Don't do dumb stuff

A decade of distress

On 23 January 2013 David Cameron gave his (in)famous Bloomberg speech during which he announced his intention to hold an in-out referendum on the UK’s membership of the EU. The intervening decade has been a difficult one. Looking back over all this time, the speech might be viewed as the starting gun for a process which led us through four prime ministers, including the incompetent Boris Johnson and the hapless Liz Truss, and the steady erosion of trust in the political process.

However, in some ways what Cameron said in 2013 needed to be said. We should remember that at the time the euro area was in the throes of a debt crisis which came very close to scuppering the single currency project. He called for enhanced European competitiveness by extending the single market; a flexible structure which "can accommodate the diversity of its members"; allowing "power … to flow back to member states" and enhanced democratic accountability and fairness so that “whatever new arrangements are enacted for the eurozone, they must work fairly for those inside it and out." There was in 2013 a growing sense that the EU was disjointed and unsure about how to proceed and it was important to ask the right questions which would allow it to get back on track. Moreover, as I wrote at the time, “the speech also gave a reasoned and rational account of the benefits of staying within the EU, notably the enhanced influence which it gives the UK on the global stage, and the benefits to jobs and growth arising from the huge FDI inflows which have come from the EU.”

But Cameron’s relationship with the EU was fractious. He was not a committed player and was unable to reach an agreement with the other members that would allow him to land the killer blow to knock out his domestic anti-EU opponents. Consequently, he left the door open to the “fruitcakes, loonies and closet racists” associated with UKIP who went on to run a campaign that knocked the Remainers for six. Unfortunately, the promises made by those intent on winning the Brexit referendum at any price now lie in ruins. Who can forget the pledge to use the £350 million per week that would be saved by not having to contribute to the EU budget to improve the NHS? Not only was that figure a gross distortion (pardon the pun) but it ignored the fact that part of any funds not sent to Brussels would have to be devoted to those areas that the EU previously funded. Consequently the NHS got very little extra cash, despite being protected from the worst ravages of George Osborne’s misguided austerity programme. It is hard to imagine that the NHS could be in worse shape than it is today without actually collapsing. Admittedly the pandemic placed great strains on the system but the fact that it was underfunded long before Covid struck has been a bigger contributor to its current dire predicament.

No shelter from the fallout

The fallout from the Brexit process has had a profound effect on Britain – on its unity, identity and its place in the world. Having taken a close-run, non-binding referendum and imposing a winner-takes-all outcome the government failed to unify the electorate around a strategy to take the UK forward. In the process of trying to square the circle of unreconcilable promises, the government wasted three years of time and effort failing to tackle the mounting economic problems of the day and did a lot of damage to the public perception of parliament. Admittedly, the pandemic blew everything off course but by then the zealots had taken over in Downing Street as moderates within government were either marginalised or exiled from the Conservative Party altogether.

Perhaps one of the most pernicious aspects of the Brexit saga is that it has enabled politicians to lie with impunity and not face any sanctions. As a consequence they have been able to ride out crises that would previously have been a resignation offence as former Chancellor Nadhim Zahawi’s latest trials and tribulations testify and further exemplified by the position of the chairman of the BBC whose close relationship with senior politicians has raised questions about a conflict of interest. Faced with a cost-of-living crisis not seen in decades (even the 1970s were not this bad as wages more than kept pace with inflation) public trust in government has collapsed. It is all very reminiscent of the 1990s when John Major’s government lost public trust following its handling of the ERM crisis and spent almost five years limping towards a heavy election defeat.

The immediate future

Quite where we go from here is difficult to say. The genie cannot easily be put back in the bottle but given the increasing realisation that the current form of Brexit is a mistake it is incumbent on the government to do all it can to mend fences with the EU. Doubling down on the current strategy is not going to get the electorate back onside, given the wide margin in opinion polls of those who think voting to leave the EU was a mistake (chart above). Issues that need to be addressed include the terms of the Trade and Cooperation Agreement between the UK and EU, which allows for tariff free trade for a wide range of goods but does not address the issue of regulatory harmonisation, which is a key element in agreements designed to increase trade flows. The issue of the Northern Ireland border has yet to be settled with the Northern Ireland Protocol Bill seeking to unilaterally override parts of the protocol that governs some aspects of trade in goods between the province and Great Britain.

