Trade Wars

Reviews | The free fall of the pound offers a first lesson

If there’s a broader lesson to be learned from Britain’s economic crisis, it’s this: beware of politicians who flippantly promise that they – and they alone – know better than the experts.

Prime Minister Liz Truss and her allies have promised that when she takes office, she will fix the economy by abandoning “obsolete economic orthodoxy” and “the so-called abacus economy”. This kind of rhetoric has become common among populist politicians — including in the United States — who portray themselves as free thinkers by disparaging the ominous-sounding “establishment” or “elites.”

Or, you know: those annoying, bean-counting experts, maybe on the fly.

Since Truss unveiled a mini-budget on Friday, the British currency has been in freefall, with the pound hitting an all-time low against the dollar on Monday. The markets clearly do not believe in the Conservative government’s stated commitments to control inflation and doubt Britain’s ability to repay its debts.

This is partly because the economic conditions beyond the control of the government are genuinely difficult. But there were also plenty of unforced political mistakes.

Sebastian Mallaby: Britain has replaced Italy as Europe’s problem economy

Sometimes an economic policy has already been discarded not because the leaders lacked the ingenuity or the moral courage to propose it before, but because it is already been tried and failed many times. Sadly, that’s the flavor of “unorthodox” that Truss and his party have embraced – and that some American politicians are also pushing.

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Among Truss’ supposedly bold and courageous ideas is to seek to stimulate the economy’s exit from an inflationary crisis. His government has announced a series of tax cuts, which are more than the types of runoff policies often proposed in the United States as an economic panacea. The Tory tax plan represents the biggest UK tax cuts since 1972.

But when an economy is overheating and demand exceeds limited supply, giving the public even After the money to be spent will almost certainly make inflation worse. It could also prompt the central bank to raise rates more aggressively in an effort to reduce demand, ultimately leading to more economic hardship.

Virtually any “orthodox” economist could tell you that. And yet, in Britain, as in most American states, tax cuts as a remedy for inflation have become strangely fashionable.

Another of Truss’ “unorthodox” ideas: price controls. This, too, has been taken for granted in the United States, although the American politicians pushing it are mainly on the left.

UK energy price controls are intended to solve a serious economic problem. Global disruptions related to Russia’s war in Ukraine have made energy extremely expensive. As winter sets in, Britons could freeze if they can’t afford to keep warm.

But energy price caps encourage more energy use, not less, because they protect consumers and businesses from price increases that would normally incentivize at least some conservation. Price caps are likely to create a combination of energy shortages and huge (as yet unquantified) costs to government.

This is another reason why UK debt looks so risky and the pound has fallen.

Virtually any approach to dealing with high energy prices will be painful to some degree. But cheaper strategies are available beyond guaranteeing lower prices for all. Relief could be targeted to low- and middle-income households in the form of flat-rate rebates. This way the price signals always do their job.

Truss has already offered bizarre and unapproved policies by experts; Several years ago she said it was a “shame” that Britain imported so many apples and seemed to suggest more food trade barriers. Because, of course, real trade wars have never been attempted.

Megan McArdle: The era of budget gifts is over. Britain’s tax cuts have to be paid for, one way or another.

But perhaps most troubling are Truss’ hints of political interference at the central bank.

In recent weeks, Truss has hinted at plans to “change the Bank of England’s mandate”. What this means precisely is unclear; markets seem to fear that this is a euphemism for more political interference in setting interest rates and other monetary policies. The central bank is already taking unpopular tightening measures and will likely need to tighten much more aggressively in the future, partly in response to Truss’ fiscal stimulus.

There is a long and disastrous record of what happens when politicians control the money supply or are even simply seen to do so. (See: Venezuela, Argentina, pre-euro Italy.) The maxim that central banks should be politically independent has become orthodoxy for good reason: to do otherwise has failed spectacularly.

To be clear: it’s not that the experts are always right. Groupthink can be wrong and sometimes dangerous. Diversity of opinion and the testing of conventional wisdom are good things.

But when politicians peddle magic solutions they claim everyone other was too cowardly, closed-minded, or unpatriotic to have ever offered before: Beware. As Truss’s leadership has shown thus far, sometimes those who promise to pull off a “quick fix” just shoot themselves in the foot.