Hi All,
The hysterical reaction to the ‘mini budget’ from
centralists across the globe is quite astounding, not least because the
opposition Labour party and the left generally are milking this for all it is
worth, except that Labour have actually stated they are only going to reverse
the cut to the high rate of taxation (for those earning £250,000) and the cap
on banker’s bonuses. Both of these items are actually smaller than the cut in
Corporate tax and the National Insurance cut or the decision in invest in
future infrastructure projects. A final point to note is that while our debt to
GDP ratio is now 100%, this is smaller than France, Japan, USA or Italy, with
Germany coming in at under 100% of the
big economies.
One cannot help but think that the issue with this £45
billion package – again a small drop in the ocean of £2.4 trillion of debt- is
the politics. Is it ‘fair’ to allow bankers to have unlimited bonuses ? Is it
fair for those same bankers to pay 40% or 45% taxes? That is the politics. But to
those who aren’t centre left in their view, aka most of the markets there is
something more fundamental. Markets are not sentimental toward any kind of
ideology. The only think that matters to ‘markets’ is making money and as much
of it as possible. So why then the rout in the bond market, the pound and the
uneasiness in the place where you would expect it to be praised?
I think the whole thing is a fig leaf for something else, in
fact it was announced 2 weeks ago: the government plans for the ‘energy crisis’.
Rather than do a Germany and tell businesses to conserve, by closing doors and
not putting on lights during the night when offices are empty, the UK has decided
to cap domestic bills at the current rate, rather than them having doubled.
The outcry on this policy has been less because there is consensus
that some kind of subsidy had to be made, but when you look at it, this policy
is going to cost more than last week’s mini budget, some say £100 billion, but
it could be way more. Again this is politics at its most crude form: no
government wants the sight of a poor pensioner on their own huddling and dying
in his or her home for lack of affordable heating. Or the photogenic mother of
three, who has to decide between heating and eating. The problem lies not in trying
to help such people, but the way this policy has been undertaken. Most people
would agree a poor pensioner shouldn’t freeze to death, but on the other hand
there are a lot of wealthy pensioners who are fit, able and go on many luxury holidays
abroad and could afford to pay for their bills, albeit they’d have to cut back
on the multiple holidays or something somewhere that wasn’t as important. But
the Truss plan is going to benefit and help that wealthy pensioner as much as
the poor one in the council house.
What commentators aren’t really saying is that Truss has
turned the UK Treasury into a giant
hedge fund and a risky, highly leveraged one at that. In effect the Treasury has gone
short on the cost of fuel, in the hope that it will come down and as we all
know a short position comes with potentially unlimited liability and this is
going to be played out over 2 years. But what could happen is the rest of the energy
dependant world simply outbids the UK or in so doing drives the prices further?
What happens if Russia covertly destroys a gas platform somewhere in the world?
In effect the cost could sky rocket and so will government debt, for the
government is going to pay for this subsidy by borrowing on its own account and
giving it to private companies -who will be making money whatever happens- rather
than using its clout and bulk buying
power directly, which would have a greater market impact than dozens of firms
trying to compete for a slice of the pie.
So aside from the risks of the package costing even more
than £100 billion and that this all has to be borrowed, there is a third, even
greater risk. The price of commodities in the world markets are all in US
dollars. Thus Britain has to convert pounds into dollars to buy gas etc. Thus in the Truss plan there is a huge exchange
rate risk : the more the Pound devalues against the dollar, the more expensive
it will be to buy and the greater the cost to the government and the greater the amount of borrowing.
With these 3 things in mind and with the plan already in
operation, you can see why markets would be sensitive to any form of tax cuts,
that require borrowing to do so, especially with inflation well above the
target of 2% . In fact the energy policy
would only make sense if it were a part of a much larger scheme, if it were a
rear guard action whilst the UK spent 2 years implementing an energy strategy
that would make her totally energy self-sufficient, if that were nuclear, green or fracking or a
mixture of both, if there were a clear strategy in place then it would be a
balm to markets.
Of course if the package had been more focused, then prices
might have fallen in any event. For when people and businesses are faced with
big energy bills, there is a rush to conserve and to ration in order to try and
not pay as much as the forecasts say. A market takes a purchaser and a vendor,
so if there are fewer sales, eventually the price of the goods in question will
go down as a matter of economic law. By giving a blanket subsidy there is no
incentive to only have the lights on in the room you are sitting in or to only
put the heat on after jumpers fail or whatever.
There are two final pieces to this jigsaw : that of Fiscal
and Monetary policy.
