Welcome to Trade Secrets. I know. I KNOW. I promised you and myself that despite moving to London in the summer I wouldn’t get pulled into writing regularly about the UK. But come on, it’s compulsive stuff for international economy watchers. Even my newsletter comrades at the excellent Unhedged, who tend to eschew commentary on subjects not American (as opposed to un-American, that’s a different thing) succumbed on Friday. I’m taking an international perspective at the UK’s excuse for its currency fall (now reversed) and bond meltdown (very much not reversed), ie that it’s a local manifestation of a global problem. Charted waters is about sterling’s historic week.
The Truss fund that’s running out of capital
Something to celebrate for Liz Truss: as of today, October 3, she’s survived 27 days in office. That’s three times longer than the nine days clocked up in 1553 by Lady Jane Grey, England’s shortest-reigning monarch, though still short of the record brevity of 118 days as prime minister, managed by George Canning in 1827 (Canning at least had a good excuse, dying suddenly while in office).
From aspirant international exemplar for reform-led growth to global cautionary tale in a month is quite the narrative arc. Truss’s government has tried to blame the international situation for its troubles, an excuse used before by prime minister Gordon Brown (two years, 318 days), who kept intoning that the banking meltdown in 2008 “started in America”. So a week after the “mini” Budget and its unfunded tax cuts, let’s stand back, look at the international situation and ask: is this excuse reasonable? Are all advanced economies in trouble with currencies and sovereign debt, with the UK just the first to go?
Rising US interest rates and the energy shock on top of pandemic-related spending has certainly made it tricky for everyone. The European Systemic Risk Board, tasked with macroprudential fretting about financial stability in the EU, recently issued a generalised warning about heightened risk. As Adam Tooze summarises here, there’s plenty of justified concern about bond markets globally.
But while the UK had a difficult hand like everyone else, handing out unfunded tax cuts and promising more to come was ham-fisted ideological incompetence. Even chancellor Kwasi Kwarteng’s announcement on Monday that he was reversing the decision to scrap the top rate of tax following Conservative MPs’ protests will not, I think, restore investors’ confidence in Truss’s administration enough. The size even of the remaining tax cut package in creating a sense of fiscal irresponsibility will remain.
The simultaneous falls in sterling and government bond prices last week had people calling the UK an emerging market. But the UK’s structural advantages both render the comparison a bit silly and underline how astonishing and unnecessary the crash was. Contrary to popular belief that it’s no longer a reserve currency (for what being a “reserve currency” is worth, which is debatable), IMF data show that sterling makes up almost 5 per cent of global foreign exchange reserves. That’s a higher percentage than the Swiss, Australian and Canadian currencies put together, way bigger than the Chinese renminbi, barely below the yen’s allocation and certainly above the UK’s share of current-value world GDP at around 3 per cent (the euro’s equivalent numbers were 15 per cent and almost 19 per cent). The UK borrows in sterling: depreciation does not increase the debt burden. It has never defaulted on its sovereign debt. The markets have traditionally cut it a lot of slack.
Following the global financial crisis, David Cameron’s government (which seemed pretty bad to me at the time but was a crack squad of Platonic philosopher-kings compared with this lot) made the opposite mistake to Truss’s, embarking on a totally unnecessary fiscal tightening, claiming that the UK was heading into debt trouble thanks to increased borrowing to cope with the banking problems in the GFC. The fact that it missed those fiscal targets and yet markets were completely unfazed, as with every advanced economy which borrowed in and controlled its own currency (hence not Greece), indicates this alarmism was totally misplaced.
Truss used up that slack — probably reduced from the loss of credibility from the mishandling of Brexit, but surely still substantial — and went far further. The UK’s boneheaded actions created international bond market contagion last week, which would not have happened without underlying problems. But a simple look at bond spreads against not just US Treasuries but German and French debt, charted by Worldgovernmentbonds.com, confirms that it’s the UK that has the serious issue.
Over the past two weeks France, Ireland and the Netherlands delivered budgets. France’s, in particular, contained significant new spending relating to the energy shock. None caused a market meltdown. And as far as policy contagion goes, let’s face it, if any other advanced economies were thinking of announcing unfunded tax cuts, they certainly aren’t now.
The UK has a high but not crippling debt-to-GDP ratio — it’s comfortably lower than in France. What the past few decades suggest are that markets are somewhat forgiving of one-off increments to debt, be that to pay for the GFC bank bailouts, income support during the coronavirus pandemic or cushioning the cost of the energy shock to households and businesses. What freaks them out is the sense that the government does not have a credible path towards fiscal stability nor the political consensus to establish one. This was the same reason the UK, again alone of the advanced economies, had to borrow from the IMF in 1976.
The excuse about international trends is feeble. The UK in some ways has some advantages over other advanced economies, and certainly over emerging markets, and it’s still managed to make a hash of a mini-Budget. A happy 27-day anniversary to Liz Truss. If she survives three days into the new year, by my reckoning, she’ll manage to limp past Canning’s 118-day record. Ladies and gentlemen, place your bets, please.
As well as this newsletter, I write a Trade Secrets column for FT.com every Wednesday. Click here to read the latest, and visit ft.com/trade-secrets to see all my columns and previous newsletters too.
Charted waters
It was a historic week for the British pound, and what could be the start of a spiralling crisis of credibility for the Truss administration.
Kwarteng’s announcement of a debt-funded £45bn package of tax cuts sent sterling to a record low of $1.035 against the US currency last Monday — the lowest since the decimalisation of the pound in 1971 — before recovering slightly on Friday. That was lower than when it fell to a 31-year low after the 2016 Brexit vote, as the chart below shows.
What spooked markets the most was not just the new borrowing proposal, but the cavalier way in which Kwarteng and Truss have sidelined big institutions designed to protect the economy, such as the Bank of England and the Office for Budget Responsibility.
All of this, critics say, adds up to evidence that the government has bungled its big economic moment, my colleague George Parker explains. (Jennifer Creery)
Trade links
The World Trade Organization’s annual public forum, somewhere between an academic conference and a business convention for the trade policy world, took place last week in Geneva. The full programme, with video and audio for a lot of the sessions, is here.
Investors have withdrawn a record $70bn from emerging markets this year, further evidence of the pressure being put on indebted countries from higher US rates and the strong dollar.
A rare apparent example of international co-operation on critical goods supply chains spotted in the wild as Japan promised to subsidise the US chip manufacturer Micron to invest in its plant in Hiroshima.
Brazil has been voting for a new president, with implications for South America’s attitude to trade and trade agreements. If the leftwing challenger Luiz Inácio Lula da Silva wins as expected, the EU should be more willing to finalise its draft trade deal with Mercosur but Lula might want changes to the intellectual property and government procurement provisions.
