David Frost
The Tories’ poll ratings are slowly ticking up again. Rishi Sunak’s Government seems to have a grip on things. So are we safely out of last autumn’s crisis? I wish we were, but I fear we aren’t. It’s easy to blame those problems on mismanagement under Liz Truss, and obviously there’s an element of that, but last year’s shock was caused by real problems. The recent bank crashes show that these have not gone away. All Western economies are now facing the consequences of two decades of fundamental economic mistakes. Interest rates are the warning sign. They are far too low for a free market economy.
Why this is a problem, and much else, is explained by the economist Bernard Connolly in his latest book, You Always Hurt the One You Love: Central Banks and the Murder of Capitalism. Yes, today it seems easier to borrow and spend. But problems are stored up for tomorrow – and unfortunately tomorrow is fast becoming today. Interest rates matter because they are a vital price signal – the price of money. Rightly used, they can control boom and bust. When a burst of innovation comes, as with the internet in the late 1990s, you want people to invest in that today and spend the money on the fruits tomorrow. What you don’t want is super-investment today and no demand tomorrow. Raising interest rates in the boom is the way of achieving this. It makes it more worthwhile both to invest in innovating sectors than in others and to save money at decent rates of interest for consumption tomorrow. Unfortunately, that didn’t happen. By the time it was clear that the economy was overheating, and central banks finally woke up, they had to push interest rates higher than otherwise necessary. But overinvestment and overspending in the boom had by now created a risk of an almighty crash as people retrenched in the bust.
No problem, said the central bankers. We’ll bring interest rates down lower than where we started. Inflation is under control anyway, and this will keep people spending instead of saving and avoid a crash. This worked at first, but it started to get our economies used to the dopamine hit of artificial stimulus – operating at interest rates that were too low. This is where so many of our problems began. In these circumstances, zombie firms that should go bust survive, producing goods inefficiently. Investment doesn’t go to the most productive. Incentives to innovate fall, productivity slows and the economy stagnates. Worse, people begin to believe that asset price increases are real, rather than fuelled by cheap credit and fake money, and start borrowing against them – and voters and companies start to think that they will always be bailed out. Then, when the next crisis hits, as it did in 2008, the economy is even less able to withstand normal interest rates. So they had to go lower still. And so the cycle continued. That’s why real interest rates were positive in the mid-1990s, but by the banking crash were well below zero, and fell even further after the Covid crisis – helped of course by oodles of quantitative easing.
This isn’t just a British problem. Every economy has its own difficulties, which makes the underlying malaise worse. In Britain, we have high immigration and not enough houses, hurting productivity and driving asset prices even higher. The Eurozone can’t establish conditions that suit Germany and southern Europe at the same time – one reason why the European Central Bank’s monetary policy has performed even more poorly than everyone else’s. And of course everyone’s situation can be made worse by policies like net zero that drive debt-fuelled investment in useless projects. So now we’ve got addicted to the Kool-Aid. We can’t easily raise rates to control inflation. Indeed UK real rates of around minus 6 per cent last autumn apparently nearly collapsed UK pension and mortgage markets. The IMF warned this week that rates held near current levels might produce a financial crisis, and who knows what further horrors like Silicon Valley Bank lurk in the depths? But equally, we can’t keep pushing rates even lower and printing more money each time there’s a problem. There’s just too much inflation and debt around. Sooner or later that crisis will come. Then Western governments, deprived of other policy tools, may have no option than to take direct control of the financial sector to avoid a crash. If that happens, we won’t live in a free market economy. Governments will direct investment. Productivity will fall further. Whether you can make a living won’t depend on your own abilities but on whether government thinks you are worthy or not.
There is one thing we could do to avoid this grim prospect. Get into a virtuous circle. Reform to drive up productivity so that we can withstand higher interest rates. Then those more normal interest rates can start to get investment and the price mechanism going again. But we’ve left it very late. Tinkering won’t raise our productivity growth from 0.5 per cent to 3 or 4 per cent. We need to do not one thing but everything: change planning to deal with our backlog of four million homes; stop wasting money on energy companies that don’t generate energy; bring market reforms to our wasteful and expensive public so-called services; build more roads, ports and airports with private money; get spending and tax down and simplify the tax system; remove burdens on job creation; incentivise education that pays off rather than worthless degrees … the list is endless. At the moment, any single one of these seems beyond us, and the total reform programme is well beyond the current Overton window of politics. Unless we can change that, we will slip further into genteel decline. This week, Liz Truss rightly pointed out that the West is losing touch with the economic fundamentals that made us succeed. All in the Conservative Party can surely agree on that. If so, we can start explaining why, and how we are going to fix it, in our election manifesto. It’s not the moment to tell voters: “It will all be fine. Don’t worry, we have your back.” That won’t prepare the country for the very difficult decisions that are coming. We must tell it like it is and get a mandate for change, or be swept away by the storm.
The Telegraph
