The UK and its lost opportunities

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by Alasdair Macleod, GoldMoney:

Two years after leaving the EU Britain has made almost none of the promised progress towards economic liberalisation. While Brussels hasn’t been helpful, libertarian ministers in the Tory government have been both conquered by the bureaucracy of the civil service and even turned into high spending statists. There has been no attempt to reduce the state’s suffocating dominance over the economy.

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On current policies, the private sector is set to continue its long-term decline, with higher taxes and ever-increasing regulation. But it needn’t be so. This article looks at the dangers and opportunities that Britain faces, principally inflation, the challenge of government spending, of maintaining a balanced budget, trade policy and why Britain should just declare unilateral free trade, foreign policy in a world where the future is American decline and a rising Russia—China partnership, and the economic craziness of the green agenda.

There is no sign that these important issues are being addressed in a constructive and statesman-like manner. Fortunately or unfortunately, rising interest rates threaten to bring forward a crisis of bank credit of such magnitude that fiat currencies are likely to be undermined. Most of the policies recommended herein should be incorporated after the banking and currency crisis has passed as part of a reset designed to avoid repeating the mistakes of big government, Keynesianism, and the socialisation of economic resources.

Decline and fall

“This is the week a government that began with such promise finally lost its soul. Its great policy relaunch is a tragic mush, proof that it no longer believes in anything, not even in its self-preservation.”

Allister Heath, Editor of The Sunday Telegraph writing in today’s Daily Telegraph 3 February

Two years ago this week, Britain formally left the EU. Yet, it is estimated there are 20,000 pieces of primary EU legislation still on the statute books. And only now is there going to be an effort to remove or replace them with UK legislation. Obviously, going through them one by one would tie the legislative calendar up for years, so it is proposed to deal with them through an omnibus Brexit Freedoms Bill.

Excuse me for being cynical, but one wonders that if the Prime Minister had not come under pressure from Partygate, would this distraction from it have got to first base? After two years of inaction, why now? And it transpires that instead of doing away with unnecessary regulations as suggested in the Brexit Freedoms Bill, legislative priority will be given to the economically destructive green agenda. This underlines Allister Heath’s comment above.

There is also irrefutable evidence that a remain-supporting civil service has continually frustrated the executive over Brexit and has discouraged all meaningful economic reform. The way the Brexit Freedoms Bill is likely to play out is for every piece of EU legislation dropped, new UK regulations of similar or even tighter restrictions on production freedom will be introduced — drafted by the civil service bureaucracy with its Remainer sympathies. For improvement, read deterioration. It will require ministers in all departments to strongly resist this tendency — there’s not much hope of that.

The track record of British government is not good. Since Margaret Thatcher was elected, successive conservative administrations have pledged to reduce unnecessary state intervention and ended up fostering the opposite. They raise taxes every time they are elected, even though they market themselves as the low tax party. While the number of quangos (quasi-autonomous national government organisations) has been reduced, in practice it is because they have been merged rather than abandoned and their remits have remained intact. Another measure of government intervention, the proportion of government spending to total GDP, has risen from about 40% to over 50% in 2020. An unfair comparison given the impact of covid, some would say. But there is little sign that the explosion of government spending will come back to former levels.

Like the unelected bureaucracy in Brussels from which the nation sought to escape, the UK’s civil service has no concept of the economic benefits of free markets. Without having any skin in the game, they believe that government agencies are in the best position to decide economic outcomes for the common good. Decades of Keynesian reasoning, belief in bureaucratic process and never having had to work in a competitive environment have all fostered an arrogance of purpose in support of increasing statist economic management. It is a delusion that will end in crisis, as it did in 1975 when under a Labour government Britain was driven to borrow funds from the IMF that were reserved for third world nations.

Against this background of restrictions to economic progress, the nation is unprepared to deal with some major issues appearing on the horizon. This article examines some of them: inflation, state spending, trade policies, foreign policies, and the economic harm from the green agenda. These are just some of the areas where policies can be improved for the good of the nation and create opportunities for greatness through economic strength.

Inflation

In common with other central banks, the Bank of England would have us believe that inflation is of prices only, failing to mention changes in the quantity of currency and credit in circulation. Yet even schoolchildren in primary education will tell you that if a cake is cut into a greater number of pieces, you do not end up with more cake; you end up with smaller pieces. It is the same with the money supply, or more correctly the quantity of currency and credit. Instead, central banks seem to believe in the parable of the feeding of the five thousand: five loaves and two fishes can be subdivided to satisfy the multitudes with some left over.

The source of an increase in the general price level is increasing quantities of currency and credit, leading to each unit buying less, just like the smaller slices of cake. And measured by the Bank of England’s M4 (the broadest measure of currency and credit) the currency cake has been subdivided into many more smaller pieces in recent times.

Figure 1 shows that M4 has increased from £1.82 trillion at the time of the Lehman failure to £2.96 trillion last September, an increase of 63%. But the rate of increase accelerated substantially in the first six months of 2020 to an annualised rate of 19.3%. This is the engine driving prices of goods higher, and to a lesser extent, services.At that time, currency inflation was everywhere, leading to significantly higher commodity prices. The commodity inputs to industry represent sharply rising production costs, coupled with skill shortages and supply chain disruptions. But these are merely the evidence of the currency cake being more thinly sliced. Buying and installing a new kitchen in your house requires more of the smaller slices of the currency cake than it did last year.

All else being equal, there are still significant price effects to come with past currency debasements yet to work their way through to prices. And given that monetary policy is to meet rising prices by raising interest rates while still inflating, higher interest rates will follow as well. The effect on bond yields and equity prices will be beyond doubt. But all else is never equal, and the effect of higher production costs will be to close uneconomic production and put overindebted manufacturers out of business. This development is already becoming evident globally, with the post-pandemic bounce-back already fading.

Being undermined, the effect on financial collateral values is likely to make banks more cautious, reduce bank lending, and at the margin increase the rate of foreclosures. The problem is that most currency in circulation is the counterpart of bank credit. A bond and equity bear market will lead to a contraction of bank credit, triggering policies designed to counter deflation.

What will the Bank of England do? Undoubtedly, it will want to increase its monetary stimulation at a time of rising interest rates and falling financial values. The Bank will also find itself replacing contracting bank credit to keep the illusion of prosperity alive. The issuance of base currency will not be a trivial matter.

But according to the Keynesians, who can only equate price levels with consumer demand, inflation during an economic slump should never happen. Worse, it will come at a time when UK banks are highly leveraged at record levels — Barclay’s, for example, has a ratio of assets to equity of about twenty times. And as the European financial centre, London is highly exposed to counterparty risk from the Eurozone which, being in a desperately fragile condition, is a major systemic threat.

With these increased dangers so obviously present, it would behove the Bank and the Treasury to rebuild the national gold reserves, so foolishly sold down by Gordon Brown when he was Chancellor. It is the only insurance policy against a systemic and currency collapse that is becoming more likely as inflationary policies are pursued.

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