Truss and Kwarteng gambling on Reaganomics minus the mighty dollar

This is Iain Martin’s weekly newsletter, exclusively for Reaction subscribers. It is a long newsletter this weekend. A lot has happened.

Well, that went well. The emergency fiscal event unveiled by Britain’s new Chancellor Kwasi Kwarteng was received so poorly by financial market participants that the reopening of trading on Monday will be viewed with extreme nervousness by the Bank of England and His Majesty’s Treasury.

The currency took a hammering on Friday and it is likely to get worse. Against the dollar it traded below $1.09. Not all that long ago, in 2015, it was around $1.50. Are you British, paid in pounds and considering a trip to America? Don’t. Or if you do go, consider buying a tent, sleep in Central Park and avoid any purchases. Take snacks.

Why were investors – those trading currencies and buying and selling government debt – so worried by Kwarteng’s announcements on Friday?

In essence, the Chancellor and Prime Minister Liz Truss are setting out to borrow even more at a time when borrowing costs are rising globally, with interest rates going up. Planned tax rises have been cancelled, and some tax reductions brought  forward.

They are doing this while central banks, having been slow to spot the inflation danger, are moving to catch up, raising rates after a too long period of ultra-cheap money. Too much cheap money inflated asset price bubbles in property and so on, advantaging those with assets and screwing the young without assets in the process.

There are those who say the central banks now risk overdoing the rate increases. There’s a recession coming, or it may already be underway in the US, the Eurozone and the UK, and rate rises will exacerbate the situation, say sceptics.

The Bank of England is trying to balance these risks and it is not easy. There was criticism of the BoE, from me included, for it not going for a 0.75% rate increase on Thursday. They opted for 0.5%. It may be that some members of the Monetary Policy Committee anticipated the extent of the negative market response and had in mind the idea the extra 0.25% would be wasted, swallowed up by Friday tea time in the panic. Needing powder kept dry to defend the currency – raising rates boosts the currency’s value – they will likely have to make a big move next of 1%, or more in stages, to restore institutional credibility and show market participants they are serious.

Th falling pound matters for all sorts of reasons, not least what it does to the cost of imports. It pushes up the price of imports, goods we import. That feeds through to higher prices paid by us all. Britain has a yawning current account deficit. That’s the gap between what we import and export. A cheaper pound should help British exporters. Their goods and services become cheaper abroad and more attractive to foreigners. But we’ll see. As it is the British have got addicted to sucking in and consuming imports, while depending on the kindness of foreigners to fund our national lifestyle.

As Valentina Romei, of the FT, put it this week: “With such a gap between the country’s consumption and its production, the pound can only maintain its value if foreigners want to lend to Britain or buy up assets such as land, housing or companies across the country.” If, she said, confidence drops, capital inflows will fall. “The price of UK assets is also likely to tumble as foreign investors head for the exit”, said Neil Shearing, group chief economist at Capital Economics.

The other problem is that the required rate increases by the Bank, making borrowing more expensive and slowing consumer and business activity, pull in the opposite direction from what Truss and Kwarteng are trying to do. The government wants to stimulate economic activity, because if ministers are right, and the recession turns out to be shallow, the resulting growth will magic away many problems in the public finances. That’s the theory.  

In the middle are those investors, who have to be persuaded it is in their interests to carry on buying UK government debt, to fund the bigger deficit. Confidence and hard-hearted calculation is all. They’re not a charity, to put it mildly.

The tax cuts and extra spending are to be funded by an extra, an extra, £63bn of gilt (debt) issuance this year. The UK government will borrow around £230bn in 2022-23, although it may turn out lower if the final cost of the energy bailout to reduce bills is lower than expected.

So far, the UK government is getting away its debt, many billions of it a month. The process is oversubscribed, meaning there are more buyers than debt. If that changes, if there’s a run on Britain, a sudden deterioration in confidence, some buyers conceivably go on strike. The BoE would have to hike rates even faster to defend the currency and attract investors, with obvious negative consequences for the domestic economy. This is not a good trap to be caught in.

Truss and Kwarteng are attempting to blast their way through this naysaying. They hope the tax cuts and assorted supply reforms, aimed at making doing business easier, send the signal Britain is open for business, a lower tax, market economy compared to, say, Germany, heading for a fall in GDP of more than 3% this year according to Deutsche Bank.

