Raising money for war

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As the warmongering rhetoric of the UK’s traditional parties (Tory, Lib Dems and Labour), along with newcomer Reform Ltd, ramps up, suggestions have been floated that the UK should start issuing war bonds, a method of borrowing from the public which was used to fund both World Wars. One of those floating the idea is Lib Dem leader, Ed Davey, and the call is also being supported by an alliance of defence industry bosses. The keenness of the armaments industry for the government to raise more money to divert into their pockets is understandable – arms manufacturers are the only consistent winners from warfare. Surprise, surprise – arms manufacturers support a plan to transfer other people’s money to themselves!

Even if we assume, for the purposes of argument, that spending more on armaments is a good thing, there is a big question over whether the government actually needs to borrow money to achieve that aim. The constraint isn’t about money – the government can always create money to fund whatever it wishes – it is about real resources in the economy. Are the raw materials, labour, energy etc to produce more armaments actually available, or do they need to be redirected from other economic uses? The way in which they are financed is a separate question entirely. On the scale on which our politicians apparently wish to manufacture armaments, it is likely that diversion of resources from other activities will be required – and which economic activities are selected to suffer the effects of that diversion is a far more important question, even if not one that any of them are in any great rush to answer.

Those advocating war bonds as a means of raising finance seem to think of it as an opportunity for ordinary people to come together and loan their pennies to the government in a great patriotic outpouring, as happened in the two world wars. Except it didn’t happen; it’s a false memory of events seen through biased lenses. And that little dampener eliminates the need to even consider whether the UK’s population would suddenly be overcome by the jingoistic fervour which the proposal presupposes.

In both world wars, the bonds were overwhelmingly sold not to ordinary individuals in the street but to a small number of wealthy individuals and to companies and institutions, unsurprisingly concentrated in London and south east England. The scheme launched in the first world war was actually a spectacular failure, with the Bank of England being forced to buy many of the bonds itself (an early example of what would probably be called quantitative easing today), hide the assets in its accounts, and then lie about having done so. As the government increased the interest rate in an increasingly vain attempt to attract more money, many of the new bonds were purchased by holders of the existing bonds converting them into the new higher interest bonds instead. As might be expected by any rational observer, the motivation of capitalists was more about making money than saving the country.

That highlights one of the issues with governments issuing bonds – they benefit mostly the wealthiest in society. By treating tax and ‘borrowing’ as alternatives, the rich end up keeping their capital and earning interest on it rather than paying tax. It’s also a double whammy – when the government spends the money into the economy, it overwhelmingly flows upwards into the hands of the wealthiest, through profits and dividends. To the extent that even a small number of ordinary people respond to the call, they end up reducing their own spending power as the flow of capital increases social inequality. It's not quite the wizard wheeze as which its advocates seem to see it. Unless you're an arms manufacturer.

Wielding the hammer. Again.

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For those who have been battered by the rise in the cost of living recently, the report that inflation is slowing down is good news of a sort. It’s usually better to get poorer slowly rather than quickly, even if that isn’t quite the way in which the government has presented it. Given the unshakeable belief of the Bank of England, and the government, that this fall in inflation is all down to interest rate increases, it means that we should be able to look forward to some interest rate cuts later this year. That will, of course, help the main target group which the government hopes can thus be bribed into supporting it, namely those with mortgages. It won’t necessarily help the poorest of all, but then they tend not to vote Tory anyway.

Economic theory tells us that high interest rates deter people from spending and therefore remove upward pressure on prices, rather ignoring the fact that they also further impoverish those who have little room for discretionary spending in the first place. The problem with the theory is the implicit assumption that inflation is always caused by too much money chasing too few goods and services, but that really wasn’t the cause of the most recent bout of inflation, which had rather more to do with the war in Ukraine and profiteering by energy companies who never let a good crisis go to waste. Still, when the only tool you have is a hammer, every problem looks like a nail, and the Bank of England has bashed away with great enthusiasm at that nail. It now seems to seriously believe that inflation with external causes which would have gone away eventually anyway has actually been vanquished by their demented hammer-wielding rather than by the passage of time.

