Reflections on a market rout

Many people have remarked about the end of days feel in the markets. Here in the UK, many regions of the country have experienced unprecedented flooding, with more to come over the weekend, whilst parts of Africa and Asia are enduring a plague of locusts. This is before we even talk of the coronavirus which has gripped the imagination like no epidemic in recent history. 

I did point out at the start of the year that short of an exogenous shock it was difficult to know what would derail the equity market. Such shocks are by their nature difficult to foresee but who would have thought that the catalyst for change in market thinking would have come in the form of something we cannot see but whose presence we are aware of – a veritable ghost at the feast? Equities have just posted their biggest weekly correction since 2008, and having experienced similar corrections in the past, I know the futility of trying to call the market bottom. The extent of market concern can be gauged from the VIX index of implied equity market volatility which has shot up to a level of almost 48 (recall that three weeks ago I expressed astonishment that it was running so low), taking it to its highest level since 2011 (chart below).

Whatever the longer-term health implications, there is clearly going to be a period of intense economic disruption. It could last for days, weeks or even months, but it is clearly going to impact on activity rates at the end of February and into March. Such is the power of the unknown triggered by the virus that face-to-face client meetings are being cancelled as businesses test their disaster recovery procedures; Switzerland has banned gatherings of more than 1000 people, with the result that two major trade fairs including the Geneva Motor Show have been cancelled, and travel restrictions are being ramped up. Naturally this will adversely affect corporate earnings, which explains the collapse in markets over the past week (I would not like to be in the insurance business at the present time). This raised a question in my mind regarding the information content of the equity market collapse for events in the wider economy. After all, investors focus on the slope of the 2-10 curve in the bond market, but is there a corresponding equity indicator?

The information content of market corrections for the real economy

In order to assess the severity of the market collapse we need an indicator which measures both the extent and duration of the collapse. In order to do this, I looked at all trading days since 1940 and calculated those periods when the S&P500 declined for five consecutive sessions, and measured the resulting 5-day change in the index (I excluded the period 1928 to 1939 due to the volatility of the index over this horizon). I reduced the sample still further to select the subset of periods where the fall in the index cumulated to more than 7% (admittedly an arbitrary value). This resulted in 15 episodes (not counting the current one). To put some values on it, I measured the sum of peak-to-trough declines across all such episodes per calendar quarter. For the most part these are zero but in 13 cases there was one such event per quarter and in 1974 and 2009 there were two, resulting in index values of between -15 and -20 (chart below).  

As a leading indicator, the index is by no means perfect. It has provided three false recession signals (1962, 1986 and 2015) and did not foresee the recessions of 1969-70 and 1980. But it did provide useful information in 1974, 2000 and 2008. In this sense it is not that much different from the 2-10 curve which often flashes false recession signals. And it may be possible to improve it by being more systematic about measuring the decline threshold.

It would thus be too much of a stretch to suggest that the equity market is pointing to a recession in the US, but given the expected impact on activity as a result of what has been going elsewhere in the world, some slowdown in growth is likely. Moreover, given the duration of the US business cycle, which is the longest in recorded history, it may also be vulnerable to shocks. One transmission mechanism from the market is the consumer wealth effect. Estimates of this effect vary but a study produced by the IMF in 2008 suggested that the long-run elasticity of US real consumption with respect to equities is around 3.5%. In other words, each one dollar decline in the value of equity holdings will reduce consumption by 3.5 cents. If the market holds at current levels (13% down), this would imply a reduction of around 0.4% in consumption. If this spills over into other assets, such as housing, the impact will be even bigger since the US housing wealth elasticity of demand was estimated at 13.7%.

Is there value out there?

We are, of course, getting ahead of ourselves. Anecdotal evidence suggests that real money investors have not sold off to anything like the extent to which the headline index suggests. If true, it might indicate that the selloff has been exacerbated by algorithmic trading. An academic study published in 2017[1] suggested that the rise of exchange traded funds (ETFs), which are essentially passive investment funds which track the market, means that investors derive “lower benefits from information acquisition”, thus reducing their incentive to undertake it. This in turn reduces the efficiency with which investment decisions are taken and raises the risk that market swings may be larger than would otherwise happen in the event of a market where investors are forced to do their own due diligence. Once the dust settles, regulators will undoubtedly take a closer look at this issue given their mounting concerns over the impact of black-box trading models on market swings.

