PS on the chancer Chancellor

My last post was mainly about the state of the economy and the reasons Rachel Reeves looks as if she's not sleeping.

Though perhaps the reason she's not sleeping is that she's not up to the job.

While I didn't vote for Labour I had long resigned myself to them winning and felt that, as at least it was Starmer-Reeves and not Corbyn-McDonnell, things should be ok. Oh they would make a mess of it slowly, as Labour always does, but nothing catastrophic. I found confidence in the fact that Reeves had had a career in finance and had been an economist at the Bank of England.

What could go wrong?

For a start Rachel wasn't what she claimed to be, or had allowed us to believe she was.

First we found out that claims that she'd been the British under 14 national chess champion were slightly exaggerated. She actually came 26th*. Some supporters tried to claim she was being harshly treated for winning the 'wrong chess tournament' as she apparently won - with 3 others - the British Women's Chess Association under 14 competition, a rather less significant achievement**. She may only have ever said that she won A rather than THE national under 14 title but she had allowed it to become part of her bio.

She claimed on her LinkedIn CV to have been at the Bank of England for a decade - it was actually 6 years. She also said she was an economist with the Bank of Scotland. Except she wasn't. She was in a customer services role with the Halifax, part of that banking group but a very different role. This came to light when former colleagues outed her. Her linkedin page suddenly got 'updated' and she let it be known that she had "brought her experience as an economist" to a role in retail banking. Oh dear***.

I thought nearly everyone realised that, if there ever was any point in tweaking your CV, it won't work now and isn't worth it. I saw much bluster evaporate under simple questioning when interviewing candidates for employment and that was a long time ago now.

So Rachel's not as sharp a tool as she'd allowed us to think. These things always come out in the end.

As far as I can understand the Reeves "plan", the top priority is growth. I agree, tick. But we have a crisis of delivery in public services. I accept that required higher taxes in the short term: things have to be paid for. However, the important point for the longer term is that significant productivity improvements are essential. Labour doesn't seem to have the a clue on how to go about that. Indeed, their first actions, bunging money at doctors and train drivers while with drawing any requirement for changes in working practices, was seriously counter-productive (pun intended). Change to the borrowing rules to enable more investment - big tick, I've thought for a long time it was daft that capital spend got slashed at the first sign of problems for the budget. Balancing current spend with taxation and investing in tangible assets at an affordable rate makes much more sense. Though the implication is that, when the economic outlook deteriorates, the chancellor will have to cut spend or raise taxes straight away. You can see why chancellors have taken the soft option of deferring capital spend - it hurts much less at the time.

Returning to "topline" in the plan - growth (pun also intended). From the outset Reeves spent too much time aggressively talking down the economy, talking up the problems and over emphasising (indeed grossly exaggerating) her economic inheritance. She can't expect those with money to invest to respond positively to all that stuff. They were always much more likely to keep their hands in their pockets. 

Those to the left of Reeves have warned that she seems to be returning to austerity. They make that out to be a political choice. I would have hoped that those folk would have heeded the major lesson of the brief Truss-Kwarteng interlude - that the elected politicians in charge of our affairs at any point in time often have much less room for manoeuvre than one might think. They can take a touch on the tiller but major rapid shifts are likely to cause a capsize. This is because, whatever the demands for spending (and they appear almost limitless), there is only so much money.

Only so much you can raise by taxes and only so much you can borrow. Too much of the former and wave goodbye to any chance of strong economic growth for the foreseeable future.The bond vigilantes will limit the latter. The former Bank governor Mark Carney referred to us being dependent upon the  kindness of strangers. But here's the rub. Those strangers aren't necessarily strangers - they are the major lenders in a market we know well. And they aren't being kind when they lend, they are just taking a cold, hard assessment of returns and risk. And they have other places they can put their money.

One of the things Reeves seems to be considering is merging the various comparatively small public sector pension schemes inter a superfund and "encouraging" it to invest in the UK in her infrastructure schemes. Most pension schemes used to invest mainly in the UK but for some time now they have invested mainly overseas, which has been one of the factors reducing the liquidity in the London stock market and its attractiveness as a place to list shares. I understand the logic in this and it is tempting. But I wouldn't want to be the one who has to tell those pension scheme members in the future that the returns on their invested pensions have been poor. Just think - their money could have been put into HS2.

Of course one could try to direct where the money goes - if you want to take a big step towards a communist economy. Not a good track record there. 

