The Gnomes of Zurich are back in charge.

Out of the libertarian frying pan into the austerity fire.

Glee at the crucifixion of Liz Truss has curdled into fear and loathing as the country realises what the Hunt u-turn actually involves.  Energy bills of £4-5000 after April 2023?  Scrapping the triple lock on pensions? And that’s only about half of the £70 billion or so of public spending cuts demanded the international money markets. Benefits are unlikely to survive this squeeze.

Don’t get me wrong. Liz Truss’s doolally libertarianism was a disaster. Her unfunded tax cuts caused a run on the pound and a shock to pension funds which required a Bank of England emergency bail out.  But we are not going back to where we were under Boris Johnson, which is beginning to look like an era of benign stability. This is a new and scary normal.

Johnson succeeded in increasing public spending on health and other services by judicious tax increases, mainly but not exclusively in National Insurance and Corporation Tax, which amounted to 2% of GDP.   Rishi Sunak kept it all within rational bounds and broadly satisfied the money markets that the government knew what it was doing even if Boris didn't.  

Jeremy Hunt has reached for the traditional Tory Plan B which is called fiscal orthodoxy. It looks similar to the austerity regime imposed by the Conservative Chancellor George Osborne in 2010.  Indeed, Osborne has now been drafted back into Chancellor Hunt's legion of advisers. Osborne's spending cuts of 19% across government departments were designed to reassure international investors that Britain could balance the books and would honour its debts.

Following the 2008 financial crash, and the subsequent recession, British borrowing costs were rising too fast. Debt was thought to be out of control. Something had to be done. The Institute for Fiscal Studies had to be squared as did the International Monetary Fund and other agencies of global finance.

Osborne created the Office for Budget Responsibility to persuade the markets that fiscal policy was no longer in the hands of politicians but had been outsourced to experts, much as the Bank of England had been made independent by Gordon Brown a decade earlier. But technocrats aren't magicians.

Boris Johnson always insisted during the pandemic that he would not return to austerity. He said that for a reason. Austerity didn't work. Cutting public spending during a recession just makes it worse, as John Maynard Keynes observed during the Great Depression. The job of government is to spend what it takes to get the economy moving again.

Osborne believed in a chimaera called “expansionary fiscal contraction” - the belief that public debt has to be reduced below 90% of GDP to prevent growth being stifled. What happened in practice was deflationary fiscal contraction, a deepening of the recession, which forced a partial spending u-turn in 2012. The Osborne's Office for Budget Responsibility concluded that his austerity had actually reduced growth by one percent in each of two years after the spending axe. That may not sound much but in cumulative terms it set the scene for a decade of low growth and stagnant wages.

Jeremy Hunt says he is not returning to austerity, but it is hard to see his u-turn in any other light. Crippling energy bills and rising mortgages will choke off retail spending, which is 60% of GDP. Increasing, or rather not cutting, corporation tax will dampen investment. Meanwhile, the Bank of England is being forced to increase interest rates under pressure from international financiers. One reason the pound has become so weak is that the American Federal Reserve is pushing bank interest rates through the roof. That means investors will flock to the US dollar for better returns.

There are deeper economic problems of course, connected to Britain's low productivity, unsustainable trade deficit and the backwash from Brexit which has damaged trade with Europe and exposed the pound to speculation. The Labour Prime Minister Harold Wilson called international bond speculators the “Gnomes of Zurich” back in the 1960s. They're back in charge. And Keir Starmer will have to deal with them soon.

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