For now, however, investors are flying blind. Whether the coronavirus effect turns out to be a flash in the pan or a prolonged problem, the time for taking risks is over. As winter slowly gives way to spring, the next few weeks are going to be interesting. There is no doubt that the recent shakeout has taken a lot of air out of the balloon and on the basis of Robert Shiller’s long-run CAPE measure, we are now starting to approach less toppy valuation levels (chart below). This long-run P/E measure is now close to 27x versus 31x before the rout started. But if this is a trigger for a cyclical correction as in 2000-01, there could be another 10-20% market downside as the CAPE heads towards 23x. 

Brave investors will likely step in at some point soon. As Warren Buffett, the grand old man of value investing, once said, “Widespread fear is your friend as an investor because it serves up bargain purchases.” But Buffett also knows the value of waiting until the price is right.

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[1] Israeli, D., C. Lee and S. Sridharan (2017) ‘Is There a Dark Side to Exchange Traded Funds? An Information Perspective’ Review of Accounting Studies (22), pp 1048-1083

Going viral

I noted a few weeks ago that the coronavirus, now known as COVID-19, was likely to make its presence felt in the markets sooner or later and yesterday was the day when the dam broke. The S&P500 fell by 3.4% compared to Friday whilst the Italian stock exchange index was down 5.4% as cases of the virus were reported in the north of the country. Trends in the Chinese market may give us some indication as to how things might pan out. The Shanghai Composite index fell 11.8% in the space of 9 trading sessions although it has since rebounded to leave it just 3.3% below the mid-January peak. This recovery has occurred despite the fact that the economy was in lockdown for a week and even now activity is only slowly recovering. However, whilst the World Health Organisation has so far not officially labelled the current outbreak as a pandemic, as more cases are reported throughout the world it seems only a matter of time.

Whilst various numbers have been bandied around, with some estimates suggesting that the virus outbreak could shave USD 1 trillion off world output, the truth is that nobody really knows, and efforts to estimate it give a sense of false precision. But we can trace out the broad mechanism by which pandemics operate. In the first instance, there is a hit to the supply side of the economy as people fall ill. Depending on the fatality rate this can either be a short-term or long-term effect. In the case where the fatality rate is low and people subsequently recover, there is a short-term reduction in the economy’s productive capacity. When the fatality rate is high, the effect is likely to be more permanent. There is also a demand side effect as people avoid contact with others, and as a result they shop less and consume fewer services (e.g. they stop going to restaurants) as they enter a period of self-quarantine.

Historical estimates of the impacts of past pandemics are often quite hazy but the Black Death which struck Europe in the 14th century wiped out anywhere between 30% and 60% of the continent’s population. GDP in England alone is estimated to have declined by over 50% in the century following the plague whilst population fell by 60% (chart below). In fact, it took 200 years for output to reach pre-plague levels and 275 years for population to recover. The good news is that (so far) COVID-19 is far less virulent than the plague which was responsible for the Black Death. Perhaps the best comparison in terms of virulence is the Spanish flu outbreak of 1918, which had a fatality rate of 2-3%. It infected an awful lot of people (around 27% of the global population at the time) but its spread was facilitated by the movement of people as World War I entered its final stages. Scientific experts differ as to why the mortality rate was so high: Some suggest that the pathogen itself was particularly nasty whereas others suggest that it was no more virulent than other strains of flu but that malnourishment and crowded medical facilities promoted superinfections that proved to be the real problem.

I don’t want to dwell on the negative aspects but suffice to say that COVID-19 is a serious disease which has the potential to inflict a big hit on the world economy. However, the risks and consequences are not evenly distributed. Some sectors, such as pharmaceuticals, may actually benefit in the short-term if they are involved in the search for vaccines, antibiotics, or other products needed for outbreak response. On the other hand, vulnerable populations in poor countries with reduced access to medical care would be expected to suffer more than proportionally if things got out of hand.

As Bloom, Cadarette and Sevilla noted in a 2018 paper published by the IMF, “several factors complicate the management of epidemic risk” notably climate change, globalisation and urbanisation but “perhaps the greatest challenge is the formidable array of possible causes of epidemics, including pathogens that are currently unknown” (as was the case with COVID-19 just a few weeks ago). However, there is still a lot that governments can do to limit the fallout once the epidemic takes hold including surveillance measures, collaboration and measures to curb the spread of disease by limiting movement (as the Chinese were quick to do).

