How could Partgate do to Johnson what Black Wednesday did to Major Larry Elliott
MStories went way back when George Soros criticized Vladimir Putin and Xi Jinping in Davos last week, even though 30 years ago the main speculator was in his eyes as mere sterling leaders rather than autocrats.
By 1992 the pressure on the pound intensified until September 16 it was blown out of the European Exchange Rate Mechanism (ERM). John Major’s government never recovered from what was quickly dubbed Black Wednesday, so the humiliation and loss of public trust was complete.
The question now is whether Partigate will do to Boris Johnson what Black Wednesday did to the Major. Is the Conservative Party’s reputation so wracked by scandal that no matter what happens between now and Election Day, defeat is inevitable?
In some ways, Johnson’s outlook looks much bleaker than it did for Major. Black Wednesday forced the then government to abandon a policy it had hitherto said was non-negotiable – the membership of the ERM. That policy, under which the pound was only allowed to trade in a narrow range against the deutsche mark, required keeping interest rates higher than they would otherwise be, prolonging the recession of the early 1990s.
Leaving the ERM system was good for the economy. Interest rates fell sharply and the pound fell in value. Fears of rising inflation proved unfounded because the recession left a lot of slack in the economy. High taxes in budgets following Black Wednesday were unpopular but ensured that lower interest rates helped producers rather than encourage consumer spending.
Once the cycle is defined, nothing is done to change it. By the time of the 1997 elections, unemployment was low, growth was robust, and the large balance of payments deficits that had built up in the boom of the late 1980s had been eliminated. However, the Conservative Party succumbed to a landslide for the Labor Party.
Rishi Sunak’s inflection last week over the imposition of a windfall tax was not on par with leaving the ERM system in September 1992, but it was devastating enough. For months, the chancellor has been resisting the idea of taxing profits made by oil and gas companies in the North Sea on the grounds that it would discourage investment. Similarly, Sunak said he will wait until the fall budget before deciding whether to provide more assistance to families struggling with rising energy bills.
This strategy has now been abandoned. In a deafening echo of the crisis-ridden 1970s, there have now been three small budgets since early February, with the government playing a role in catching up with the cost-of-living crisis.
To some extent, what Sunak did made perfect sense. Only the Treasury has the means to prevent millions of families from slipping into fuel poverty, and £15 billion in additional purchasing power could shield the economy from recession later this year.
However, there are some significant downside risks. The first is that pumping more demand into the economy will add to inflationary pressure, causing the Bank of England to be more aggressive when it comes to raising interest rates.
The bank believes that the current inflationary pressure is caused by a series of supply-side shocks, including the loss of workers due to Brexit and the pandemic, bottlenecks with increased demand after the shutdown, China’s zero-Covid policy and – most recently – the war in Ukraine. . What matters for short-term interest rate policy is what the Monetary Policy Committee (MPC) on Threadneedle Street thinks will happen to inflation. And what Sunak did last week will only add to the MPC’s concerns.
In theory, changing the policy mix is a good thing. There is a strong case to say that monetary policy (what the Bank of England does) was too loose and fiscal policy (what the Treasury does) was too strict. But the situation is not as clear as it was in the aftermath of Black Wednesday when the tight fiscal / monetary policy mix did the trick. With annual inflation already at 9%, the bank’s credibility is on the line. There is a risk that Snack loosening the fiscal policy will lead to an exaggeration of monetary policy on the part of the Bank.
Even if, by some miracle, the policy mix turns out to be perfect, there won’t be the kind of recovery we saw after Black Wednesday. Living standards will continue to decline this year even after Sunak’s latest measures, but not to the same extent. Paul Dells of Capital Economics says real disposable income for small-budget households was on track to decline 2% in 2022, but it will still fall 1% even after money is deducted from energy bills.
Black Wednesday shattered the Conservative Party’s reputation for economic efficiency. Major received no credit for the subsequent recovery because it only happened because the UK government abandoned austerity policies that it insisted were non-negotiable.
Johnson is in an equally bad situation. After Black Wednesday, a new and largely effective framework for controlling inflation was quickly assembled. Today, the government’s economic policy is rudderless, fluctuations and short-term announcements occupy a long-term strategic position.
Sunak says he is financially conservative but does not act like one. With the permission of the prime minister and chancellor, “big government” is now back in vogue, the first result of the pandemic and now Russia’s invasion of Ukraine.
Ministers speak the language of the right but – usually after a lot of kicking and shouting – they end up behaving like an incompetent party of the left. Voters probably won’t forgive Johnson for Partigate even if the economy booms between now and the next election. They certainly won’t forgive him if the economy suffers, as it probably does.