Criticism of the UK government’s fiscal plans continues to mount. From the opposition, but also from a growing number of backbenchers within their own Conservative Party. The depreciation of the pound and the rising interest rates on British government bonds show that the financial markets have a clear vote of no confidence have spoken.
The Bank of England (BoE) was forced to to intervene drastically in the ‘dysfunctional’ UK bond market, which ‘poses a risk to the country’s financial stability’. The central bank is going to ‘temporarily’ buy government bonds, while it wanted to slim down its portfolio of British government bonds – which had become quite fat during the pandemic.
So that’s all the result of the tax plans that the Conservative government of Prime Minister Liz Truss unveiled on Friday. “The market has passed judgment, and it’s not positive,” said Vivek Paul, investment strategist at BlackRock asset manager.
Even the International Monetary Fund, notoriously reluctant to criticize wealthy countries, does not spare the criticism. The IMF asks the British government to ‘re-evaluate’ the planned tax cut. £45 billion in tax cuts are in the pipeline, to be financed with new loans. According to the IMF, this support package is ‘untargeted’ and will increase inequality, while further fueling high inflation.
In summary, the criticism of Finance Minister Kwasi Kwarteng’s ‘kamikwasi budget’ is that the plans have been insufficiently calculated, that they ignore economic wisdom, and that they make an already bad situation worse. The British government is sailing blind, deaf and dumb.
Blind ?
Although it is the largest tax cut in 50 years, it is not formally part of a budget. The Ministry of Finance speaks of ‘a budgetary event’. Since 2011, it has been a legal obligation to have budgets subjected to a critical review by the Office for Budget Responsibility. Through its Orwellian twist, the government was able to avoid an independent analysis of the measures taken.
After much criticism, Kwarteng said that the plans of the cabinet will be clarified on November 23, and an explanation of how the state finances will remain within the predetermined limits. That means financial markets will have to wait another eight weeks to figure out what the picture really is, an eternity in a world horrified with uncertainty.
Deaf ?
Higher incomes in particular benefit from the planned tax cuts. Someone with a gross income of 50 thousand pounds will soon be left with 737 pounds more. With an income of one million pounds that is 55 thousand pounds.
In doing so, the government pays tribute to the philosophy of ‘trickle-down economics’. In short, tax cuts for corporations and the rich are good for the poor because they lead to higher spending and more wealth. And it eventually seeps through. Like if you give a horse enough oats, there will be some for the sparrows after a while on the road.
The government assumes that these measures will boost economic growth, making them pay for themselves and keeping public finances sustainable.
Deutsche Bank economist Jim Reid reacts stunned to the “unabashed revival” of the trickle-down economy, first fully endorsed by US President Ronald Reagan in the 1980s. ‘It goes against the current economic orthodoxy and the zeitgeist.’
In practice, the theory does not seem to work, according to David Hope of the London School of Economics and Julian Limberg of King’s College London. They studied the experience from eighteen countries, including the Netherlands, over a period of fifty years. Tax cuts for the super-rich created greater inequality without benefiting the rest of society, according to their research.
Lee Hardman doesn’t understand Kwarteng’s logic either. The currency expert at asset manager MUFG points out that the chance that the highest incomes will spend their tax breaks and thus boost the economy is much smaller than for the lowest incomes. Yet, according to the Resolution Foundation think tank, the poorest half of the population only 12 percent the benefits of the tax cut.
stupid
A higher government debt, therefore, without a guarantee for more economic growth. Moreover, according to economists, it certainly does not help inflation, although Kwarteng claims it does.
The additional currency depreciation exacerbates the problems for the Bank of England, which is under increasing pressure to raise key rates in order to defend the value of the pound that has plummeted. Last Thursday, the Old Lady of Threadneedle Street raised interest rates by 50 basis points to 2.25 percent.
The BoE is therefore in a difficult position. On the one hand, interest rates have to go up further to fight inflation, while at the same time as bond purchases are pushing long-term interest rates. The latter is therefore explicitly ‘temporary’. Frightening news for companies that will soon have to refinance loans, or the millions of Britons with variable mortgage rates. Rising interest rates will result in an additional loss of purchasing power, which can give the housing market a serious blow. As with the financial markets, Kwarteng is keeping them in the dark for the time being with his silence.