Businesses face the prospect of considerable disruption in the face of government action/inaction on a number of legal matters. For example, the UK ‘Temporary Permissions Regime’ which allows EEA-based financial services to maintain their ‘passporting’ rights into the UK market, expires on 31 December 2023. If this is not extended or amended, there is the risk that financial services trade could be severely disrupted. Then there is the prospect that the Retained EU Law Bill, which passed unamended through the Commons last week, will intensify business uncertainty. In brief, this allows the government to revoke certain retained EU law at will, undermining the position of many businesses which continue to trade with the EU.

Simple fixes that the government could make include extending the Temporary Permissions legislation and deferring the introduction of the Retained EU Law Bill in a bid to kick it into the long grass. Similarly, postponing debate on the Northern Ireland Protocol and accepting that the current arrangements will have to remain in place for a while, will take some heat of tensions with the EU. None of this is to say that the UK is about to reconsider its position on EU membership. For one thing it is unlikely that the EU would be thrilled about a UK application anytime soon, nor is the electorate likely to have the stomach to rerun the debates of 2016 once again. Needlessly picking fights with the EU on issues we were told were settled two years ago will not get us anywhere, however.

But it is evident that the political class needs to address the elephant in the room that the current form of Brexit will not make the UK better off. That the Conservatives cannot or will not do so is perhaps understandable, given that so many members of the government were pro-Leave. Labour’s position is less forgivable. It continues to deny the extent of the problem for fear of upsetting the anti-EU media ahead of an election, despite recent polling evidence. At the very least politicians owe it to us to take a leaf out of the Obama playbook on foreign policy: “Don’t do stupid sh**.” Whilst in some ways this may be sound advice that comes too late, the next best option is don’t make it worse by ignoring the problem.

2022 in review: Setting us up for a difficult 2023

The economy in 2022

For the second year in three, 2022 was characterised by a one-off event that completely changed the economic landscape. Whilst 2020, and to a large extent 2021, was derailed by pestilence, this year was dominated by war. Those of a religious persuasion might recognise these as the first two Horsemen of the Apocalypse. Most of our predictions were derailed by the Russian invasion of Ukraine which resulted in a bigger surge in inflation than anticipated and forced central banks to raise interest rates to their highest since the GFC. However, this year was not just about monetary policy: governments were forced into using an active fiscal policy to offset the worst effects of the cost-of-living crisis on households. However, it will not be enough to prevent recession in large parts of the industrialised world in 2023 and the continued rise in government liabilities may yet turn out to be a big problem in future.

Covid slipped down the list of things to worry about in 2022. In my year-ahead piece almost a year ago, one of the options I laid out was that the Omicron variant would prove to be the last hurrah for Covid, which would regress to become an endemic problem. That is indeed how things panned out in 2022 although as China opens up following its zero-Covid measures there is every prospect that global cases will start to pick up once more. We cannot yet be sure that we are out of the woods. However, I did expect that as Covid related supply shortages began to ease, inflation would slow towards the end of 2022. It has not worked out like that.

Newspaper headlines have been full of suggestions that recent events herald a return to the conditions of the 1970s, with a commodity price shock triggering a surge in inflation accompanied by increasing industrial unrest as unions push for higher wage claims. Whilst the parallels are attractive on the surface, a closer look at the evidence suggests the comparison does not quite hold up. One of the key differences so far is that real wage growth has been crushed by the recent surge in inflation whereas in the 1970s it remained positive (although we have been compensated with lower real interest rates). Here in Britain, the strikes that have hit train, postal and health services are a response to the fact that many workers are being squeezed very hard, two years after they were lauded as key workers who kept the country going during the initial Covid lockdown. Labour relations are going to be a problem for governments in 2023, particularly in France and the UK.