The latest bit of thrashing around from Reeves, after her visit to China (did they chide her about Huawei, I wonder?) was the rather sudden and bizarre reintroduction of the Heathrow third runway into the conversation. There is a case for the third runway as Heathrow routinely runs very close to capacity so has next to no resilience against problems at Heathrow or indeed at other connecting airports. But as the owner of Heathrow has no current intention of attempting to resurrect the project and the controversy it would cause all over again one couldn't imagine any concrete being poured for several years. Just get on and build those houses, Rachel. Not easy but surely more guaranteed to bring benefits. Benefits, moreover, that would be spread around the country. But maybe Angela told you she can't deliver them?

Well just go back and tell her to get on with it. House building is an example where you could nearly reach the target or surpass it. After all, you can't build 80% or 120% of a third Heathrow runway, can you?

Despite having executed the equivalent of an F1 driver stalling on the grid, Reeves got a football manager's vote of confidence from Starmer, who said she'd be in post to the end of her contract. Sorry, the political equivalent, the next election. 

But then it doesn't matter whether there is a change of chancellor, the economic circumstances - the exigencies of our situation - would be pretty much the same, as would the room for maneouvre.

The one possible reason for changing is that a new chancellor could adopt some change to the latest version of the "golden rules", loosening the straight jacket of what counts as being prudent and underpins budgets these days. Gordon Brown's version was that the government should only borrow to invest in the future, met on average over the economic cycle with a sustainability rule, limiting the debt to GDP ratio. George Osborne tweaked these in 2016 to have national debt falling as a percentage of GDP and achieving a budget surplus by the end of the parliament. The can kicking equivalent of make me righteous but not yet. Jeremy Hunt modified it to target the overall deficit. Rachel has gone back to a target where day to day revenues meet day to day expenditure by the end of the parliament and that public debt should fall as a share of the economy. Those of you who have stayed awake may say that is pretty well what it said before, but Reeves adopted a new definition of public debt (PSNFL, public sector net financial liabilities. If you hear an economics editor say "persnuffle" they aren't sneezing). This gave her a bit more wiggle room without spooking the markets.

She also tweaked a third rule, introduced by Osborne, called the welfare cap, designed to limit payments on social security. From my reading she tightened that to limit the scope for future policy changes to increase social security spending. I imagine this was to protect her against spendthrift pressure later in the parliament, "can't  break my rules".

A  new chancellor could further tweak the rules. But that wouldn't instill confidence so, at least for now, wouldn't help.

So we're stuck with Reeves, her rules, her growth mantra and the utter vacuum that lies behind it. 

The problem is it turns out that Rachel is a chancer. A chancer with her CV and a gambler with her budget. Go bold she thought. It worked for Geoffrey Howe and Margaret Thatcher in 1981 even though 364 economists wrote to the Times to say they'd made a big mistake. That time boldness paid off. 

Sometimes boldness is indeed the right approach. Many fail because they aren't bold enough. 

But on this occasion a more incremental approach was called for. I understand why she thought it best to get all the bad news on tax out of the way at once and get on with mending public services by a big boost in spending rather than being timid. But they were political, not economic reasons. The markets twitched but didn't melt down but business didn't buy it. The desperately needed growth is further away, not closer. But going back isn't an option.

It usually takes chancellors more time than this to run out of road. The better analogy might be that the road is there, but Rachel's motor has no engine.

Winnie the Pooh may have been a bear of little brain but at least he had some self awareness. I'm afraid Rachel is a bird of far less brain than I had thought. 

She (and we) will have to live with it.

Sleep well, Rachel. At least until the next set of economic and employment data.

* https://order-order.com/2024/10/15/investigation-rachel-reeves-british-chess-champion-myth-busted/

** https://x.com/Simon_Nixon/status/1858524910856937489

*** What's true on Rachel Reeves' LinkedIn CV - and what's not. Evening Standard 14 Jan 2025, https://www.standard.co.uk/lifestyle/rachel-reeves-cv-scandal-memes-b1195128.html

What did they think would happen? And what do they think will happen?

A year ago economists and the hapless Sunak government were optimistic about the UK economy. 

The end of 2023 had been miserable. High energy prices, persistent inflation, staff shortages causing problems everywhere and figures subsequently published would show that there had been a "technical" recession, with two successive quarters of falling GDP.

But by January the most optimistially deluded of the Tories felt that a golden scenario was in prospect: falling inflation leading to lower interest rates and rising real terms wages. Advisers suggested the economy was liked a coiled spring, ready to recover because of a combination of factors, with an outside chance of a victory in an autumn general election.

