Rachel Reeves’ unbearable acquiescence to the City bankers – UNHERD

The curse of finance ministers whose country’s business model is broken is that they are powerless to transform the economy, yet too powerful not to take the blame. But when the economy is merely stagnating, not yet in free-fall, preventing the descent into a financial crisis should require no more than average competence. Sadly, the evidence so far suggests that Rachel Reeves cannot even meet this low bar.

Seeking to combine the image of a radical reformer with the reputation of a safe pair of hands, Reeves began her litany of mixed messages before she moved into 11 Downing Street. While she acknowledged the “severe damage” inflicted by George Osborne’s austerity programme, she adopted his austerian language to liken Britain to a person who had “maxed out the credit card”. Then, once in the Treasury, she demonstrated how using such language leads inexorably to a contractionary fiscal programme. Turning John Maynard Keynes’ dictum “Anything we can actually do, we can afford” into its opposite (“If we cannot afford it, we cannot do it”), Reeves embarked on an austerian downward spiral.

First came expenditure caps on caring for the elderly, which would save the measly amount of £1 billion annually. Having warmed up, she followed with the termination of winter-fuel payments for pensioners, shortly before one of recent history’s coldest winters. Along with cancellations of urgent hospital and railway works, these cuts saved another £5 billion, with a further £16 billion tax rises in the works. Then, in her autumn mini budget, Reeves broke her promise not to touch National Insurance Contributions by extracting an additional £25 billion from employers. Hoping to frame this final measure as pro-labour, her tactic fell terribly flat once workers realised they would be paying for most of it in the form of dampened wages.

By that stage, the new Chancellor was caught in the same doom cycle that typified Osborne’s tenure: each austerian measure meant to rein in the deficit boosted the borrowing requirement, spooked debt markets, elevated interest payments, reduced its fiscal space and caused the Chancellor to seek more austerian measures which, in turn, deepened the economy’s stagnation. And so it would go on.

Tory critics have taken Reeves to task for being too ready to talk Britain down. But they seem to have forgotten that her claim of inheriting a £22 billion black hole from the Tories was a faithful imitation of Osborne’s strategy to blame his austerity, in turn, on the “scorched earth” situation he had inherited from Labour. The Tories have also accused her of being insufficiently austerian, which is disingenuous: if deeper austerity were the right remedy, why was the doom loop under Osborne just as bad? If anything, deeper cuts in expenditure today would only worsen Reeves’s predicament.

Obviously, the Tories are trying to exploit Reeves’s woes. But what is truly startling about her stewardship of the Treasury is both how faithfully she has stuck to Mr Osborne’s playbook, and how similarly the UK economy has reacted. And this despite the quite monumental difference in the circumstances the two Chancellors inherited as they took office. Soon after his appointment, Osborne received a windfall from the Bank of England — in total, £124 billion was transferred from the Bank of England to the Treasury between 2010 and 2020. In sharp contrast, Rachel Reeves will be sending to the Bank of England £34 billion of taxpayer money every year for the next four years! To see why we need to recall what happened after the financial collapse of 2008.

From 2009 to 2022, in addition to the taxpayers’ bank bailouts and ultra-low interest rates, the Bank of England created £875 billion with which to buy government bonds from the bankers. The idea was to flush the banks with cash in the hope that they would then hand it out in loans to stressed households and firms during the Great Recession. In the process, the Bank of England made money from the interest rate difference — between the ultra-low official interest rates it was paying banks for the money they kept in their Bank of England accounts and the higher interest accrued by the government bonds. Hence the £124 billion windfall which the Bank of England transferred to the Treasury.

However, the situation was reversed after 2022. With the pandemic disrupting supply chains and triggering inflation, the Bank of England raised interest rates tenfold so as to restrain credit and reduce the demand for goods and services, in the hope that prices would stop rising. At the same time, to restrict further the quantity of money in the economy, the Bank of England began selling the government bonds it had purchased back to the bankers thinking that, with every such sale, the money paid by the banker to the Bank of England for the bonds was removed from the monetary system.