Aside from the economic aspects, it is the natural fear of the unknown that has caused markets to take fright. If investors are rational, they should not be selling now. As Warren Buffett said in a TV interview, “the real question is: ‘Has the 10-year or 20-year outlook for American businesses changed in the last 24 or 48 hours?” There again Buffett is 89 years old and mortality statistics suggest there is a 14.87% chance that he will depart from this life in the next year (sorry Mr B. Blame the actuaries!). But if you are a 35-year old investor, you might have a different outlook on things and fear of the unknown is a powerful influence on behaviour. However, to put a positive spin on things, as the number of Chinese cases continues to rise – albeit at a slower pace – so does the number of recoveries, with 35% of those diagnosed now having been cleared, and they outnumber deaths by a factor of 18:1.

As Bloom et al wrote, “We cannot predict which pathogen will spur the next major epidemic … But as long as humans and infectious pathogens coexist, outbreaks and epidemics are certain to occur and to impose significant costs.” The best we can do is to take actions to manage the risk and mitigate their impact, although as the deadly outbreak of Ebola in West Africa in 2014 showed, it is possible to limit the consequences relatively quickly. Let’s hope so.

Priti vacant

The Home Secretary, Priti Patel, sits on the right-wing of the Conservative Party and can best be described as socially illiberal (see this clip from one of the BBC’s flagship current affairs programmes in 2011 in which she quite clearly advocated the return of the death penalty). She also backed Theresa May’s hostile environment immigration policies, presented in the immigration bills of 2014 and 2016. But Patel is nothing if not entrepreneurial although her efforts to go off-piste by holding unauthorised meetings with Israeli politicians and businesspeople in 2017 did result in her being sacked from May’s government. Nonetheless, her voting record marks her out as an economic liberal, generally voting against policies such as higher taxes.

This week’s announcement by Patel that British businesses will effectively be barred from hiring “unskilled” workers from outside the UK after the Brexit transition process ends, is both socially and economically illiberal. The policy, which is outlined here, will bring in a points-based system “that will attract the high-skilled workers we need to contribute to our economy” whilst keeping out those the government presumably deems undesirable. Undoubtedly there is a preference amongst some voters for this kind of policy, as this clip reporting the views of a BBC Question Time audience member makes clear (the fact that it is both offensive and inaccurate is beside the point – this is what some people believe). However, the policy suffers from a number of theoretical and practical limitations that potentially threaten to introduce yet more economic disruption.

Starting with the macroeconomic implications, the fact that business investment has been so weak over recent years underlines the importance of labour input in driving growth. In Q4 2019, business fixed investment volumes were only 1.3% higher than mid-2016 levels – an annual increase of less than 0.4% per year. To put that into context, the average annual growth rate over the period 1966 to 2015 was 2.9% – and even that is widely considered to be too low in comparison to other European economies.

My calculations suggest that since 2015, the contribution of capital to potential GDP growth (currently estimated at around 1.5% per year) has fallen by 0.2 percentage points to 0.5 pp per annum largely due to a lack of investment which has resulted in a less efficient capital stock. Total factor productivity, which accounts for factors such as technical progress and other intangibles, has recorded a dreadful performance since 2008 and is currently not giving any boost to potential growth (chart). Thus the labour contribution accounts for a good one percentage point per annum. This can be broken down into the increase in the overall working population (0.2 pp); participation (0.2 pp); the employment rate (0.4 pp, defined as the extent to which available labour resources are being used) and hours worked (0.4 pp).

Other things being equal, measures that disrupt labour supply will act to curb the economy’s growth rate. As it is, the population is ageing and the retirement of the baby-boomers means that the working age population is growing at a slower rate than in the past. Moreover, the big boost derived in recent years from an increase in hours worked and the employment rate (number of employees relative to the total working age population) appears to be losing momentum (cf chart). Patel’s response to this problem was to suggest that any shortfalls can be met from the 8.5 million people currently classified as “economically inactive” which effectively means raising the employment rate. But of that figure, 2.3 million are classified as students; 1.9 million are looking after their family and 2.1 million are registered as long-term sick. Only 1.9 million are classified as looking for a job. This implies that the employment rate can only rise from current levels of 79.5% to a theoretical maximum of 81% – the 1.5 percentage point rise represents the amount by which it has increased over the past four years. There is a lot less slack in the labour market than the Home Secretary seems to think. 

