Gordon Brown and his cohorts go back to their Keynesian default setting

By Liam Halligan
Last Updated: 12:33am BST 10/08/2008

I hesitate to admit this, but one of my earliest memories is a political
speech. I distinctly remember, as a pyjama-clad seven-year old, hearing
the following words. "We used to think you could spend your way out of
recession by boosting government spending. I tell you, in all candour,
that option no longer exists. And in so far as it did exist, it only
worked on each occasion since the war by injecting a bigger dose of
inflation into the economy, followed by higher unemployment as the next
step…"

OK - I didn't remember the quotation verbatim. I had to look it up. But
I do vividly recall a haggard, yet determined Jim Callaghan on News at
Ten delivering these words to the 1976 Labour party conference. I turned
around to ask my mum what the Prime Minister meant by "candour". But she
was back in the kitchen making my tea.

This is more than sentimental tosh. Callaghan's "in all candour" speech
marked a sea-change in the history of post-war economic policy-making.

Until then, "Keynesians" reigned supreme. Successive governments - in
the UK, Western Europe and the US - had used "deficit financing" and
high state spending to "pump-prime" economies. They justified these
actions using erroneous interpretations of the work of John Maynard
Keynes, the great inter-war economist. Such policies plunged the world's
most advanced economies into crisis after crisis - with the cash
propping up inefficient industries and the markets lending only at
escalating interest rates.

Prior to Callaghan's speech, the history of the Labour party, in
particular, was littered with grim episodes involving huge national
debts, soaring inflation and a plunging pound. But "in all candour" was
a turning point, marking the start of the Western world's painful, but
essential, conversion to monetarism, lower tax and independent central
banking.

Throughout the 1980s, as unemployment spiralled, and the UK endured long
overdue structural changes, clearing up after years of Keynesian
consensus, such "small government" policies weren't popular.

But eventually, certainly by the early 1990s, everyone realised - as
Callaghan was brave enough to admit - that high state spending is a
mug's game. Some diehards kept the red flag flying, but those with a
chance of gaining power had grasped deficit-financing doesn't work - and
wrecks any nation's long-term economic health. Until now…

Under severe pressure, humans revert to type. And as Messrs Brown and
Darling respond to today's economic woes, we're seeing their true
colours. The Prime Minister and the Chancellor are, basically,
Keynesians - which isn't surprising. After all, when I was in my pyjamas
staring at the man on TV, they were firebrand socialists, shouting down
Callaghan's words.

While we shouldn't be surprised, then, we should be worried. With their
backs against the wall, the Brownites are drawing on their inner beliefs
- big government and big deficits. And in today's world of fibre-optic
currency dealing and round-the-clock markets, such policies are even
more fatal than during the 70s.

Last week, the International Monetary Fund warned the UK not to try
"spending its way out of a slowdown". Back in 1976, deficit-spending
forced Labour's then Chancellor, Denis Healey, to beg for an IMF bail-
out. The Washington-based institution feels the need to intervene once
more.

And no wonder. The UK has the highest budget deficit in the G8. Other
leading nations have recently pared their borrowing, but Brown has just
let rip. In June, the Government took on another £9.2bn of debt on our
behalf - 40 per cent higher than June 2007. Labour - disgracefully - has
vastly exceeded its own borrowing forecasts every year for the last
eight years.

The IMF wants "concrete and front-loaded plans to bring debt back below
the ceiling". Ministers claim the 40 per cent of GDP threshold remains.
But they exclude "temporary" Northern Rock liabilities, much of the
Private Finance Initiative and a host of other items Brown has swept off
the nation's balance sheet.

The markets and ratings agencies aren't fooled. That's why the IMF
worries about Britain losing its fiscal credibility - weakening
sterling, provoking more inflation and pushing interest rates above
where they would otherwise be.

Inflation is now high and rising - particularly producer inflation.
Unemployment is creeping up. But the UK is still a long way from
recession. Yet, faced with the reality of losing an election, and devoid
of judgment and steel, Brown and Darling have reached for the
intellectual comfort-blanket of their youth. The UK is now running a
Keynesian economic policy.

Problem over the 10p tax rate? Let's borrow another £2.4bn. Trouble with
the fiscal rules? Wait for Parliamentary recess, then leak we're going
to break them. Northern Rock still a mess? Here's £3bn more. Slump in
the polls? In need of a headline? Let's just borrow, borrow, borrow - as
we won't be around to deal with the mess.

"Yes I have allowed borrowing to increase," said the Chancellor last
week, "because that's the right thing to do to support the economy." Do
these guys know nothing about economics - or the history of their own
party? Borrowing on this scale is insane.

"There are times," said Jim Callaghan after he left office, "perhaps
once every 30 years, when there is a sea-change in politics, a shift in
what the public wants and approves of."

That shift is now happening. The public - the vast majority, anyway -
wants lower taxes, less public sector waste and, whisper it, lower
government spending. Brown simply doesn't get that. We can only hope his
successor does.

Oil price won’t tank in our lifetime

Are commodity prices capitulating? Since its mid-summer $147 high, oil
has dropped over 20 per cent – falling below $120 last week for the
first time since May. Last Friday alone, crude lost almost $5 a barrel –
a development buried under coverage of the Olympics and South Ossetia.
Is this the great reversal? That’s what many hope.
# Have we reached the end of the road for oil?

If crude prices kept heading south, stockbrokers, central bankers and a
fair few Western politicians would breathe a mighty sigh of relief.
Remove sky-high oil and inflation may abate, interest rates could fall
and the global economic gloom might lift.

The recent crude drop is driven by the idea that the Western economic
slowdown – particularly in the US – will lower global oil demand.

Last week, crude futures dipped on the news that real US consumption
fell 0.2 per cent in June – as rising inflation swamped George Bush’s
misguided $100bn tax rebate.

There have also been signs of higher oil supplies from Opec – with Saudi
Arabia now saying it will boost production to a 25-year high. And Lehman
Brothers added to the mood of determined hope last week by “calling the
top of the oil market”.

I’m afraid this is wishful thinking. As this column has argued for a
long time now, the “fundamentals” – supply and demand – suggest oil will
remain uncomfortably high for years to come. The main reason crude
prices have increased sixfold since 2002 is that unstoppable force –
“globalisation”.

As the likes of India, China and the other “emerging markets” continue
getting richer, their rapid population growth and escalating fuel use
per head, means global oil demand will keep soaring.

This is a structural change – an ongoing development that utterly
overwhelms any cyclical downswing in oil demand from a slowing Western
world. And that’s if you believe Western oil demand will fall
substantially as a result of current economic woes. I don’t.

That’s certainly the lesson from the last US recession back in 2001. The
ongoing growth of oil demand points to $100+ oil forever in my view –
or, at least until there is a major technological change.

Remember that 70 per cent of all crude use is transport. And the number
of cars on the world’s roads – currently 625m – is set to double in the
next 20 years. Given that, nuclear or renewables won’t save the day –
unless you believe in atomic or wind-driven cars.

Until the power of the oil lobby abates, and the automotive industry
starts making LPG and/or electric cars on a major scale, crude demand
will keep cranking up. The supply side doesn’t look much better either.
Despite the incentive of higher prices, world oil output is likely to
remain flat at best.

That’s the message from an authoritative new Chatham House report –
which concludes that within “five to 10 years” prices could easily reach
$200 a barrel amid a global “supply crunch”.

Liam Halligan is chief economist at Prosperity Capital Management