One way to think about the inflation problem in the short-term is that it is the outcome of a distributional conflict between firms, workers and taxpayers which will only be resolved when the various actors accept the outcome. Indeed all players have to accept that they will be made worse off: At issue is the extent of the losses they are prepared to bear. The fact that central banks have raised interest rates to combat inflation has complicated matters by raising the burden on households. My issue has long been that higher interest rates will do nothing to offset a supply-side inflation shock, although central banks have to be wary of second round effects, particularly where labour markets remain tight as is currently the case in the US and UK. But as pointed out by the journalist Sarah O’Connor, author of this article on why worker power has not strengthened in 2022, while central banks fret about a wage-price spiral, the current situation looks more like a living standards bloodbath.

On the basis that inflation slows in 2023, as base-year effects drop out of the annual calculations, and as European economies – and maybe the US – fall into recession, the calls for interest rate cuts will build. Central banks are unlikely to heed these calls, and maintain policy tighter than might be justified by economic conditions, which would be a contrast to the post-GFC period when they held policy looser than justified by economic conditions. Central bankers are paranoid about repeating the mistakes of the 1970s when they eased policy too early only for inflation to take off again.

A bad year in the markets

On the basis of data back to 1928, 2022 was one of the worst years for total asset returns with the S&P500 losing around 17% whilst returns on Baa corporate bonds were the second worst in history (beaten only by the collapse of 1931). It was not supposed to be this way. Indeed I expected equities to perform relatively well, largely because of an absence of alternatives. But the surge in interest rates and fears of recession well and truly did for markets. It is not usual for a year of losses to be followed by a second consecutive decline but it has happened before – most notably for equities over the period 2000-2002. I would like to say that things can only get better but we cannot be sure that they will.

2022 was also the year in which crypto assets were reassessed. Long-term readers will be aware of my scepticism regarding cryptocurrencies but I was not prepared to write them off at the start of the year on the basis that there seemed to be genuine retail interest in their adoption. But as the energy costs associated with mining Bitcoin continued to rise, they became an increasingly unattractive prospect. Matters were not helped by the bankruptcy of the FTX exchange amid allegations of fraud. As a result Bitcoin lost two-thirds of its value against the USD, to currently trade at 16558 – still almost triple my back-of-the envelope estimate of fair value.

Politics: Some right calls, some wrong

If I got anything right about 2022 it was that geopolitics would be at the forefront of the agenda after two years in which governments were preoccupied with Covid. I did point out there was a risk that Russia would invade Ukraine and that western relations with China would continue to fray. I also tipped Emmanuel Macron to get a second term as French President. However, the one call that went badly wrong was that Boris Johnson would end the year as UK prime minister. As I wrote at the time: “Ditching a third Tory leader in six years, before their term is up, will not play well with an electorate that appears increasingly restive, particularly when there is no obvious candidate to replace Johnson.” I stand by the logic – Johnson’s departure will do the Tories no favours at the ballot box. But I could not have foreseen that Johnson’s replacement would themselves be replaced after a spectacularly incompetent fiscal plan was rushed through.

Last word

Tough times are now the order of the day. We survived the GFC, coped during the pandemic and are having to tighten our belts to deal with the most significant war on European territory since 1945. I look back fondly to the days of the Great Moderation when we had to invent things to worry about (who now remembers the Millennium Bug?). We can be thankful we got through 2022 relatively unscathed but as we look ahead to 2023, there will be bigger challenges ahead. Happy New Year to you all.

On Christmas Night ...

Twas the night before Christmas, when all through the house, not a creature was stirring, not even a mouse. There certainly weren’t many train drivers around either, Rishi mused, given that they were on strike. Ambulance drivers, nurses and postmen were, like Christmas cheer, also a little thin on the ground this year. Rishi shivered. Ever since he had moved into his London townhouse almost three months earlier, his life appeared to be running out of control.

He had the sense that the place was haunted. The portraits of all the previous occupants gazed out on him as he went up and down the stairs to the cramped but expensively decorated apartment that one of the recent occupants had lavished so much money on. He could almost hear their disapproving whispers urging him to get tough with the unions and bring the country back to its senses.

Rishi sighed as he trudged up to bed. At least tomorrow he could shut himself off from everybody and lounge around in his underwear drinking Crème de Menthe by the pint. It may not be much but it was at least a plan. It’s not like there was a Queen’s Speech to look forward to this year. Dejectedly Rishi slumped into bed. It had been a tough year and he was glad it was almost over. A good night’s sleep was just what he needed.

