Some thoughts on the “crisis” in the UK
First things first, this is unprecedented.
I am literally staggered at the hash that the Truss/Kwasi Brexit cult has made of the “special fiscal operation”.
I have worked as a professional economist for 35 years, followed U.K. politics since the early 1970s, and never seen anything like this - never imagined in my worst nightmares that I would ever see anything like this in the U.K. The U.K. looks more like an Emerging Market, or even banana republic or monarchy.
I would say the level of basic economic illiteracy we are seeing, rolled out by HMG is just extraordinary.
So the UK faces high and rising inflation, and twin deficits, a large budget deficit and a wide trade and current account deficits. In which part of any Econ 101 course does it say that when faced with that mix, that cutting taxes, and borrowing more to stimulate growth will/ can be sustainable?
It should be obvious to any economics student, not even University, not A level, but let’s set the level low, GCSE, so a 16-year old, should know that this would only add to pressures on inflation and the imbalances, and would have to force the Bank of England to hike policy rates even further. Higher policy rates would inevitably kill off any growth that Kwasi et al are trying to deliver with their tax cutting agenda.
And on what planet does Kwasi et al think that the market will buy an unfunded stimulus package, after forcing out the chief civil servant at the Treasury, and failing to produce a macro forecast from the OBR to support such a programme? This was always going to end in a negative market reaction.
Kwasi, you are a new chancellor, who has little credibility in the market. The fact that you went to Eton and wrote some dissertation at Cambridge on coinage in the U.K. in the 17th century, means nothing to the market. What have you achieved in office to warrant the confidence of the market? You have to work to get the trust of the market, not release a flimsy, unfunded, incoherent growth plan to the markets. The result was always going to be a disaster. Build confidence first, and then the market might trust your ambitious policy ideas on growth.
And this is not about the war in Ukraine, and the energy crisis. The fall in UK markets this week has nothing to do with those actions. They are the result of the total cock up in the presentation by Kwasi on the “special budget operation”. Actually by taking such rash action, by presenting such a disaster of a fiscal plan, and destabilising the markets, risking a systemic crisis in the UK, Truss/Kwasi are risking the security of the UK - they are making us economically weaker, and more vulnerable in the face of the threat from Putin.
Truss and Kwasi have taken a potentially catastrophic risk with the UK ecomomy, and our security.
And what we learned this week is that the UK has indeed faced a systemic crisis.
I was worried about the doom loop from unfunded tax cuts, to weaker sterling, to higher borrowing to higher borrowing costs to higher mortgage costs, the collapse of the housing market, to risks to banks, and then higher policy rates, rinse repeat. But incredibly what we saw this week was the near collapse of the UK pensions industry. Imagine that. A huge UK and global systemic risk. And why? Because there was no joined up thinking between the UK government, the BOE and the regulator. And what was the UK regulator doing to allow a situation where UK pension funds were put into such a position where they were forced into fire sales of Gilts which risked their very survival? Someone dropped the ball? Their hedging policies were part of the problem. Why was this not known/resolved long before this week?
I would blame a lot of the above on Brexit. I would contend that the regulator was not focused on the risks fo the pension system because they were looking the wrong way - priorities were on Brexit related issues, MFID2, ESG, rather than bread and butter financial regulation and supervision. Imagine after the GFC, how on earth was the UK left in a situation where our pension sytstem was brought to the brink of collapse? It’s just extraordinary.
Credit to the BOE for stalling its QT and moving to use QE in effect to save the Gilt and pension market. Needs must. But let’s not forget that this has made their efforts to fight inflation more difficult. They are pumping more liquidity into the system at a time when they should be doing the opposite. So the Truss/Kwasi move will not only stall growth but risks higher inflation - or at least undermining the efforts of the BOE to contain inflation.
Now the Truss/Kwasi line is that tax cuts are all about making the UK competitive, and attracting international business to the U.K. The U.K. needs to be competitive, but I am sure that the reasons that international business do not want to locate to the U.K. are nothing to do with the level of taxes or bankers bonus caps. They have more to do with the results of Brexit and the messaging about the Global Britain brand. Brexit has resulted in a collapse of trade and a huge increase in red tape and bureaucracy for businesses in the U.K. and trading with the U.K. The nationalist and racist message that underpinned Brexit also sent a message that foreigners were not welcome in the U.K. Many foreign skilled workers have left the U.K. now. That is causing labour shortages and wage price pressures, and we are going to have to pay more to attract skilled foreign labour. That will make the U.K. less competitive. Brexit is making the U.K. less competitive, not more competitive. We need to change the whole Brexit message and we need to invest in U.K. education, housing and transport to make sure some of those poor kids in the north of the U.K. have a chance of filling high paid job vacancies in the south.
Now imagine foreign business looking at the U.K. this week, what are they seeing and will that encourage investment in the U.K., or otherwise? What they are seeing is political instability, economic policy incoherence and chaos, Sterling falling, interest rates going higher, expectations of a deeper recession, and evidence of systemic risks under the surface. All this points to political instability, and a more uncertain policy outlook. No international business, in their right minds, will locate to the U.K. under these circumstances. Actually I think those here will be thinking of leaving.
Worrying here that the Truss/Kwasi team are eager to just carry on, failing to understand in my mind what is going on, and seemingly ignoring the best advice from the likes of Charlie Bean, Mo El Erian, Blanchflower, et al. Logic would suggest they should stall the tax cuts, stabilise markets, better explain the supply side reforms that they expect to spur growth. And later on, perhaps then look at priories between spending and taxation.
But going on from here, come what may, is frightening. It actually proves they are not fit for office in my view. They seem to want to keep tax cuts, but now fund these by cutting spending. The markets might initially appreciate that. But the Truss government has no mandate for spending cuts and in the middle of a cost of living crisis, the timing for such is terrible. If they go ahead with this I expect a surge in industrial action, which is already rising rapidly, and this will just disrupt the economy further, killing growth. I expect a repeat of the winter of discontent of the late 1970s, and huge systemic risks resulting.
The only way out of a U turn from Truss, or a change in government either within the Tories or thru elections. Otherwise the U.K. is heading into a deep and systemic crisis with globally systemic risks given the shear size of the U.K. financial sector.
And remember here, this comes as we face the worst security situation in Europe since WW2, and Putin is attacking our very system of government, Western Liberal Democracy versus Kleptocracy. The Truss government, thru its cavalier economic policy orientation, is risking our macro and financial stability, and our security and ability of the U.K. and the West’s ability to defend against Putin. Truss and Kwasi are national security risks to the U.K. and the West.
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Your comments in this article appear to be more political than economic.
re:unprecedented - wouldn't the crisis period in 1976 surely dwarf this episode (at least so far) in severity? it appears like a return to that (but I'm not a true Anglo-expert) so I will defer to your view on this