As for a points-based system (PBS), the report from the government’s non-partisan Migration Advisory Committee (MAC) released last month was less than enthusiastic. The Committee chairman’s comments indicated that whilst he understood the government’s need to communicate complex issues to the electorate, PBS currently only represents a “soundbite” with no coherent plan as to how it would work (surprisingly enough, his contract as chairman of the MAC was not renewed). The biggest criticisms include the inconvenient fact that countries which do rely on a PBS, such as Canada and New Zealand, only use them in parts of their immigration system – it is not the bedrock. Moreover, when the UK experimented with such a system to recruit non-EU workers between 2002 and 2006, it did not attract the highly-skilled workers which the government hoped for. And as the MAC report notes, the current system to attract highly skilled workers from outside the EU “does not work well … [because] the skills bar for entry is set far too high, targeted at those at the very top of their field and is too risk averse.”

The government has accepted one of the MAC’s recommendations, to reduce the annual salary threshold from £30,000 to £25,600. Workers who do not meet the points requirement to qualify for entry must therefore meet this salary threshold – the idea being to dissuade “lower-skilled” workers from entering the UK (though as the government points out “under the points-based system for skilled workers, applicants will be able to ‘trade’ characteristics such as their specific job offer and qualifications against a lower salary”).  As if the other aspects were not contentious enough, this element threatens to open up a new can of worms. Many jobs in the health and social care area are not low-skilled at all, yet do not offer a salary which meets this threshold. A phlebotomist, for example, will struggle to earn £20,000. Full-time social care workers, of which around 20% are foreign nationals, earn around £19,500 per year – 24% below the recommended limit.

The government plans to introduce these new rules once the transition period with the EU expires at the end of this year. Not only is that not a lot of time to adjust but as Tom Hadley, director of policy at the Recruitment and Employment Confederation, said: “Jobs the government considers ‘low-skilled’ are vital to wellbeing and business growth. The announcement threatens to shut out the people we need to provide services the public rely on. We need access to workers that can help us look after the elderly, build homes and keep the economy strong.” What the policies amount to is an upgrade of the state-sponsored hostile environment which the Conservatives have pioneered over the past decade. Such an unwelcoming environment runs the risk that the UK is no longer the first port of call for talent in a world where other countries are desperate to import skills which are in short supply at home. If the government does go ahead with its introduction, my guess is that within a couple of years it will be forced to water down the restrictions.

And for all the contradictions inherent in the new rules, the biggest of them all is that Patel’s parents, who migrated to the UK from Uganda in the 1960s, would not have qualified for entry under the rules their daughter has drawn up. You could not make it up. Except that the government is indeed making it up as it goes along and runs the risk of strangling itself in a knot of contradictions.

Frost in Brussels

I am far from sure whether yesterday’s keynote speech in Brussels by David Frost, Boris Johnson’s policy adviser on Europe, was an opening gambit in what is likely to be a long and bitter negotiation between the UK and EU or was really the statement of intent it was made out to be. It was provocative, as might be expected from one who is a self-confessed supporter of Brexit as he made it clear that the UK will not accept supervision from the EU as part of a post-Brexit free trade deal. Worse still, Frost airily dismissed the economics with an “it will be all right in the end” attitude, without putting forward any evidence to support his claims. Perhaps it’s all an act or maybe he really has no idea what he is talking about. But if this is to be the tone of the British government’s approach to Brexit throughout 2020, it is going to be a long, hard year.

Frost’s attempt to rationalise Brexit

Frost’s justification for Brexit leaned heavily on the work of Edmund Burke who, despite being “one of my country’s great political philosophers”, was born and raised in Dublin where he spent the first 21 years of his life. Burke was a student of the French Revolution and one of his most famous works, Reflections on the Revolution in France, argued that the revolution would end in failure because its foundation on the abstract notion of rationality ignored the complexities of human nature and the institutions which were built around it. Academics struggle to interpret this work. This paper by David Armitage notes that there is ongoing debate about whether Burke “was a realist or an idealist, a Rationalist or a Revolutionist.” Frost chooses to interpret him as a realist by invoking the premise that the formation of the EU constitutes a revolution in European governance which overrides national institutions serving the people of individual countries. But whilst Frost’s view of a monolithic EU has some foundation, his interpretation is not one I recognise.

He argues that “if you can’t change policies by voting, as you increasingly can’t in this situation –  then opposition becomes expressed as opposition to the system itself.” But this is to ignore the fact that whilst EU laws are drafted by the Commission, they are passed into law by the European Parliament – comprised of the MEPs we vote for. And whilst it may be true that “the key [EU] texts are as hard to read for the average citizen as the Latin Bible was at the time of Charles the Bold” I can attest that British laws are equally hard to understand for non-lawyers such as myself. After all, I have (tried to) read a lot more British law in the last two years than is good for me.