A quick slug of whisky provided the tranquilliser that would send him to sleep: A deep slumber when the pressures of the job would fall away. Then suddenly he heard it. Tap-tap-tap on the window pane. One of the most secure houses in London and someone was trying to break in. Incensed, Rishi stormed over and flung open the window. And there, sitting on the windowsill, was Tony Blair.

 “What the hell are you doing there?” asked Rishi.

“I am the ghost of Christmas past,” replied Blair.

“But you’re not even dead, at least not physically,” said Rishi. “How can you be a ghost?”

“You don’t have to be dead to be a ghost,” Blair answered. “Just look at Keith Richards. Anyway, I’ve come to show you what life was like in Merrie England in the days of BC.”

Seeing Rishi’s puzzled look, Blair helpfully added, “Before the Conservatives. Here, grab hold of my arm. And do call me Tony”.

Before he could even reply, Blair reached out and for a moment all went blank. But then Rishi recovered his composure and realised that the two of them were standing in a hospital waiting room. “Where are we?” he asked.

“This is the waiting room at St Thomas’ Hospital,” replied Blair.

“But it’s empty,” said Rishi. “Is everyone on strike?”

Blair visibly bristled. “No. It’s 2010 and the place is empty because a Labour government has ensured there are sufficient staff to tend to patients quickly with the result that waiting times are minimal.”

This time it was Rishi’s turn to bristle: “Your spending plans crashed the economy,” he snapped.

“Remind me again,” retorted Blair, “how high is the public debt to GDP ratio now compared to 2010? How weak is the pound? And what about…”

Before Blair could finish the sentence, Rishi cut him off.  “What about Iraq?” he yelled.

“Brexit,” responded Blair.

Before he had a chance to think of a clever retort, Rishi found himself sitting up in bed. Had he merely dreamed his weird encounter? Whatever was in that whisky, it wasn’t good. Rishi lay awake in his bed, too pumped to sleep, when his thoughts were interrupted by a tap-tap-tap on the window. “If that’s Blair, I will push him off the windowsill,” said Rishi to himself. Flinging back the curtain, expecting to see Blair’s grinning visage, Rishi was astonished to be greeted by the sight of Liz Truss.

“Don’t tell me you’re the ghost of Christmas present,” said Rishi shakily.

“I am indeed,” replied Truss. “I’m here to show you the power of free market economics and the Britain that I created during my term in office.”

Rishi was bemused: “But you were only in the job for 44 days. How much could you actually do in that time?”

“Clearly you are not a believer in Trussonomics. Come with me to a Citizens Advice Bureau to see how the people gratefully acknowledge the power of markets to set them free,” she replied.

“Maybe not a great move, Liz,” said Rishi. “Got any other venues in mind?”

“How about any Conservative Party branch in the country?” said Truss, hopefully.

“Maybe not a great choice either given what you did to the brand,” he muttered sarcastically.

“A group of hedge fund managers, then?” She was beginning to sound desperate.

“Why would I want to mix with those peasants?” said Rishi, loftily.

“Oh, come on Rishi. You’re not exactly entering into the spirit of this exercise, if you’ll pardon the pun,” wailed Truss.

“Well, the truth is, Liz, that my life is so much more miserable thanks to your misguided tax-cutting plan.” Rishi was shouting now.

“But that was all Kwasi’s idea.” She seemed on the verge of tears.

“I don’t care. Go away and leave me alone.” He was definitely shouting.

“There are many worse ghosts than me you know,” pouted Truss.

“I really don’t see how. Anyway, I don’t believe in ghosts and I certainly don’t believe in you. I’m going back to bed.” With that Rishi slammed the window shut and realising that he was in some sort of bizarre Dickensian plot sat down to await the ghost of Christmas future, musing that it was better than waiting for the Four Horsemen of the Apocalypse. At this point in the story, you are probably expecting Keir Starmer to tap on the window and show Rishi how bleak and miserable the future will be unless he changes course. But Starmer never showed up, which frankly is a blessing. After all, we will soon enough see what it will bring. 

Merry Christmas to you and yours.