Fiscal policy is simply to do with taxation and spending,
which is the preview of democratic politics and politicians. For the past 12 years
fiscal policy has swung from mild austerity to full blown Keynesian spending.
In 2010 the newly formed coalition government was determined to bring down the deficit
inherited from the bank bailouts of 2008 and the subsequent recession.
Note that the deficit
is the difference between income and expenditure of the government accounts.
There’s always been a deficit ever since
the whole structure was created by the incorporation of the bank of England in
1694 but the only times in British history where the budget balanced- due to
the fact governments had to live within their means, as the Pound was
convertible to gold at £4.30 an ounce, was the post Napoleonic period to 1914 and
even then the government borrowed during periods of war , such as Crimea and the
Boer Wars. The national debt is the
overall accumulation and outstanding total debt to which interest is paid upon
and again even up the first world war the national debt was £866 million,
roughly 30% of GDP, but this was a decrease from 100 years before that when the
national debt was over £1 billion (!).
In any event the Coalition and then the Conservatives up to
2016 and Brexit did reduce the deficit year on year, but the overall national
debt still went up. In 2016 we had Brexit and the government began to release
the taps on spending by a relatively tiny amount, until Boris Johnson came into
power and was determined to spend money on his infrastructure projects, which
became derailed by the next 2 years of Covid. Whereas in 2010 people were worried
about £100 billion plus deficits, Covid brought about massive deficits. In one
year the Treasury was forced to borrow £300 billion. Whilst the next year
brough this down to £144 billion in borrowing, we are for this year alone
borrowing so far £75 billion. The total
national debt has surged to £2,400 billion or £2.4 trillion.
Thanks to the war in Ukraine we now are facing even more
demands on borrowing (see above). As we borrow more every year then more interest
is payable every year, thus increasing the deficit every year, even if government
spending stood still.
The problem that politicians are facing is that just as they
need to tackle the large deficits that are being racked up every year, monetary
policy is being tightened.
Monetary policy is about controlling the overall aggregate amount
of money in the economy and just as important the cost of that money, which is
basically what interest rates are. In Britain the Bank of England is tasked
with controlling the money supply and therefore inflation. Thus this crucial element of the economy is not
the purview of the democratically elected politician, but the Mandarin civil servant
come bureaucrat type. The Bank of England was in fact created as a privately
owned bank in 1694, but with a national function, that is to fund and then manage the government’s borrowing
needs to fight France. Regulation and other stuff came later and it was still a
privately owned business up until Labour nationalised it in 1948. Gordon Brown,
also a Labour politician gave the bank ‘independence’ in the late 1990s, but
crucially took from it the power to regulate the banking and insurance system
and replaced it with a ridiculous system. In the good old days a wayward risky
bank, would be invited to London and the Governor, wherein the CEO would get a
telling off, mostly by the raising of eyebrows and such was the authority of
the Bank , it worked. An informal gentleman’s system – typically British – that worked well.
It does so by increasing or decreasing the cost of money in
the overall economy. If the cost is high, then the overall amount of money goes
down, if it is low, then the overall amount of money increases. The Bank sets its own interest rates and
these set the base rates for the rest of the economy as it is the Bank of England
whom is the ‘first creator’ of the monetary base. Whilst the governments over
the past 12 years have been conducting fiscal restraint, until Covid, the Bank
of England had slashed interest rates to near zero and engaged in vast monetary
loosening, via the e-printing called Quantitative easing, in this case the Bank
bought government debt and has so far acquired about a third of it .
What is happening right now is the reverse. The Bank is not
only raising interest rates , but also is no longer buying up government gilts
(as UK bonds are called) and is going to start selling off its portfolio by £83
billion a month. This has created a very illiquid market , as there is too many
sellers and not enough buyers. Not only is the government now trying to sell a
much greater degree of debt, but the debt markets are also having to absorb the
debt owned by the Bank of England. Again this is what is causing UK gilt years
to go upwards (yields are the difference between the nominal value of the bond
and the current market price for it, as government debt is traded just like a stock
or any other security) .
Whist the government does need to have a credible plan to
deal with the overall debt Britain has, the Bank of England could and should
hold off from selling its share of the government debt. In fact what it could
do is simply keep hold of it and wind it down over time, even if that is ten
years. This would actually help the taxpayer as the Bank is owned by the government
, for year now the interest – which in the Bank’s balance sheet is profit and
to the government a dividend on their shareholdings - on that debt has gone
from the Treasury to the Bank and back to the Treasury .Likewise when the debt
the Bank owns is wound down it will go Treasury Bank Treasury. Well could all
be a winner from that.
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