Where Frost does have a point is that European institutions are, in British eyes, “more abstract, they were more technocratic.” There is not the drama associated with the European Parliament that is associated with Westminster, but as the lessons of the last twelve months have shown that is not necessarily a bad thing. Where I do not agree is the coda to the sentence in which he states European institutions “were more disconnected from or indeed actively hostile to national feeling.” They were perceived as hostile to national interests, it is true, but that is largely thanks to the disinformation (or lies, if you will) pumped out by journalists like Boris Johnson during his time in Brussels.

Nor am I convinced by Frost’s simplistic argument that “Brexit was surely above all a revolt against a system” where “the system” was the EU. “I don’t think it is right to dismiss this just as a reaction to austerity or economic problems” may be his view but not one necessarily backed up by the evidence. The Leave campaign made all sorts of promises that they could not deliver about the benefits of Brexit and the issues were simply too complex to be boiled down into a “yes/no” question, as even my Leave-supporting friends admit. Frost makes the mistake of drawing inferences about the 2016 vote which were not evident at the time. For an eminently clever man, Frost’s arguments were little more than a weak post-hoc justification. And if I can see that, you can bet that the smart people in the EU Commission will come to a similar conclusion. But if the justification for Brexit was weak, wait until you hear his economic arguments.

Trying to justify the economics

Frankly, the economics did not even rate a D+. His opening gambit was to dismiss the work done by the UK Government and the BoE thus: “I would question some of the specifics of all those studies. This probably isn’t the moment to go into the detail … But, in brief, all these studies exaggerate – in my view – the impact of non-tariff barriers.” Try that in an undergraduate essay and see how far you get. To apply the Farage tactic (“I could be more specific about my objections but now is not the time”) is not good enough. Economists are not interested in his view – they want the evidence that contradicts their own. Indeed, the evidence suggests that non-tariff barriers can be more restrictive for trade than actual tariffs. Simple things like technical barriers to trade (regulations on the content of products) or inspections and other formalities that require goods are checked for various reasons are pretty hard to get around. Indeed, there is a well-established literature on the empirical costs of border effects[1].

He went on to note that “many Brexit studies seem very keen to ignore or minimise any of the upsides, whether these be connected to expanded trade with the rest of the world or regulatory change.” There is a reason for that: With the exception of Patrick Minford, whose “analysis” is not worth the time of day, I struggle to think of any study which points to a net economic benefit from Brexit. Similarly, “there is obviously a one-off cost from the introduction of friction at a customs and regulatory border, but I am simply not convinced it is on anything like the scale or with the effects these studies suggest.” But that’s the sort of reasoning used by those who believe the Earth is flat: “Because I cannot see the curvature I am simply not convinced it is anything but flat.”

Ultimately, this speech contained nothing to convince any of us who believe the economic costs of Brexit are non-trivial that the government can be trusted to look after the interests of the economy. Frost made it clear that “we are ready to trade on Australia-style terms if we can’t agree a Canada type FTA”. Since Australia has not yet signed a trade deal with the EU he means the UK is prepared to trade on WTO terms at a time when the WTO has ceased to function properly. But it gets worse. “We understand the trade-offs involved – people sometimes say we don’t but we do … Much of the debate about will Britain diverge from the EU I think misses this point. … But it is perfectly possible to have high standards, and indeed similar or better standards to those prevailing in the EU, without our laws and regulations necessarily doing exactly the same thing … I struggle to see why this is so controversial.” That last line sums it up. The British government either does not understand the EU’s position or chooses not to do so. If you want to have access to the club, you simply have to abide by the rules. This is not a matter for debate.

The galling thing about the whole speech is that it echoes the tone of Theresa May at her worst. It was similarly content-light, promoted a revisionist version of history and made promises which will be undeliverable if the EU refuses to bend. Johnson will run into the same problem as his predecessor. Obviously both sides have to sound tough at the start of negotiations but it really does not have to be like this. What concerns me most is that if this really does represent the UK government’s position, we are headed for a major clash before the year is out. And despite what anyone else may say to the contrary, a hard Brexit is most emphatically not what people voted for in 2016. It’s going to be a rough ride. 

