MMemories flashed back when George Soros reprimanded Vladimir Putin and Xi Jinping in Davos last week, even though 30 years ago sterling was the autocratic leaders rather than the autocratic leaders the main speculator was targeting.
During 1992 the pressure on the pound increased until 16 September when it was blown out of the European Exchange Rate Mechanism (ERM). John Major’s government never recovered so quickly from what was called Black Wednesday, so the humiliation and loss of public trust was deep.
The question now is whether Partigate will do to Boris Johnson what Black Wednesday did to the Major. Has the reputation of the Conservative Party been so damaged by the scandal that no matter what happened before Election Day, defeat is inevitable?
In some ways, Johnson’s outlook appears bleaker than Major’s. Black Wednesday forced the then government to abandon a policy it had previously described as non-negotiable – membership of the Reinvestment Mechanism. This policy, which allowed the pound to trade in a narrow range against the German mark, required keeping interest rates higher than they would otherwise, and prolonged the recession of the early 1990s.
Leaving the ERM system was good for the economy. Interest rates fell sharply and the value of the pound depreciated. Fears of rising inflation proved unfounded as the recession left a lot of slack in the economy. Higher taxes on households after Black Wednesday were unpopular but confirmed that lower interest rates helped producers rather than encourage consumer spending.
After setting the cycle, nothing has changed. By the time of the 1997 elections, unemployment had fallen, growth was robust, and the huge current account deficits that had built up in the late 1980s had been eliminated. However, the Conservative Party succumbed to a landslide for Labour.
Rishi Sunak’s change last week wasn’t about an unexpected tax like the exit from the risk management system in September 1992, but it was disruptive enough. For months, the chancellor opposed taxing the profits of oil and gas companies in the North Sea because it hampers investment. Similarly, Sunak said he will wait until the fall budget before deciding whether to provide more assistance to families struggling with high energy bills.
This strategy has now been abandoned. As a deafening echo of the crisis-ridden 1970s, there have now been three small budgets since the start of February, as the government faced a cost-of-living crisis.
To an extent, what Sunak was doing made perfect sense. Only the Treasury had the resources to prevent millions of families from falling into fuel poverty, and the additional £15 billion in purchasing power could keep the economy out of recession later this year.
However, there are some significant downside risks. The first is that additional demand in the economy will add to inflationary pressures, causing the Bank of England to be more aggressive in raising interest rates.
The bank believes that the current inflationary pressures are caused by a combination of supply-side shocks, including the loss of the workforce due to Brexit and the pandemic, tightening of demand as demand rises in the wake of the shutdown, China’s anti-Covid policy and – most recently – the war in Ukraine. . What matters for near-term interest rate policy is what Threadneedle Street’s Monetary Policy Committee (MPC) 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 are strong arguments that monetary policy (what the Bank of England does) has been too loose and fiscal policy (what the Treasury does) too strict. But the situation was nowhere near as clear as it was after Black Wednesday, when a loose mix of monetary and fiscal policies was enough. With annual inflation already at 9%, the bank’s credibility is at risk. There is a risk that Snack’s fiscal easing will lead to excessive monetary policy by the bank.
Even if, miraculously, the policy mix turns out to be perfect, there will not be the kind of recovery we are seeing after Black Wednesday. Even after Sunak’s latest measures, living standards will continue to decline this year, but not to the same extent. Paul Dales of Capital Economics says real disposable income for households before the mini-budget is expected to fall by 2% in 2022, but will still fall by 1% even after money from energy bills.
Black Wednesday shook the Conservative Party’s reputation for economic literacy. Major received no credit for the subsequent recovery, as it only happened because the British government abandoned austerity, which it insisted was 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 policies are out of control, with volatile statements and short-term announcements taking the place of long-term strategy.
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, first as a result of the pandemic, and now Russia’s invasion of Ukraine.
Ministers speak the language of the right but end up behaving like an incompetent party of the left, usually after much kicking and shouting. Voters are unlikely to forgive Johnson Partigate even if the economy is booming before the next election. You certainly won’t forgive him when the economy suffers, which it probably does.