The newest UK Chancellor of the Exchequer Kwazi Kwarteng just unveiled a mini budget that has effectively torpedoed the Pound (GBP) to levels not seen since 1985. There seems to be a madness to the approach being taken by the current Conservative government- newly revamped under Prime Minister Liz Truss, and the new hands-on-deck seem determined to go down with all guns blazing.
Fig. 1: taking a Pounding- GBP vs the USD
Source: investing.com
The Pound was trading as high as 1.4250 as recently as June 2021. In the last 15 months then we’ve seen it lose 37 cents against the dollar- a near 26% fall, in that time. What’s truly alarming is that it was above 1.27 last Friday. This is a self-inflicted wound and there are many questions surrounding the decisions underpinning the strategy.
So, what did Mr Kwarteng do that seems so suicidal that the value of the portfolio of Odey Asset Management jumped 145% on their shorting of UK government debt and the Pound? The main step that Kwarteng took- the big policy decision that the UK government is now committing itself to: tax cuts. And not broad-based tax cuts but removing the top tier of taxation. And- just to ensure that no-one misses the point about who this is meant to benefit, he has also removed the cap on bankers’ bonuses that had been put in place by the EU in the wake of the financial crisis of 2008. That limited bankers’ bonuses to two times their annual wage and it was thought that one of the first acts under Brexit would be to remove that given the importance of the City of London’s financial square mile to the UK economy, but fear of the opprobrium that it would lead to meant that it was left on the backburner. So, it comes as a bit of a shocker that one of the first acts of the new Chancellor is to take a hit to the revenue stream of the government and simultaneously announce that bankers’ wages can climb unimpaired. To be fair to him, there is the sense that bankers were getting overcompensated in their fixed remuneration to offset the caps and that this move will allow the fixed component of their salaries to fall again.
But this announcement seems to be on par for the post-shame face of the Conservative party that started under Boris Johnson’s leadership. The list of scandals involving breaches of ethics, open favours for Tory donors, illegalities and outright lying mixed with accusations of mis-spending billions during Covid, favouring energy firms during a period of galloping energy prices, re-introducing fracking, privatising the NHS makes this but just the last in a long list of missteps by the Tory government. The optics look terrible at the very least. But politically this party has been surviving on some post-Brexit fever dream where they keep talking about ‘levelling up’ and ‘getting things done’ but in reality only deliver speeches rather than results. Kwarteng’s defiant promise of delivering more tax cuts in the future- ostensibly to help British residents to “retain more of their income because I believe it’s the British people who are going to drive this economy” sounds like an empty platitude lacking in substance. What it does signify is the doubling down on trickled-down theory which even President Biden of the United States has challenged as a long-running policy mistake.
PM Liz Truss even supported this line of policy at the recent UN meet when she received this rebuke from Biden.
There seems to be a burn all bridges approach to this government eve as they try and disown their own past economic policies. They’ve been in power since 2010 and yet half their promises seem to be based on ‘clearing up this mess’ and ‘bouncing back’. In other words, they appear clueless.
And in this appearance of cluelessness is the biggest clue as to the massive sell-off of the Pound: there is very little confidence in the UK government in being able to implement the correct strategies to help them recover from the disastrous Brexit separation from the EU. More importantly, for a party that is now heavily seen to be in the pocket of lobbyists and big money interests they seem to have lost the confidence of those very same interests. They appear to be a party that is in terminal decline (polls suggest that a snap election now would see them lose the majority by a comfortable number of seats), with shocking links to vested interests (the PM’s Chief of Staff was just outed by the papers for receiving his salary through a lobbying firm) and so it should be no surprise then that the Chancellor himself was an employee of the Odey Asset Management that made the huge killing on shorting the Pound and UK debt.
It certainly looks like the Conservative Party is the new- and possibly last, refuge of the libertarian billionaires and their social experiments in laissez-faire economic policies. Just how is critical spending in infrastructure going to be financed? They have announced energy price caps for households for the next two years and support for businesses for 6 months leading to a possible additional expenditure of GBP 180 billion. With bond yields rising this looks like yet another specific reason for investors to flee the UK. It would have been easier to nationalise the energy industries- and far cheaper.
There is an inexplicable self-destructive instinct in this UK government. Although the mandate they won under Johnson should have carried them through comfortably into 2024 there is every reason to believe that the unpopular decisions being made are going to cause many backbenchers to abandon ship. They may label these policies as a dash for growth but- as the financial papers have pointed out, the last time such a combination of huge tax cuts and steep jump in subsidies occurred- in the 1970s, the UK entered a deep recession with runaway inflation. Perhaps they truly believe in the hype they’ve created about their policies but to the outside world- and to the financial markets, this looks like a desperate kamikaze run.