And that brings us to the sting in the tail. Alongside the half-promise of interest rate relief at some unspecified later date came the warning that inflation might not have gone away yet because the hostile acts of the Houthis in Yemen against shipping in the Red Sea may yet cause a further bout of price rises, as goods either become scarcer, or the cost of shipping them increases. In terms of the threat of inflation, it’s a reasonable fear – but it doesn’t follow that the answer is to continue using that hammer. The mechanism by which high interest rates impact inflation caused by hostile acts at sea is, being charitable, less than entirely clear. It’s not as if the Houthi leadership is looking to buy houses in the UK, and will be deterred from launching rockets by continued high mortgage costs. High interest rates aren’t going to affect the scarcity of goods or the price of shipping them either, merely help to ration them on price. It doesn’t take a genius to work out who loses most from rationing by price.

Hammers and nails

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They say that when the only tool you have is a hammer, every problem looks like a nail. The Bank of England is demonstrating the consequences of that. It’s easy enough for the UK Government to repeat ad infinitum that the BoE has sole responsibility for controlling inflation, but the only tool that they’ve allowed the Bank to have is the very blunt instrument of interest rate rises, a tool which the Bank is using with abandon despite the fact that the problem with which they are dealing bears little more than a passing resemblance to a nail.

The theory behind interest rate rises is simple enough: if the cost of money increases, people will borrow less and spend less, and if less money is chasing goods and services, the price of the latter will stabilise. Like most theories in economics, however, it’s only as valid as the assumptions underpinning it, and in this case, the assumption is that inflation is caused by too much money chasing too small a supply of goods and services, the classic cause of inflation. If that assumption were true, making money more expensive might well work, albeit at a cost. However, in this case, the problem isn’t an excess of money in the UK economy, it is a price shock caused by events – some of them, such as Brexit, caused directly by inept government actions, and others, such as war and the pandemic, completely outside the control of the government, let alone the Bank. The Bank’s governor has himself admitted to feeling “helpless” in this situation, although that hasn’t stopped him wielding the hammer with gusto against the imaginary nail.

In response to an external price shock, interest rate increases don’t stop the poorest needing to buy essentials, they simply pile more financial pressure onto people. Continuing to hit the non-nail with the hammer can only make things worse, potentially leading a government which claims to be promoting growth to preside over a recession instead. In response to the level of price shock that we are experiencing, only government can take action; blaming the Bank, as some Tories have done, is simply abrogating responsibility. And even the government, with all the resources at its command, cannot prevent the sort of price shocks we are seeing; but what it can do (and is refusing to do) is to mitigate the effect on the most vulnerable in our society. If there’s one clear lesson from the pandemic, it is that the government is not, in practice, constrained by a lack of money, a point which they are demonstrating yet again with the huge costs of supporting Ukraine in its defence against the Russian attack. They could equally deploy sufficient resources to help people through the current crisis, but have taken a conscious decision not to do so. They are, instead, fiddling around the edges of the problem, leaving those who can’t cope to their own devices. They’ve probably assumed (and its not an assumption which I’d challenge) that the people bearing the brunt of the crisis aren’t, and never will be, Tory voters. It’s just another demonstration of a complete lack of care for any citizen who isn’t one of them.

Risk and outcome

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Reaction to the appearance of the Governor of the Bank of England in front of MPs yesterday concentrated on his view that exiting the EU represented a risk to the economy in the short term.  In reality, his position overall was rather more neutral than that on the question, since he went on to say that in the longer term, no-one could be certain whether the overall impact of exit would be a good thing or a bad thing for the UK.  It all depends on what happens afterwards.  (That is something of a parallel, by coincidence, with the point that I made about Welsh independence a few days ago.)

I don’t really understand the reaction of those supporting exit, in trying to argue both that there is no risk involved and that anyone who says that there is must therefore be biased.  Anyone in the position of the governor must be continually looking at what might happen in the future and pondering whether and to what extent it increases uncertainty in the short term.  He would be guilty of dereliction of duty if he didn’t identify that a major decision with uncertain consequences poses a risk to current policies and strategies.

If I were supporting exit, I think that I’d be responding in rather a different way.  The question is surely not whether a UK exit would represent a shock to the economic system, but whether that is a good thing or a bad thing, how much of a shock, how long it would last, and whether the long term benefits would outweigh the short term risks.  It’s an approach which might also help to build a more informed debate on the issue.  Concentrating instead on whether the Governor is or is not entering the political realm looks like either a lack of confidence in their own arguments, or falling into the default short-termism which characterises UK politics.