The Chancellor’s team will have expected some market unease. That’s why they trailed so much of their plan in advance, assuming investors would get used to the idea. Can it work? If gas prices continue to fall, and inflation has peaked, perhaps.

While I like lower taxes and enterprise, my concern is about the political economy dimension and the backdrop.

The government is doing this during a European war. That war is likely to get worse, even dirtier, with Putin mobilising at least 300,000 more Russians, and maybe up to one million men. This is an era of energy wars and privation. It may be that in a few months, the UK government has to come back, like other European governments, and say the emphasis is on securing basic supplies and getting through.

The older I get the more convinced I become that it is unhelpful to see the interplay between governments, leaders, markets and history in cartoonish ideological terms, as a simple struggle between free markets and statism, confusing rhetoric with reality, when history shows it is usually way more complex than that.

Take energy, the cause of current discontents. It is a great power bloc activity, hence its role in the major wars of the 20th century, and in the Russian invasion of Ukraine and energy blackmail of Europe today. It is a delusion to think of energy as a free market. Yes, it has free market components, but it is a creature of government licensing, state regulation, infrastructure, taxation and subsidies. An organised cartel – OPEC – part controls the oil price and can adjust production to set the price. The US political decision to go for shale gas transformed the energy situation. And thank goodness, because US exports of it have filled up the shortage stockpiles in Europe to get the democracies through this winter.

Markets are simply being logical in backing the dollar, crushing the pound and the euro, because investors can see the US for all its problems remains the world’s engine room, with energy security and the realistic prospect its economy will be a third bigger in ten years time.

Money too is a central bank, state-licensed activity. Anyone thinking those institutions in a war era are going to cede control of the system to some deregulated blockchain dude with a sideline in magic mushrooms is tripping. Central bank power is nation state power and great power bloc clout.

The downside is the central bank class has made a mess, by trying to put off pain it kept money so cheap for so long they decoupled it from its basic capitalist function, that savings, earning a return for the saver, flow into funding business expansion and innovation that is tested by the market.  

As a mentor of mine likes to put it: “Everything is connected.”

This was understood by the best of those involved in the great struggles of the 1980s. Read the memoirs and interviews, featuring US Federal Reserve chairman Paul Volcker, or Margaret Thatcher, or Chancellor Nigel Lawson, and what comes through strongly is the realism, the statecraft, the amount of attention they paid to the brute realities of currency fights and the sophisticated, clear way they talked robustly to their counterparts.

The website Politico made the claim this week that Thatcher and Reagan were in lockstep in the 1980s. That is nonsense. The two friends shared a principled view that the state had grown too big and private enterprise needed to be boosted, correctly. But there were numerous spats about the currency, and the way the Americans let the dollar be too strong for their own convenience. The dollar in that decade made it tough for European policymakers to plan in an orderly fashion, one of the reasons the ERM (the Exchange Rate Mechanism, constraining European currencies within a band) was invented by the Europeans, and Lawson, who later voted for Brexit, pushed for Britain to join. To create some stability, was the theory. It didn’t work. The markets pushed Britain out in September 1992.

Trussonomics has been described, wrongly, as Thatcherite, because Thatcher is Liz Truss’s hero. What’s being attempted here today by the new administration is Reaganism, hoping tax cuts and supply side reforms will spur growth.

But Reagan always had the mighty dollar. He could do – within reason – what he liked because the dollar would always take the strain, someone would always buy American debt. He could balloon the deficit, and as he joked, it was big enough to take care of itself.

Britain does not have the mighty dollar to take the strain. The new government is conducting this experiment in the middle of a currency war, in the middle of an energy crisis, going into a global recession.

I hope I’m wrong to be so concerned. We had all better hope the experiment works.

Heroic Zelensky held his nerve

Walk up through the old town in Tallinn, capital of Estonia, and you reach the Orthodox Church. Inside Alexander Nevsky Cathedral the theme is God, gold and Russian power. The contrast with the stripped back aesthetic of the non-Orthodox, Estonian churches nearby is striking.

Estonia’s independence, declared in 1918 on 24 February, and re-established in 1991 when the Soviet Union fell apart, has been hard fought. This country with a population of only 1.3m has been coveted and rolled over by rival powers for centuries, by several empires, by the Russians and by German marauders. Roughly a quarter of the population today is ethnically Russian.

