United States as an economic cure-all. The Tories’ tax regime represents the biggest British tax cuts since 1972.
But when an economy is overheating and demand exceeds constrained supply, giving the public even more cash to spend will almost certainly make inflation worse. It could also spur the central bank to raise rates more aggressively in an effort to tamp down demand, ultimately leading to more economic pain.
Virtually any “orthodox” economist could tell you this. And yet in Britain, as in most U.S. states, tax cuts as a remedy for inflation have become puzzlingly in vogue.
Another of Truss’s “unorthodox” ideas: price controls. This, too, has gotten purchase in the States, though the American politicians pushing it are primarily on the left.
Britain’s price controls on energy are intended to address a serious economic concern. Global disruptions related to Russia’s war in Ukraine have made energy painfully expensive. As winter sets in, Britons could freeze if they can’t afford heat.
But energy price caps encourage more energy use, not less, because they shield consumers and businesses from the price hikes that would normally incentivize at least some conservation. The price caps are likely to create some combination of energy shortages and enormous (as-yet-unquantified) costs for the government.
This is another reason British debt looks so risky and the pound has plummeted.
Virtually any approach to dealing with high energy prices will be painful in some dimension. But less costly strategies are available beyond guaranteeing everyone lower prices. Relief could be targeted to lower- or middle-income households in the form of flat rebates. That way, price signals still do their work.
Truss has proposed bizarre, non-expert-approved policies before; several years ago, she said it was a “disgrace” that Britain imported so many apples and appeared to suggest more trade barriers on food. Because, of course, real trade wars have never been tried.
But perhaps most troubling are Truss’s hints of political meddling at the central bank.
In recent weeks, Truss has alluded to plans to “change the Bank of England’s mandate.” Precisely what that means is unclear; markets seem to fear it’s a euphemism for more political interference in the setting of interest rates and other monetary policies. The central bank is already undertaking unpopular tightening measures and will likely need to tighten much more aggressively going forward, partly in response to Truss’s fiscal stimulus.
There’s a long and disastrous track record of what happens when politicians control the money supply or are even just perceived to be doing so. (See: Venezuela, Argentina, pre-euro Italy.) The maxim that central banks should be politically independent became orthodoxy for a good reason: Doing otherwise has failed spectacularly.
To be clear: It’s not that experts are always right. Groupthink can be wrong and sometimes dangerous. Diversity of opinion and stress-testing of conventional wisdom are good things.
But when politicians peddle magic fixes that they claim everyone else was too cowardly, close-minded or unpatriotic to have ever proposed before: Be suspicious. As Truss’s leadership so far has shown, sometimes those promising to fire a “silver bullet” are really just shooting themselves in the foot.