The chancellor is dealing with the fallout from a war in the Middle East, which has created soaring inflation and fuel shortages. The political class is anxiously watching the economic charts. There are three words that keep popping up in Whitehall, parliament and the papers. Not “cost of living”. The three words are “balance of payments”. The year, you can guess by now, is 1976. The embattled chancellor is not Rachel Reeves, but Denis Healey. One cap, one hand and the rest is history.
The Sterling Crisis and the IMF Bailout of 1976 are perhaps the most misunderstood economic events in recent British history. Columnists and politicians like to refer to them, especially in relation to the current Iran crisis and our own beleaguered Labor government. But they barely understand the events they are describing. The point is not that our current crisis is the same as then, despite some passing similarities. In fact, in many ways, the current crisis is worse than 1976.
The reason why is simple. We cannot afford our current standard of living. We don’t produce enough of what we want—or enough of what the rest of the world wants—to pay for the things we can’t produce ourselves. Add on top of that a global economic crisis, like the US-Iran war, and the economy starts to tighten. As the world struggles to secure supplies of fuel, food, trash, plastic and other essentials in its wake, we will struggle to secure our supply. Even if we do, we’ll have to sell more of our businesses, our properties, our future tax revenue to pick up the bill.
We have allowed ourselves to get into this position by forgetting the iron law of international economics: every country must pay its own way. Ensuring this was the aim of politicians like Jim Callaghan and Healey. This is what maintaining the balance of payments meant in practice. It is the essence of what it means to face the cost of living. And it has been forgotten by our current political class.
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For 40 years this issue has been banished from politics. Our economy is based on the myth that we can enjoy, in eternity, a free lunch. A lunch paid for by savings and loans provided by the rest of the world to feed our voracious appetite for new goods and services. It is a belief in consumption without consequences. The US-Iran war is not the cause of the crisis; This naive attitude towards trade is the cause. War is just another shock to a broken system.
At the simplest level, the balance of payments is the sum of all the resources we export to the rest of the world minus all the resources we import from the rest of the world. This includes everything from the goods and services we consume every day, from the food we eat to the movies we stream. However, it also includes money we borrow from abroad and dividends we earn from overseas investments, as well as a host of other financial flows.
If your economy is in balance, it means that for everything you receive from the rest of the world, you are giving something of equal value. This does not constitute an exchange of consent. We need refined oil for shipping, but we can export accounting services to pay for it. If your economy is in surplus, like Germany’s, it means that the rest of the world is consuming more of your resources than you are demanding from them. What you do with that excess is up to you. You can save it for a rainy day, pay off debt or invest in your production capacity. General government debt in Germany has fallen from 81 percent in 2010 to 64 percent today. This gives Germany much more flexibility in dealing with strikes and is funding a major rearmament program to deal with the growing Russian threat.
If your economy has a balance of payments deficit, like Britain, you can do two things. One is depreciation. This is why the pound is now worth a sixth less than it was before the financial crisis. This raises prices at home for everything we import, especially food and fuel, and is part of the reason we all feel so poor. The other mechanism is more insidious: selling your assets to the rest of the world. That’s why from utility companies to iconic brands, 40 percent of British business is foreign-owned. That’s why a third of all government debt it is in foreign hands. Politicians who celebrate our record levels of foreign direct investment do not realize that what they are actually cheering is the destruction of British capitalism. It’s like selling your house to pay for the weekly shop and claiming to be a financial genius.
Callaghan and Healey knew what was needed to respond to geopolitical shocks like those of the 1970s: increased production. The classic, wrong story, is that the IMF loan was caused by government depravity. This was not the case. The British state had increased spending in the first half of the decade, but mainly to keep up with wage demands through greater provision of social security and public services. The government was overcorrected in efforts to improve living standards during this period rather than a more realistic policy of maintaining living standards at pre-1973 levels. However, government spending was not out of line with other European countries and was lower than West Germany which did not require an IMF loan. The issue was the sudden increase in the prices of imported goods, especially oil, which doubled the cost of imports in just three years.
The accepted wisdom was that the only way to pay for this new world of higher oil prices was to increase our production capacity, which would reduce oil imports and increase national income to pay for more expensive imports while reducing the impact of future shocks. They ramped up North Sea oil production not only to meet domestic consumption, but to generate export revenue to balance our trade. Labor also shifted resources towards industry and away from public spending, with industrial production increasing by 12 percent in just three years between 1976 and 1979. This helped turn the economy around. Britain went from a balance of payments deficit of £1 billion in 1976 to a surplus of £5 billion in 1981. We had gone from living on the kindness of foreigners to standing on our own two feet.
The irony is that today’s Labor politicians remain trapped in the intellectual framework of Thatcherisma philosophy they claim to reject. In her 826-page memoir, The Downing Street years, Thatcher refers to the balance of payments only once. The reason why she paid so little attention to him is obvious. It would have been impossible to implement her political program if she had been forced to pursue a balanced trade policy. The rotation of state borders required a new one consumer consumption policy fueled by cheap debt and tax cuts to keep its core vote happy enough to ignore mass unemployment and deindustrialization. Speaking about the overheating economy of the late 1980s, she let slip the mask, writing that persistent balance of payments deficits “concerned me because they confirmed that as a nation we were living beyond our means”. However, under her leadership and ever since, we have done just that.
This is not just an abstract accounting exercise. In the wake of the Iranian conflict, the IMF predicts that the UK will lead a balance of payments deficit of 3.4 per cent of GDP in 2026 – equivalent to £115 billion. This means we are sending the equivalent of nearly £4,063 per household overseas to pay for our imports, cover our debts and provide returns to overseas shareholders to stave off rampant inflation. If we had a balanced economy, this is money that could be spent on domestic investment, rebuilding our energy infrastructure or investing in new industries. This would give the government much more room to support families and help protect the most vulnerable.
The real rollercoaster is not fossil fuels, but our international financial position. This has left Britain at the mercy of the big trading blocs in Washington, Beijing and Brussels. That’s why we are in bond markets. Tragically, Labor had a plan in opposition to push inward investment by £28 billion a yearquadrupling the government’s capital investment through a green investment plan. It abandoned this radical agenda and according to the OBR, government capital investment will be just 0.1 per cent of GDP higher than the end of the decade.
Business investment is down, further reducing our productive capacity. Focusing solely on green technology was a mistake. We cannot live by green technology alone. We need to increase production across the board, including fossil fuels, critical raw materials, machine tools as well as high value services. However, the principle of shifting resources from domestic consumption to investment was sound. The government must rediscover this courage and embrace a new manufacturing policy.
The alternative is to defend a status quo, a policy of consumption that is unable to live up to its own terms. Despite the promise of endless growth, most people have experienced a 20-year cost-of-living crisis. Despite the promise of financial discipline, we are addicted to borrowing. Despite the promise of wealth, we have had to sell off large parts of our economy to pay for everyday expenses. The storm clouds darken with each new global shock. Only time will tell if the lightning from this Middle East war brings economic fire — or some much-needed political enlightenment.
(Further reading: Iran’s new oceanic empire)
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