I was in Estonia this week to moderate a panel on the state of the West, in the context of the war in the Ukraine, at Think Tank Central’s Defending Freedom conference.

Among the guest speakers was the Ukrainian Oleksiy Goncherneko, member of parliament for Odessa. Having served for three weeks in the territorial defence force, in the battle of Kyiv, he concluded he was more use with a selfie stick making videos explaining the war to foreign television audiences than he was with a Kalashnikov, and since then he has become a familiar voice on broadcast media across the West banging the drum, brilliantly, for Ukraine’s fight for freedom.

The bravery of Zelensky was the latest example, he pointed out, of the individual in history making a difference. When the chatter was about Ukraine having to surrender in days, and Zelensky fleeing, he held his nerve. This morale-boosting early decision changed the course of the war, encouraging the armed forces, the population and Ukraine’s allies to resist.

Just think, if Zelensky had listened to the appeasers and run or surrendered in late February, Russia would have rolled in unimpeded, its armed forces intact. Where would a victorious Putin have turned his attention by now? Sweden’s Gotland, in the Baltic Sea? Finland? Poland? The Baltic states? Would it even have been possible to meet in Tallinn?

Finish off poor old James Bond

The producers of the James Bond franchise announced this week that in future films the new 007 will be getting in touch with his feelings and exploring his sensitive side.

Hasn’t the old boy suffered enough at the hands of Hollywood? The tailoring has been ruined. The suits are too tight. Worse, in recent films the Bond character has been watered down emotionally by his owners to the point of pathos. At one point mid-film during the latest Bond I thought he was going to announce he had retired to Bath to write a self-help book, or established a think tank focussed on peace and reconciliation.

I don’t understand why they want to change Bond. If the producers want a woke secret agent, invent one and let those of us who enjoy Bond as intended get on with it.

Perhaps it is about money. A shocking thought. Hollywood producers interested in money. The last Bond film, delayed by Covid, had to make $800m to recoup the outlay, it is said. MGM claims it made money. Who knows.

The audience for No Time to Die was estimated at 64% male, which is clearly a problem, in Hollywood. We cannot have a situation where more men than women are going to see a particular type of film, as it might fuel our stupid fantasies of driving fast cars and ordering martinis. Bond must change, we must change. I wonder if the producers have thought this through, though. The risk is a sensitive Bond alienates the male fanbase but fails to win over more women. So many of us British men now pretend to be fully in touch with our feelings, and never shut up about it, that it’s becoming commonplace. True Bond escapism could become what women viewers want, to get some respite from British men showing their sensitive side.

Britain is, like, literally, great

Stuck in Helsinki on Friday, thanks to a late-running, then failed, connecting flight from Estonia, I was plunged into the post-modern, globalist dystopia that is the forced airport hotel stopover. These are first world problems and readers will know the drill.

There’s the nice man at the Finnair desk handing me a 17 euro shopping voucher, because he informs me the hotel kitchen will be closed when I get there. The even nicer Finnish lady in the airport grocery store sorting it out when the Finnair voucher didn’t work with the scanner, then insisting I use the leftover 6 euros to try some Finnish chocolates. And her telling me about how beautiful Cornwall and Britain looked when she travelled there two weeks ago on an Agatha Christie excursion, taking in an English pub and mourning for the Queen. She wants to visit Scotland but says it looks very expensive. After this week’s tax cuts for English taxpayers, that won’t be handed on by the high-spending incompetent SNP government in Scotland, that situation will get worse. Then it’s the late night shuttle bus, and the airport hotel. The kitchen wasn’t closed after all but the food looked suboptimal. A nice man sold me a litre of Finnish beer and some crisps instead.

Then the 6am shuttle bus back to the airport, where I spot more of the stranded Brits who had left Tallinn. They were engaged in a classic English pursuit, drily mocking contemporary linguistic trends and youthful Britons.

“Everything these days is, like, literally, yeah,” says one. “Yes, have you noticed Mike says literally, like, all the time? Literally.”

No matter how nice the country or the people, or the Finnish shuttle bus driver who ensured we made our flight, an unforced foreign stopover always induces a longing for home and an appreciation of what we have. Perhaps the pang was even stronger this time because of the funeral on Monday. It was immaculate. Britain has problems. Still, what a remarkable place. It’ll be okay, eventually.

Take me back home, like, literally, to dear old Blighty.

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