Britain can’t thwart the markets – POLITICO

Jamie Dettmer is Opinion Writer at POLITICO Europe.

Britain was the center of global attention last week as it held a jaw-dropping royal funeral, filled with the military pomp of yesteryear. “Queen’s farewell makes Britain proud again, just for a day,” was the headline of a column by John Crace in The Guardian.

“Thoughts that we were a nation in decline, with much of its population unsure if they could afford to eat and heat in the months to come, were put on hold. We had a history worth celebrating. We and the country mattered,” he wrote.

This week, Britain is once again at the center of global attention for another jaw-dropping event – but this time it’s for all the wrong reasons.

At the funeral, not all of the Queen’s horses and all of the Queen’s men took a wrong turn, but after the announcement of Chancellor of the Exchequer Kwasi Kwarteng’s mini-budget, an apparent misstep that plunged the markets shocked into turmoil, it is now doubtful they can put Britain back together.

“It’s a great time to buy, the USD is 24% stronger than January 2020 and we can still ship worldwide,” the banner on the website of Herring, a supplier, currently reads. of premium quality English footwear, famous for its sturdy country brogues. by King Charles III.

And after the fierce economic and financial tsunami triggered by the not-so-mini budget, many UK luxury goods makers are now similarly hoping a cratered pound will boost their international sales, helping them weather the storm. . However, they also face headwinds from soaring corporate interest rates and, if they need imported goods to finish their products, higher costs.

These manufacturers aren’t the only ones wanting to take advantage of Kwarteng’s “launch for growth” budget, either. Vultures are circling on Wall Street and among global private equity firms. They see the fall in the value of the pound – prompted by the Chancellor’s tax windfall – as a golden opportunity to grab prized UK businesses on the cheap, engulfed by falling consumer confidence and a spiraling cost of debt, just like they did during the pandemic.

By announcing the biggest tax cuts in half a century – mainly for the wealthy – which will require an unprecedented additional public borrowing of £411billion over the next five years, the new Chancellor has essentially pushed Britain Britain in a crisis rivaling the collapse caused by the Financial Crash of 2008, when the government had to bail out too-big-to-fail banks.

The financial crash, however, has been global and its guilt widespread, while Britain’s latest crisis is a self-inflicted wound by two people – Kwarteng and Prime Minister Liz Truss, economic libertarian ideologues who laid out their vision years ago. in the book “Britannia Unchained”, published in 2012. Here they argued that the only way to stimulate economic growth is to transform Britain into a low-tax, deregulated economy capable of attracting foreign investment, to reward go-getters and spur entrepreneurs. .

And although Truss has made little secret of what she plans to do during the long Tory leadership race to replace Boris Johnson, the growth race budget has surprised many. Presumably they thought that once in power, Truss and Kwarteng should take a more orthodox approach rather than take a huge gamble with public finances – the biggest a British government has taken since World War II, some say. .

Kwarteng’s mini-budget triggered not only a fall in the pound, but also a massive sale of British government gilts, described by the normally laid-back Mohamed El-Erian, adviser to Allianz and Gramercy and president of Queens’ College of Cambridge, as “the eye – burst.

The Chancellor has since played down any concerns about a sterling crisis or the sale of government securities, or the fact that lenders are even more skeptical of Britain than of the UK. Greece or Italy. “Market jitters” was how government spokesmen characterized the negative reaction to the cuts, which were announced against a backdrop of high inflation and low productivity.

But the reaction is much more than market jitters. Truss and his Chancellor have lost market confidence, which is hard to regain.

This was underscored this week, when markets ignored coordinated and supposedly reassuring statements from the UK Treasury and the Bank of England (BoE). The Treasury has said Kwarteng will outline its fiscal rules and how it intends to pay Britain’s mountain of debt next month, but markets are in no mood to wait. Meanwhile, the damage to Britain’s economy mounts and Tory lawmakers are asking the beleaguered Chancellor to present his plans much sooner.

Additionally, while any immediate emergency interest rate hike has been ruled out, BoE Governor Andrew Bailey said he “will not hesitate to move interest rates as much as necessary.” to curb inflation. The statement struck some forex traders as a hesitation – even a challenge – that they would like to challenge, while others simply heard an empty threat.

However, the BoE finally stepped in on Wednesday, stepping in with an “emergency financial stability operation” to avert a “significant risk to UK financial stability” by buying long-term government debt to deal with the soaring cost of borrowing. The BoE is also postponing its plans to start phasing out quantitative easing.

As such, Britain’s central bank is now caught in a push-pull dilemma: to keep the country’s financial system afloat, it must embark on another round of monetary easing, which could fuel inflation, while planning to try to slam the brakes on by raising interest rates — a move that defeats the purpose of growth.

But the inconsistency is growing and the BoE’s decision should not dampen the turmoil. The markets are speaking loudly and indicating that the strategy of cutting taxes by adding even more debt to what has already been incurred during the pandemic is simply not viable or sustainable. And Thatcherite libertarians Truss and Kwarteng should know how dangerous it is to test the patience of the markets. It was, after all, their idol, the Iron Lady, who coined the aphorism, “you can’t thwart the markets”.

She was speaking as the euro and bond markets were in turmoil on unrealistic expectations, as European economies diverged dramatically and the banking systems of Greece, Ireland, Portugal and Italy Spain were only brought to their knees thanks to the support promised by the International Monetary Bank. Fund (IMF).

So while public debt markets shun the prospect of relentless flows of government bonds for an economy hit by double-digit inflation and facing a huge structural balance of payments deficit, Britain is now also destined to turn to the IMF? The IMF is already unimpressed with Kwarteng’s mini-budget, issuing a highly unusual warning demanding a reversal of announced tax cuts and arguing that the measures will deepen the cost of living crisis.

History is also instructive on this point, as Kwarteng is not the first British Chancellor to rashly embark on growth with his feet firmly planted on the accelerator pedal.

In 1972, Anthony Barber also decided that the only way to get the UK economy out of its rut ​​of stagflation, high unemployment and stagnant production was to aim for growth by cutting taxes on income and purchases.

Like Kwarteng, Barber also argued that taxation “too often dumbs down businesses” and promised 10% economic growth over two years. His tax cuts – again financed by public borrowing – together with the liberalization of rules governing bank loans, caused a short-lived expansion dubbed the “barber boom”, but inflation soared, reaching 24%, the balance of payments deficit worsened and the Arab oil embargo added further woes. A banking crisis has been triggered.

When Prime Minister Edward Heath appointed Barber, a former tax lawyer, Labor leader Harold Wilson joked it was the first time he realized Heath had a sense of humour. But the joke was on Britain, and the fiscal profligacy resulted in an IMF bailout.

Historical parallels are, of course, not exact – they never are. Nonetheless, the implications of Barber’s momentum for growth are a warning that the government would do well to heed.

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