And there’s the rub: Bonds come with fixed interest rates during their lifetime. So, when the Bank of England official interest rates rise, pushing all rates higher across the economy, an older bond with a fixed lower interest rate becomes less attractive and its price falls. Having raised interest rates, the Bank of England had effectively pushed down the value of the older bonds it was selling off, thus inflicting large losses on itself. And it was not only on itself. It was also on the tax payer because, back in 2016, Philip Hammond, one of Reeves’ Tory predecessors (who was at the time receiving windfall monies from the Bank of England), had committed the Treasury to indemnify the Bank of England for any future losses. Reeves, unwilling to reverse Hammond’s commitment, is now paying the price.

This is why every year for the next four years she will be putting aside the £25 billion she took out of the economy by raising National Insurance Contributions, adding that to the £5 billion she saved from cutting pensioners’ winter fuel allowance, throwing in also the £1 billion she cut from the social care for the elderly bill, and adding another £3 billion from some other source for good measure. Then, she will transfer that £34 billion bundle to the Bank of England to compensate it for the money it had passed on to the City’s bankers. Every year. For four years at least. All because of a flawed set of monetary rules in which interest accrues on the bankers’ reserves which they keep at their Bank of England accounts.

Could a different set of monetary rules avoid this fiscal madness? Here are two steps the monetary authorities could have taken: First, the central bank could refrain from selling government bonds at knockdown prices — instead hold them to maturity. Second, don’t pay bankers the high official interest rate on every pound they choose to hoard at the central bank.

Indeed, many leading central banks do exactly that: they hold bonds to maturity and pay the bankers the going interest rate only for part of their deposits, the rest at zero. This is precisely how the European Central Bank (which, by the way, no one can accuse me of being a lackey of) avoided major losses when deflation gave way to inflation. There are no good arguments for why the Bank of England should not follow the ECB’s example — except that the City bankers would not like it.

And only a cowardly Chancellor would think this was a good enough reason to maintain a £34 billion subsidy for the banking sector every year. And not for any improved services but just for being around and ready to bank whatever the state is prepared to send their way. Is there a better example of such fiscal irresponsibility or, more accurately, madness?

Some may ask whether Rachel Reeves is really to blame, especially given the supposed independence of the Bank of England. But this question is founded on a widespread albeit erroneous understanding of the Bank of England’s independence. It does indeed set interest rates independently of the government. And if they err by setting interest rates too high or too low, it is unfair to blame the Chancellor. But the issue here is not the level of interest rates. It is, rather, the mindless fire sale of government bonds; the high interest accrued to bankers’ money; and, crucially, the assumption that the taxpayer will have to indemnify the Bank of England for whatever losses it suffers as if it were any other private company or bank. All three issues are in the remit of Parliament and fall under the Chancellor’s responsibility to legislate for the common good. In short, they could be otherwise.

Just look at Reeves’ predecessors. Philip Hammond promised to indemnify the Bank of England in case it lost money from its government bond purchases. Before him George Osborne and Alistair Darling legislated that the Bank of England could print money for the bankers but not for households, against the advice of the not-exactly-leftist International Monetary Fund. And last, but certainly not least, Rachel Reeves has decided not to legislate away the stealthy subsidy to the bankers, adopting instead their inane, self-evidently self-serving arguments and refusing to follow the more sensible ways of the ECB or of the Swiss authorities. Chancellors, in short, cannot hide their responsibility behind a distortion of the notion of central bank independence.

Taking a broader perspective, ever since Margaret Thatcher vandalised Britain’s ailing heavy industry and replaced it with a vicious financial system that generated growth as long as society’s common wealth was liquidated, it was only a matter of time before a global financial crisis would bring Britain to its knees. Following the 2008 crash, overgenerous money printing for the bankers and austerity for everyone else trapped the UK into a low-wage, low-productivity, low-growth, low-take-home-pay, low-rent equilibrium. That is why, for a while now, Britain has felt like an advanced rentier society that has run out of rents.

As the last election loomed, you had to be unjustifiably optimistic to expect Labour to fix Britain’s broken business model. Nothing in their Manifesto warranted such hopes. Nevertheless, it was not too much to expect minimal levels of competence and enough courage from a new Chancellor to rescind an annual handout of £34 billion to bankers already flash with taxpayer cash. Alas, it is now evident that, overpowered by an urge to be liked by the City, Blackrock, the Davos crowd, Reeves has fallen into a black hole largely of her own making.

John Kenneth Galbraith once quipped that “[t]he process by which money is created is so simple that the mind is repelled”. Today, it is hard not to be repelled by how Britain’s scarce fiscal resources are sacrificed on the altar of the Chancellor’s cravenness.