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[1] Anderson, J.E., E. van Wincoop (2003) ‘Gravity with gravitas: a solution to the border puzzle’, The American Economic Review 93 (1), 170–192

Advisers advise, ministers decide

The resignation of Sajid Javid as Chancellor of the Exchequer following the reshuffling of Boris Johnson’s government came as a major surprise since Javid had, by all accounts, been promised that he could continue in the job despite changes in ministerial responsibility elsewhere. It has emerged that Javid was offered the chance to stay in post, but only on condition he fired all his special advisers and replaced them with those appointed by the prime minister’s office (i.e. by Boris Johnson’s de facto chief of staff, Dominic Cummings). Javid had rather unkindly been labelled as CHINO (Chancellor In Name Only), and it is clear that he was not prepared to compromise any further in order to retain his position at the heart of government.

All this comes less than a month before Javid was due to present his first post-election budget to parliament which was (is?) expected to include tax breaks for low income earners and a boost to social spending, coupled with measures to claw back some revenue from higher earners. His replacement is the little-known MP Rishi Sunak who has 27 days to prepare himself for the budget presentation. Clearly this will not be his budget – it will be the one imposed upon him by Downing Street and will have the fingerprints of Dominic Cummings all over it. It does appear that the current government is a highly centralised administration, offering little scope for individual minsters to set the direction of policy. But particularly in the area of fiscal policy, there is a sense of conflict between what the Johnson government wants to deliver and the caution which the Treasury reserves towards big policy initiatives which involve spending money.

The first issue is whether the resignation will have any implications for the direction of policy. It almost certainly will not derail the government’s plan to take more low-paid earners out of the tax net. The Conservative election manifesto promised to raise the threshold for National Insurance Contributions to £9,500 (currently £8,632). Using HMRC data as a baseline, which suggests that an increase of £2 per week will cost £300m of revenue, this implies an annual revenue loss of around £5 billion (0.2% of GDP). I would be surprised if that was not one of the measures to be presented by the new Chancellor on 11 March. The Conservatives also expressed an “ultimate ambition … to ensure that the first £12,500 … is completely free of tax” which on current calculations would put a £22bn annual hole in public revenues (1% of GDP). Such largesse will have to be paid for and various trial balloons have been floated, including restrictions on pension tax relief where cutting the relief rate from 40% to 20% for workers earning more than £50,000 per year could claw back £10bn. Another option which has been mooted is the levying of a tax on properties above a certain (high) value threshold. The problem is that although such policies might play well with non-traditional Tory voters who lent their votes to Johnson in December, they will not go down well with voters in the Conservative heartlands in southern England.

The alternative to a big clawback is that the government simply runs a looser fiscal stance. Prior to the election campaign, Javid announced a set of fiscal rules in which the government would seek only to balance the current budget by the middle of the decade and borrowing to fund investment would be permitted to rise to 3% of GDP – around half as high again as the previous set of fiscal rules – whilst debt servicing costs would be limited to 6% of tax revenues. These are estimated to allow for fiscal expansion equivalent to 1% of GDP. However, it would be easy enough to tweak the limits to allow for a slightly larger expansion and to blur the distinction between current and capital spending by setting even more nebulous targets for balancing the budget.

But there is a bigger issue at stake than the nature of the fiscal stance and it goes to the heart of who runs government. The prime minister is primus inter pares – first amongst equals – but he (or she) cannot control everything. And it will raise further questions about the role of Cummings, for it is known that he and Javid did not see eye-to-eye on many issues. Margaret Thatcher once famously said that “advisers advise and ministers decide” but press reports over recent months suggest that the advisers are doing a little more advising than is good for government. Ironically Thatcher made this comment in the wake of the 1989 dispute between her economic adviser, Alan Walters, and the then-Chancellor Nigel Lawson. Lawson was an advocate of the UK joining the ERM but Walters was not, and what should have been an internal government matter got out of hand when Walters published an article outlining his position. Lawson subsequently resigned (as did Walters) but the damage to Thatcher’s position ran deep and she was forced out a year later.

The lesson from that episode was that when it comes to a showdown in which a prime minister has to choose between the advice of a minister and listening to an adviser, it is usually a mistake to choose the latter over the former. It smacks of authoritarianism and does nothing to foster good relations between the prime minister and other MPs on whom he ultimately depends. We should not over-dramatise today’s events. The budget will still be delivered and many of the ideas currently on the stocks will be put forward. But it should act as a warning to Boris Johnson that he will not always get his way and although he is currently flavour of the month he must beware alienating those who may have a different point of view. As a classics scholar, Johnson will be all too aware of the fate which befell Caligula – although in fairness Johnson has not yet appointed a horse as an adviser.