Rishi Sunak's economic plans are as shaky as Liz Truss's

The cost of government borrowing went through the roof. In fact, the price the markets charge for lending the Tory government ready cash jumped to above the rate that Liz Truss and Kwasi Kwarteng were forced to pay last year, after their bonkers mini-Budget.

You remember – the mad “dash for growth” that put paid to Truss’s miniscule premiership and ultimately gave us Rishi Sunak. But why do the markets now think Sunak’s financial plans are just as wobbly as those of Truss?

Essentially, the markets are coming to terms with the fact that inflation is not going away any time soon. That means central (i.e. government) banks are going to have to engineer a recession in order to squeeze excess demand out of the economy. To create a recession – a daft policy I’ll criticise in a moment – central banks will have to jack up interest rates to around 7% or more.

Expecting this imminent rate rise, financial markets on both sides of the Atlantic are getting their retaliation in early. They have moved to charge the government the sort of higher interest they expect central banks will soon start charging high street banks for providing liquidity.

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If these technicalities seem arcane just hold on to the notion that everyone on Wall Street and in the City of London now thinks the central banks have cocked up dealing with inflation and are going to have to press the button on higher interest rate charges to slow the economy. Investors are just charging a higher rate now rather than wait for the central banks to do it first.

You’ll remember that one of Sunak’s five key pledges is to reduce inflation (even though that is supposed to be the job of the “independent” Bank of England). Clearly, Rishi is going to fail on this one.

Worse, the level of inflation in the UK is still outpacing the level in our industrial competitors. Which is why the markets expect a bigger recession here than elsewhere. Predicting when the recession will actually hit is always a risky game.

The Bank of England itself was originally forecasting one for this year. That didn’t happen because the Bank took cold feet (under political pressure) over raising interest rates too quickly. Result: prices are still rising like the clappers. Which means the recession will be humongous when it actually arrives – probably next winter.

But is a recession really necessary as a cure? Think about it: we live in a capitalist economy where “rational” experts think engineering mass unemployment is the only way to stop supermarkets putting up prices. That’s insane.

Two peas in a pod - Rishi Sunak and Liz Truss have both failed to gain the trust of the markets

It’s making the innocent pay for the sins of the guilty. And in this bonkers system, the ostensible solution to inflation also involves the central banking authorities … raising the cost of a mortgage! That’s raising inflation to fight inflation!

Let’s pause a second and trace the origin of the current inflation. First, when the pandemic broke out in 2020, the Bank of England responded by printing oodles of money (aka quantitative easing) to finance the lockdown.

Other countries did the same. That created a vast potential excess demand in the economy, given that output had cratered, and we weren’t allowed out to spend. When the pandemic ended at the start of 2022, global supply chains were left in chaos, creating massive shortages everywhere.

The excess demand from quantitative easing combined with these shortages to trigger inflation. Companies took advantage of the situation to rebuild profits by bumping up prices as far as they would go. Next, to add to the bonfire, the Russian invasion of Ukraine initiated a massive hike in energy prices.

But grasp this: prices can only go up if there is consumer spending power that can pay the new going rate. This cash demand has to be engineered somehow before the inflation (rising prices) can manifest itself.

Greedy supermarkets and greedy energy companies can only bump up prices if there is extra spending power to snare. This extra spending power ultimately came from central banks printing money and from the rock-bottom interest rates they maintained under political duress.

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Knowing this, central banks in Britain and the US started to wind down quantitative easing (printing excess money), beginning last year.

But then something else went wrong. Years of artificially low interest rates have encouraged all sorts of bad banking practices. This has produced a crop of serious bank failures – think Silicon Valley Bank and Credit Suisse.

Again, the response of central banks has been perverse. True, quantitative easing has been reversed in Britain and America – which should have curbed excess demand without engineering a recession. But this year central banks responded to the new crisis in the banking system by replacing quantitative easing with another source of extra money.

They have quietly provided vast extra liquidity direct to high street banks, allowing the latter to extend credit lines. Result: more demand and yet more inflation.

There are other options that can be used to fight inflation. Energy companies can be ordered to freeze prices – they would still make acceptable profits, but not ludicrously profligate ones.

Private banks can be nationalised rather than subsidised, and de-risked by making them mutual companies run on behalf of depositors. Excess demand can be trimmed from the economy by raising taxes, not by raising interest rates to engineer unemployment.

There are other exotic remedies such as offering greater tax breaks for saving to discourage excess consumption and encourage investment. None of these solutions to inflation necessitates crashing the economy into a brick wall.

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Sadly, for anyone contemplating voting Labour next year, shadow chancellor Rachel Reeves has been assaulting the airwaves with yet more promises to be more fiscally conservative than the Conservatives. Reeves is ex-HBOS and ex-Bank of England, so don’t expect anything from her except mainstream orthodoxy in economics. She and the current Chancellor, Jeremy Hunt, are vying to see who can be the most abject in kowtowing to the dictates of the City of London when it comes to using the blunt tool of a recession to kill inflation.

Indeed, Reeves has attacked Hunt’s economic adviser, Sushil Wadhwani, for daring to criticise the Bank of England’s latest (and 13th in a row) interest rate rise.

Here in Scotland, we can only look on in exasperation and impotency. According to the latest opinion polls, exasperated Scottish voters (including pro-indy ones) are set to help Reeves into 11 Downing Street just as the big recession hits.

But a recession is the last thing Scotland needs. Our average GDP growth rate over the period 2000-19 was a miserly 1.4%. That masks a drop from 2.4% on average between 2000-07 to a catastrophic 0.7% between 2008-19.

Humza Yousaf and the SNP government need to clear the policy decks and concentrate all their political firepower on raising economic growth – even at risk of breaking with its Green allies.

Otherwise, it will be those Scots least able to afford it who will pay the price for curbing an inflation they had no part in creating.