Artillery Row

The pound is not the dollar

British Reaganomics is a non-starter

Cast your mind back a couple of years. The government decides much of the country’s businesses need to cease trading, and the vast majority of individuals must be confined to their homes, for an indefinite period of time. They borrow hundreds of billions of pounds to make this happen. 

The Bank of England, which is supposedly independent from government, helps them in this endeavour by purchasing £300 billion worth of government bonds and keeping interest rates practically at zero. This is unanimously supported by all the major opposition parties, whose complaint is only that they think the government should go further. After all, received opinion holds that a “V-shaped” recovery is certain. Apparently, governments can put entire economies into a freeze, and then simply defrost them like nothing’s happened. Astonishingly, the central bank appears to agree.

As we move into 2022, reality begins to bite. Inflation starts rocketing — although we were told it would only be “temporary. Energy bills start getting increasingly unpayable and national growth is minimal. Common wisdom is that the austerity of the last decade cannot be repeated; it’s neither politically nor economically feasible. Instead, the new grand idea is to be “pro-growth. Genius. Why did nobody think to grow the economy before? This involves borrowing even more money — just as interest rates finally start to rise and doing so becomes more expensive. 

Britain is no longer a preeminent economic power

Then a tax-cutting prime minister comes to office on the explicit platform that now isn’t the time to start thinking about how or when to pay all this debt back. In any case, all of our problems can be attributed to “Putin’s illegal invasion of Ukraine”.

In the dramatic aftermath of Kwasi Kwarteng’s “mini-budget”, it’s now become fashionable again to question the economic wisdom of our overlords — although the Chancellor’s measures were miniscule compared to previous moves happily cheered on by almost every politician, central banker and economist in the country. Rachel Reeves, Labour’s Shadow Chancellor, thinks this mini-budget of all things reflects the “economic mismanagement of the government”.

It’s something deeper than “mismanagement” which has got us where we are today, although that’s certainly played a role. As the events of the last two years have demonstrated, the assumptions underpinning economic decision-making in this country are increasingly absurd. 

Much of this mess stems from a fundamental inability to grasp that Britain is no longer a preeminent economic power and does not have the capacity to act like one. As Janan Ganesh recently argued in the Financial Times, our political class is obsessed with America and constantly acts as if Britain is a comparable case. In an economy built on illusions and delusions, this is the biggest and most consequential.

America can — just about — get away with some of the questionable economics that Britain has unsuccessfully experimented with, because it has some major advantages that we don’t. Perhaps most significantly, America issues the world’s reserve currency. The US dollar is, by far, the most desirable currency in the world and dominates international trade. Investors want — and need — ready access to dollar-denominated assets. This was once true of the pound sterling, of course, in the long-gone days when Britain was the world’s foremost financial powerhouse.

The success of President Reagan depended on the US dollar

High demand for the dollar means there’s pretty much endless demand for American government bonds. Unlike Britain, the United States is the world’s largest economy and has never defaulted on its debt. US bonds are therefore considered some of the safest assets in the world. There’s always steady demand from foreign creditors, meaning America is constantly able to borrow money at low interest rates. This is one reason why it can fund the kind of measures — such as spectacular spending commitments and sizable tax-cuts — that we seem to think are also available to us. But they’re not. At one point last week British debt was deemed riskier than that of Greece and Italy. It’s time to get real.

The prime minister’s supporters often point to “Reaganomics” as proof that tax cuts and deregulation invariably lead to higher growth and productivity — whilst defeating inflation in the process. But, crucially, the success of President Reagan depended to a large extent on the strength of the US dollar. Between mid-1980 and February 1985, the dollar rose in value by 77 per cent. This was a major help in the battle against inflation by making American imports significantly less expensive — giving a further boost to living standards. A strong dollar is something that President Biden’s America is experiencing, too.

In Britain today, we’re experiencing the complete opposite set of conditions. Even before the volatility on sterling markets last week, the pound has weakened by about 15 per cent against the dollar this year alone. This is having the result of making imports yet more expensive and therefore contributing to increased inflation — a particular problem in a country that has just posted its widest trade deficit on record. Reaganomics also worked thanks to a specific set of demographic advantages, such as the mass entry of women into the workforce. The British working population is getting older and is set to decline.

None of this is easy for any patriotic-minded person to read, let alone write. But serious progress will be impossible for as long as we continue to console ourselves with fanciful thinking, as we have done for so long. Britain desperately needs to undertake an honest examination of its capacities and finally stop pretending that we are the power we once were.

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