Now that outside chance was always a long shot and we may never know what on earth was in Rishi Sunak's mind as the wally without a brolly stood in the Downing Street rain calling an early general election. There was supposition that the economic outlook was negative rather than positive - interest rate reductions had been deferred by the Bank and maybe things were going to get worse rather than better.

They didn't actually get worse through the late summer. Inflation dropped to 2% (though it's gone back up a bit since) and growth was much improved at 0.7% in Q1 and 0.4% in Q2.  We'll never know whether a November election would have been closer, though one still couldn't imagine anything other than a Labour win. Just like in 1997, when the Tories had delivered 3 good years of an economy was going well, the electorate had long since made up their mind that they didn't want more of the Tories, even if there was nothing like the kind of love for Starmer as for Blair.  A couple of good quarters was never going to return Sunak to no 10.

However, at the start of 2025 there is none of the cautious economic optimism of a year ago. Growth was flat in Q3 - it fell in GDP per capita terms. Labour's mission for growth has stalled on the launch pad - indeed there are fears of recession. The cost of government debt (gilts) - the most important indicator of confidence in the government and the thing that sank Liz Truss - ended 2024 at 4.55% but has continued edging upwards and this week reached 5.4% for 30 year gilts, the highest rate since 1998.  For context the OBR projected rates 0.4% higher for 5 year gilts by 2030 as a result of the Reeves budget but we've already past that figure. 7% would be getting into Greece bailout territory.

The rate at which the UK can borrow matters because higher debt repayments on our mountain of public debt means higher taxes or less to spend on services. In order to maintain confidence the chancellor pledged to meet the latest version of the Treasury's "golden rules". At the time of her budget she had some £10bn of leeway, a figure the Institute for Government called 'small'.  The increase in rates has meant the leeway has disappeared. If rates go higher she would be forced to break her rule, cut services, or raise taxes. Raising taxes would break a promise from just a few weeks ago that the tax rises in her budget were a once in a parliament event and she wouldn't be back for more. Cutting services will go down a storm with the Labour left and result in lots of hand wringing all round. The Institute for Government said it was 'not clear' how Reeves would respond in the event of even a 'modest' revision to forecasts.

In the run up to the budget Mrs H and I commented to each other that Reeves looked as if she wasn't sleeping. We thought she was worried about the decisions in her big bang first budget. She looked even worse in the Commons this week:

There was a lot of crowing in the Daily Mail a few days ago about the situation the economy and Rachel Reeves find themselves in. To be fair, while the budget unsettled markets, this week's problems are more to do with the world economy, in particular the extra debt Trump's administration is likely to take on. It's a simple matter of supply and demand: more demand for borrowing pushes up rates. Lenders will generally see the US as the best risk, leaving other countries scrabbling around - and needing to offer even higher rates - to borrow as much as they want or need.

The bond markets have come to be seen as the primary factor in keeping the tendency of governments to borrow and spend in check, hence the term 'bond vigilantes'. Who are these vigilantes? Mainly everyday financial institutions like pension and investment funds. Your pension fund is highly likely to hold gilts, quite probably from several countries. They have no axe to grind politically and are simply trying to make good returns and manage risk for their investors. They aren't speculators like George Soros, who famously crashed the pound back in 1992. The bond vigilantes have become the ultimate protector of the financial probity of governments.

You can see from the graphic shown in the same Daily Mail article this week that there hasn't been a sudden loss in confidence in the UK. Yes, since Reeves's budget, rates have been similar to those immediately after the kami-Kwazi Truss budget, but not as the result of a spike as happened then, just an inexorable increase as markets adjust to the international situation:

The Mail's gleeful comparisons with Truss-Kwarteng debacle are way off beam. Gilt rates now are higher than then, but the margin over short term interest rates is small, with Bank rate currently 4.75%. In contrast under Truss 30 year gilts, at 4.8%, were a whopping 3% more than the then Bank rate. She pushed the gilt rate up by 2.5 percentage points - doubled it pretty well - and the sterling index (the pound's value against a basket  of other currencies) plunged 12%, whereas it has been relatively stable of late and is stronger since summer. 

False news in the Mail? Well the facts are right, it's the inference that's clearly incorrect. I'm not sure what the right phrase is for ignorantly - or deliberately - drawing the wrong conclusion. False news doesn't really fit - deception, misrepresentation perhaps? How about hoodwinkery? (Yes of course I just invented that).

