3 minute read
UK Economy
DANIEL LACALLE is chief economist at hedge fund Tressis and author of “Freedom or Equality,” “Escape from the Central Bank Trap,” and “Life in the Financial Markets.” Daniel Lacalle
Truss Isn’t to Blame for the Turmoil
The UK should avoid the high inflation and economic stagnation of the ’70s
e live in strange times. The same people that vehemently defended massive deficit spending and money printing as the solution to the global economy now blame the turmoil of the UK bond and currency markets on a deficit-increasing budget.
I find it astonishing that not one of the so-called experts who have immediately placed the cause of the British market volatility on former Prime Minister Liz Truss’s budget has said anything about the collapse of the yen and the need for Bank of Japan intervention, which has been ongoing for two weeks. Why did so many people assume the Truss mini-budget was the cause of volatility when the euro, the yen, the Norwegian krone, and most emerging market currencies have suffered a similar or worse depreciation versus the U.S. dollar this year?
What about the bond market? This is the worst year since 1931 for bonds all over the world, and the collapse in prices of sovereign and private bonds in developed and emerging market economies is strikingly similar to that of their UK fixed-income peers.
The same economists that say deficits don’t matter and that sovereign nations can spend and print currency as they please (“expansionary policies,” they call them) now say that a UK Keynesian budget that increases spending but cuts taxes may destroy the economy. Yet they forget that Japan had to massively intervene in the yen as well without any tax cuts and keeping its misguided fiscal policy of spending and borrowing.
Truss and her former chancellor of the Exchequer, Kwasi Kwarteng, aren’t to blame for this insanity. The policy of negative real rates and massive liquidity injection by the Bank of England is. Kwarteng and Truss are only to blame for believing that the policies of spending and printing that are defended by almost all mainstream Keynesian economists should work even when the music stops.
In these past years, British and developed nations’ governments didn’t pay any attention to fiscal imbalances because money was cheap and abundant. Deficits soared, spending was uncontrolled, and the problem was hidden in the balance sheets of central banks that, like the Bank of England, purchased more than 100 percent of net issuances of government debt. After years of printing money and increasing debt to new all-time highs, persistently high inflation appeared, and now central banks need to hike rates and reduce money supply growth just when fixed-income funds are loaded with toxic debt at negative nominal and real yields. And the rate hikes mean that margin calls are more expensive and that losses are unbearable.
UK pension funds need to get rid of the liquid assets they own as margin calls rise. When margin calls kick in, many need to sell their most liquid assets, which are Gilts in the UK and government bonds elsewhere.
The irony of it all is that the defenders of monster deficits and borrowing if it comes from bloating the size of government feel vindicated. It was the evil tax cuts!
The political analysis of the mini-budget is astonishing. No one in the UK parliament sees any need to cut spending it seems, yet those expenses are consolidated and annualized, which means that any change in the economic cycle leads to larger fiscal imbalances as receipts are cyclical and, with it, more currency printing.
Every time a UK government buys the argument that higher tax rates finance higher annual and consolidated spending, they get one step farther away from being a leading global economy and one step closer to bringing the UK back to the 1970s.
Truss should have presented the budget that she believes in, not the one that she thought that consensus would buy. By presenting an “expansionary” spending budget that she probably didn’t even believe in sprinkled with a few modest tax cuts, she handed her opponents the axe to use against her, and the opportunity to attack came from a global market collapse and blaming it all on minuscule tax incentives.
The only lesson for the UK is to remember that if you follow Greece’s economic policies, you get Greek debt, unemployment, and growth. The UK government should do everything to avoid the ’70s elevated inflation and economic stagnation, not try to vigorously replicate them.
