British Prime Minister Liz Truss attempted her best Margaret Thatcher imitation this week, vowing steadfast determination to stick by her Chancellor of the Exchequer’s deficit-digging tax cuts amid a financial-market meltdown that has left her country on the cusp of a debt crisis.
After remaining silent for three days while currency markets pummelled the pound and investors dumped British government bonds in the worst market sell-off in three decades, Ms. Truss finally emerged on Thursday to defend Chancellor Kwasi Kwarteng’s move to slash taxes and increase borrowing in a much-maligned Sept. 23 “mini-budget.”
“Too often, tax policy has just been seen as being about redistribution. It’s not,” the new PM told BBC Radio. “It’s also about how we grow the size of the pie so that everyone can benefit.”
She promised that the £45-billion ($68-billion) package of tax cuts announced by Mr. Kwarteng will “get our economy moving” by stimulating investment and growth. It was hard not to draw comparisons between Ms. Truss’s refusal to reverse course and Ms. Thatcher, who faced a similar political storm in 1980. The late Tory PM uttered one of her most famous lines as she scorned fellow Conservatives worried about the fallout from her free-market policies amid high unemployment.
“You turn if you want to,” she said. “The lady’s not for turning.”
If the Iron Lady went on to be vindicated, Ms. Truss may not be so lucky. Back then, Britain’s economy needed shock therapy and Ms. Thatcher was only too willing to deliver it. But the chronic “British disease” she sought to cure with supply-side tax policies and deregulation was very different from the economic problems that Ms. Truss faces today. In 1980, Britain’s economy was coming off a horrible decade of labour unrest and stagflation that had sapped investor confidence and forced it to seek a bailout from the International Monetary Fund. The country had long relied on capital controls to limit runs on the pound.
The main lesson to be taken from this week’s British market meltdown is that, after years of largely ignoring deficits, investors are once again turning their attention to fiscal sustainability of Western governments. The market’s reaction to the flood of borrowing required to fund Ms. Truss’s tax cuts and energy subsidies should serve as a warning sign for governments elsewhere. The days of easy money are over and promises to tackle deficits down the road no longer cut it.
The other lesson is that, unless you have the explicit or implicit backing of the U.S. Federal Reserve or the European Central Bank, you had better get your affairs in order. Governments without the near limitless firepower of the Fed or ECB behind them will face a harder time persuading investors to hold their bonds without a solid plan to reduce their debt and deficits. Mr. Kwarteng’s failure to provide one proved supremely damaging to his own credibility and Britain’s, too. He now promises a plan in November.
As former Bank of Canada and Bank of England governor Mark Carney told the Financial Times, amid a slowing global economy and determined efforts by central banks to wrestle inflation, “there is a limit to unfunded spending and unfunded tax cuts in this environment.”
Canadian politicians should take note. Expensive new programs such as the ones the New Democratic Party is pressing Prime Minister Justin Trudeau’s minority government to adopt – or else – would be unwise. But so, too, would be Conservative Leader Pierre Poilievre’s vow to slash taxes.
On Wednesday, the Bank of England announced it would purchase up to £65-billion ($99-billion) worth of British government bonds over the next two weeks to support the pound, which had fallen to a record low against the U.S. dollar on Monday. The central bank is also expected to dramatically increase interest rates, with market expectations of its benchmark bank rate now reaching a punishing 6 per cent by May.
The two actions – the massive bond-buying exercise and interest-rate increases – might seem contradictory. Buying debt is inflationary, since it drives up bond prices and drives down yields, while rate increases seek to quash inflation by depressing demand in the economy. It remains unclear how markets will react to such mixed signals. But such is the mess Ms. Truss and Mr. Kwarteng have created. An unprecedented situation requires an unprecedented response from the central bank.
You could hardly imagine a more inauspicious beginning to the Truss era, which could now turn out to be even shorter than those of Boris Johnson and Theresa May. In a different time, her supply-side tax cuts might have been heralded as bold and inspired. Instead, they are largely seen as reckless and ideologically driven.
The lady might even have to consider turning.
Konrad Yakabuski