So I have some sympathy for Reeves. But not a lot - much of what is happening was entirely predictable. And she did leave herself little wiggle room, when she could have held some comittments back. Like bunging the train drivers a big increase when they're already paid around twice their equivalents in France and nearly three times their equivalents in Spain, for example. 

So no golden economic scenario in prospect for her and Starmer. The latter of course is already significantly tarnished in the eyes of the public by the pensioners' winter fuel allowance cut (I expect this story to keep running with the current cold snap) and the rows over freebies for suits, glasses, gig and football tickets.

There are other indicators of economic problems. Not long ago there were a lot more vacancies than unemployed. But now there are only 1.8 people unemployed for every vacancy, almost what it was before the pandemic. The number of vacancies has fallen 29 months in a row. The boss of one employment agency called this a "slow motion car crash" and a sign of impending recession. "When I've seen this before, that's what's happened". And this is before the employer's NI increase kicks in, in April.

What I'm wondering is why on earth Reeves and Starmer thought giving a weak but convalescing economy one of the biggest kicks possible in the budget would do anything other than make businesses pause investment and recruitment plans. With tax already at historically high overall levels her budget was one of the biggest tax raising budgets ever. £40bn of new taxes made it bigger in real terms than Lamont's post ERM crash 1993 budget and much bigger than anything Brown or Osborne did. It also provided for significantly higher borrowing as well, £30bn of it. £70bn a year of extra spending, £40bn of it on day to day services and the rest increased capital investment.  Even the Guardian said it was a return to tax and spend on a massive scale, pushing the UK towards European levels of spending.

Which was like giving the economy a huge kick in the nuts while force feeding it a Red Bull sugar and caffeine rush. No wonder it has stumbled around feeling sick.

A lot of attention focussed on how Reeves chose to raise tax, mainly the employers NI increase. Large companies can deal with it. They can generally pass on costs in their prices. The multi-nationals are looking at which country to invest in, have long term plans and can be reluctant to change course abruptly. But the larger part of the economy, small and medium sized businesses, are in a different boat. One can't blame them for pausing while they see how they can get through what will, for many, be a difficult time. 

I've always felt Labour is happier dealing with big companies. They have a better understanding of that culture, with unions, collectively bargained pay and economic regulation. In contrast they've always seemed to me to have little or no understanding of why someone would start a business or go through all the hassle and risk of trying to grow it. At their heart they are more comfortable with a socialist collective type of economy. Add your own adjectives, such as sclerotic, perhaps.

I don't actually expect the economy to shrink, at least not significantly, despite Reeves's well aimed but badly thought out kick. For a start, the public spending increases in the budget will increase GDP in the short term. This is why the OBR's budget forecasts showed a bit of a short term increase in growth, followed by it weakening later in the parliament as the spending increases work through and the growth depressing impact of the tax rises is felt. I think it is more likely to stumble on, flatlining. Maybe Ed Balls can reprise his much used but then incorrect gesture from a decade ago, false news at the time. But now there's the danger of inflation remaining stubborn or even going back up a bit, risking the scenario known as stagflation.

Meanwhile in other areas than the economy Labour is already setting out on courses of action which will steadily erode the precious few gains and improvements made under the Tories.  The best example of this is education where Bridget Phillipson risks undoing the gains made in education not just under the Tories but the previous Labour governments as well. Somehow education was a notable success for the Tories over the last decade with large improvements in our position in international league tables for literacy, numeracy and science despite significant real terms reductions in funding. 

Controverially perhaps I feel much of the credit for this lies with Michael Gove. While that might be a name one hardly dares mention to any current or former teacher, the evidence is clear, though the credit is far from entirely his. The main reason, in my view, is that education has not been a political football since Richard Baker, Thatcher's education secretary in the late 80s, introduced the national curriculum and the "Baker" training days now known as inset days. As an aside, wasn't it astounding that teaching had precious little of what became known as continuing professional development before that? I recall the odd teacher going off for a sabbatical but keeping up to date back then seemed to be entirely ad hoc. From Baker onwards successive Tory and Labour education secretaries have built on their predecessors achievements rather than changing course. Labour introduced academies, now it threatens to water them down.  Phillipson, in thrall to the producer part of the process (i.e. in this case teaching unions), has set out on a path which is likely to erode these various achievements as well as being, in what folk had been saying was an out of date phrase but seems to have gained fresh legs, utterly "woke". I'm referring, of course, to decolonising the curriculum (there wasn't much colonialism in what I was taught in the 50s and 60s for God's sake - just teach history, warts and all and keep contentious takes like critical race theory out of it).  Though taking the decision to put schools into special measures away from Ofsted and giving it to civil servants probably presents greater danger.

