The Things My Wife Worries About

Social and economic decline dominate the UK headlines. Are they real? It's time to take The Sniff Test.

The Narrative of the Day

My wife worries that our economy and society are simultaneously going to pot. She sees stories about this most days. Wellbeing depends on believing we have control over our lives and can help out family and friends. The news can undermine our belief by playing on events beyond our control.

The Sniff Test is about what is knowledge, what is democracy and what society sees through the Overton Window. The window reveals what is acceptable at a point in time and right now the view is changing. Today people expect to see government addressing their immediate concerns. The tolerance for grand gestures about the fate of society is over.

The top two stories on the BBC website this morning are about America. We are in a funk about Donald Trump. Our leaders want to close their eyes and wait four years for him to go away, but worry that the riff-raff may like his ideas. Trump has withdrawn the US and $1 billion funding from the World Health Organisation. In his absence from Davos, it falls to President Zelensky of Ukraine to inform Europeans that the days of buying Russian gas and hiding behind US security guarantees are over. There is no escaping the shadow from the States.

Trump’s second inauguration is not a pivotal event. The arc of history has been turning for a while. This may be the conclusion of the Fourth Turning predicted by Strauss and Howe. After all, the gender wars they identify with the death of the long cycle, appear to be over. Or we may be at the end of the post-Cold War era begun in 1989, the neoliberal order that emerged in the 1970s, or the period of liberal democracy dating from the mass enfranchisement after the 1960s civil rights movements. But every end is a start, hence we ask what comes next.

It feels to me like the end of the period of big spending, boundless money creation and accelerating wealth inequality that followed the 2008 financial crisis. If so, I should sell my bitcoin, because its price depends on the amount of money created. I’ll tell you if I do. To keep my wife and other readers happy, we’ll go light on the economics and stick to the question.

A Change in Behaviour

There are lots of great economics writers. I have read John Mauldin on the US for years. You might try John Authers for a daily dose of the investor consensus, and for original and sophisticated analysis subscribe to Coldwater. One or more writers may say we are in a new cycle of rising interest rates. This means things we’ve taken for granted for 40 years, such as rising stock markets and house prices, might not last.

Bill Clinton was the poster child of neoliberalism. He chaired the Democratic Leadership Council from 1990-91. Despite the name, this was a group of peripheral politicians who wrested control of the party from the losers of all but one election since 1964. The DLC were New Democrats, inspiring New Labour in Britain, and both were centrists favouring market-oriented economics, controlled government spending and a moderate social agenda.

Clinton’s chief strategist said that if there was reincarnation he would come back as the bond market. It stands alone in its ability to intimidate the powerful. When we read about the rapid fall in the price of government bonds, this is the bond vigilantes at work. Their eyes are trained on Rachel Reeves.

Bond investors want to get their money back. They also care that the value of that money is not eroded by inflation while they wait. If they have doubts, they don’t wait to sell government bonds and send a warning to profligate politicians.

Seven times since Clinton’s era the warning shot has proved accurate. The authorities respond with cuts to official interest rates, such as the Bank of England’s base rate. This means our savings earn less, our mortgages are cheaper and companies are more likely to borrow. The economic green shoots appear, investors go back to buying bonds, and interest rates gently decline.

It's not playing out that way this time. Bond investors’ behaviour has changed. The Bank has cut official interest rates but market rates go up. Why?

Interest rates compensate us for not spending our money. The more uncertain the future, the higher they are. Governments are the biggest borrowers against the future, so the more uncertain we are about them, the more interest we demand. This has knock on effects for the cost of our mortgages and the prices of houses, stocks and shares.

The neoliberal consensus talked about temporary measures to address the financial crisis, Covid and the war in Ukraine. But the neoliberals are gone and as Milton Friedman said, there is nothing as permanent as a temporary government programme.

The Future’s Not Bright

While the US economy leads the western world, it is the last to feel the chill winds blow. The US can issue lots more dollars because people want to buy US technology, goods and services, and to invest in US stock markets and government debt. Far fewer people want to invest in the UK.

This is unfortunate because we need them. The chart shows the basic balances of a range of countries. This is one measure of financial stability and captures dependence on other people’s money. Britain has long been dependent on a strong desire to move money here.

Our situation cannot be blamed on Brexit because things have improved since 2016. It’s not the last government’s fault. Capital goes where it is treated best, which means where it flows freely and is taxed lowest. By punishing companies for hiring people, Rachel Reeves made it harder to be in business here.

Last week the government issued a policy which it hopes will make the UK a centre for AI. The policy does all the things that governments should, by investing in infrastructure, making resources available, and easing planning permission for support services such as data centres and electricity generation. It even makes it easier to poach top talent from abroad to boost home-grown research.

But the UK does not have a research problem. It has some of the best higher education establishments in the world and punches above its weight in creating knowledge from innovative ideas. The challenge in the UK is turning that knowledge into profitable, high growth companies to face off against the best in the world. Most of our ideas and startup companies end up in the US.

The UK government is making it easier to use AI and harder to hire people. This seems unlikely to endear it to the electorate. That might be okay if politicians keep investors happy and have money to spend on voters. Broadly speaking, there are four things that investors look for when pricing debt. The cost of borrowing tells us if they are happy.

Waste, Entitlement, War and Tax

Investors won’t give money to governments if they think it is going to waste. This is where the vibe shift comes in. For the last 15 years or so, it’s been okay to spend record amounts of money, promote the rights of minorities and fly round the world burning fossil fuels promising a greener tomorrow. But there is nothing to show for it.

Keir Starmer challenged civil servants he claimed were “comfortable in the tepid bath of managed decline”. He then sanctioned 25 new task forces and advisory councils, and the ordering of 67 reviews and consultations. Strike one for the government on waste.

At £622 billion, health and social security are half of projected government spending. The national debt cannot be controlled without reining in both. In practice, this means growing spending by less than inflation for decades, while increasing its effectiveness. No government has been able to do this and politicians get re-elected when they spend more not less.

The result is £2.8 trillion of government debt. The interest on that is £109 billion this year and heading higher as interest rates rise. Strike two for the government on entitlement.

No one wants wars, pandemics or recessions. There is a patchy peace in Gaza and Trump wants a deal on Ukraine. There is a Cold War feel to America and Russia deciding the fate of Europe, but without a military worth the name we are left on the side lines of the conversation. Everything about pandemics is predictable other than the timing, while a recession would increase government spending and lower its income. Maybe we’ll be lucky.

Bond investors care that governments have the money to pay them back. That means if taxes are cut, economic growth rises enough to increase total tax take. If you raise taxes as Reeves has done, you must not cause activity to fall. A lack of confidence in the economy is a further strike against the government. Three strikes and you’re out.

Out of Wriggle Room

Investors don’t need immediate results, but they do need commitments and progress. The government arrived claiming they inherited a spending black hole and proceeded to spend even more. This is not a good look.

Part funding of promises with taxes that cut confidence in the country and reduce economic activity has made the situation worse. As Michael Taylor of Coldwater Economics says,

“Britain has little, if any, wriggle room left before its public finances become seriously unsustainable, and is pursuing fiscal and monetary policies which are directly making matters worse, and fast.”

The government may blame Trump, tariffs and the Tories, but the vibe shift in favour of direct action that improves our lives means it will not get away with it. Michala is right to worry. Next week we’ll look at whether Starmer will fair better patching up our torn social fabric.