Things have gone quiet on watering down industrial relations legislation (but it will come back) and of course we have the dogmatic pursuit of a net zero electricity grid by 2030 which no genuine expert thinks is any other than 'challenging'. Having had to be told by the US to ditch Huawei from our telecomms system we're now thinking of putting Chinese stuff in key elements of our disaggregated, renewables dominated grid. But don't worry, I expect periods of dunkelflaute (a German word for periods of windless, cloudy days in autumn and winter) are more likely to crash the grid in coming years.*

This scenario, with a limp and unenthusiastic economy, large pay rises buying off strikes with no reform or efficiency strings attached and things that work replaced with what the providers prefer to dish up is broadly what I feared and why I didn't vote for Labour in the last election. 

There are grounds for hope that Labour will prove incompetent at delivering damaging change. It's remarkable that so early in Starmer's term as PM he picked up the whinge of previous ineffective PMs and ministers by saying that the levers of power weren't connected to anything and the civil service was getting in the way. The difference this time was he then had to back down after the civil service unions complained. I'm sure the civil service and other elements are obstructive at times, Michael Gove's blob etc. But I've also always thought that ministers don't understand that, in many areas, the civil service is there to formulate policy, not to implement things in practice. Which is why bodies charged with doing that, like the NHS, exist. Those levers in many areas don't connect to anything because they never have.

A few ministers do understand that. Unfortunately, not the right ones. “The only minister who really knows how to work the system and get officials delivering what he wants is Ed Miliband, who has been there before,” a colleague of the climate-crusading energy secretary told Tim Shipman of the Sunday Times**. “And Ed is the one minister we don’t want to be a success if we want to win the next election.” 

There is grave concern about the economy flatlining and few Labour advisers now privately defend the decision to deny winter fuel allowance to all but the poorest pensioners. “The political mistake they made was in conflating toughness with strength,” the party veteran said. “They wanted to look strong, so they tried to act tough. But when you beat up on poor old ladies, you just look like a bully.”

Wes Streeting, the health secretary, is the government’s best communicator, but the source said: “Wes always knows what to say, but it’s unclear yet whether he knows what to do.”

Until they figure out the right rather than wrong things to do, let's hope that's true. 

Some of the above draws on David Smith's column 'The coiled spring economy that failed to bounce back' in the Sunday Times on 29 December 2024, though he didn't quite as directly link it to Reeves's budget or use analogies like a kick in the nuts. The comment on the implication of a long term fall in vacancies also came from the Sunday Times business section. Smith's column this week was called The bond vigilantes are back - and that's no bad thing (12 January). I'd already written my paragraph on their significance by then but his helpful summary of the movement in bond rates meant I didn't have to look them up. 

Other sources:

Rachel Reeves' first budget is a clear break from the recent past, The Institute for Government review of the budget, was published on 30 October 2024. Note to their editor: it really should be "Reeves's budget"

Rachel Reeves goes back to the future with a tax and spend budget. The Guardian 30 October 2024

* Wind was our biggest source of generation in 2024, providing over 30% of our electricity. When I worked in energy economics 40 years ago we already knew that wind was the most practicable and economic of the renewables. However we also knew that guaranteed supplies were needed as renewables are intermittent. On some cold days earlier this month wind contributed a tiny fraction of its theoretical capacity, just a few percent of demand. Officials denied we were close to blackouts but there wasn't much resilience for, say, our biggest single source of supply (the interconnector with Norway!) dropping out. A Scandinavian politician had a vivid comment on Germany's energy policy with its over reliance on wind with insufficient base load generation which caused problems across northern Europe recently. He called it 'shit'. I doubt Ed Miliband will take note.

** Politics is notable for party colleagues also being rivals. The delicious and indiscreet quotes from Labour 'colleagues' are from Tim Shipmans's column '2025 will be a political shoot out. Which leader has most to fear?' in the Times on 4 January. This column also explained for me the debacle of the Tory leadership election. James 'not so' Cleverly was favourite to win it until, many believe, some of his supporters tried to fix who would be his opponent in the final run off. Cleverly’s camp think four of his supporters voted tactically for Badenoch, to keep Jenrick out, while Jenrick’s team believe one of theirs voted for Badenoch to keep Cleverly out. Without those votes switching, the run-off would have between Cleverly (42 votes) and Jenrick (40), with Badenoch (38) eliminated. D'oh, they're too incompetent to even frig their own leadership election!