Truss doubles down on the new British tradition of reckless debt

If it’s not a basket case already, the UK economy is on the cusp of such status: inflation at nearly 10%, a plummeting currency, soaring interest rates, government debt at 100% of GDP, and surging energy prices ahead of winter. But in an apparent bid to ensure the UK’s descent to economic chaos is guaranteed, PM Liz Truss and her chancellor Kwasi Kwarteng have embarked on an astonishing display of fiscal recklessness that has severely rattled markets.

The irony of those comparisons of Truss to Margaret Thatcher is that her fiscal policies are exactly the reverse of the Iron Lady’s — and far more reminiscent of the pre-Thatcher Tory party and the Callaghan Labour government that followed it, which had to go with a begging bowl to the International Monetary Fund (IMF) in 1976.

A return to the IMF is now being forecast by notoriously bearish economist Nouriel Roubini, amid circumstances that look a lot like Ted Heath’s “dash for growth” that ended in disaster for the British economy in the 1970s. Truss and Kwarteng have unveiled — in stages, given the death of the queen, a massive fiscal loosening including subsidies of £150 billion or more for energy users, and another £45 billion in tax cuts — the largest in 50 years, and aimed primarily at high-income earners. A planned increase in company tax back to 25% has also been ditched.

How will it be paid for? Entirely by borrowings — at a time of rapidly rising interest rates. If the move triggers a crisis in bond markets, the UK could be headed for a second IMF bailout in 45 years.

An “emerging market turning itself into a submerging market” was how former US Treasury secretary Larry Summers termed it. The British pound fell to 37-year lows against the US dollar and is now at just US$1.03, with suggestions parity may not be too far off. That’s partly because the US dollar is currently so strong — all currencies, including the euro, the Aussie dollar and the yen, are performing poorly against the greenback, even if they’re performing well against other currencies. But it also reflects market sentiment about the trajectory of the UK economy.

Under four successive prime ministers, the Tories were unable to restore the UK budget to balance, before the pandemic arrived and Boris Johnson and his chancellor Rishi Sunak turned on the fiscal taps to support the economy. Just as the UK deficit was coming back down this year, Truss and Kwarteng have now once again embraced deficit spending — not in response to a pandemic, but because the Bank of England is determined to keep lifting interest rates until inflation is crushed.

That is, the UK government is hellbent on trying to undermine its central bank’s monetary policy — guaranteeing that interest rates will rise higher for longer in order to get inflation back down.

The energy package was a political necessity; Britons face a bleak winter, despite gas prices coming off recent highs. The country is heavily dependent on gas, and has allowed major storage facilities to close, making it even more reliant on imports. That’s exacerbated the UK’s Brexit-created trade problems: its trade deficit in the second quarter of the year widened to a new record of £27.9 billion.

But the tax cuts, designed to provide big tax relief for the wealthy (who are the least likely to spend), reflect the discredited belief that tax cuts pay for themselves through higher growth. That they are entirely funded by borrowings has shaken markets.

The next UK election is due in 2024. Truss is on a clock to restore Tory fortunes — Labor under Keir Starmer has a substantial lead in all polls, and a double-digit lead in some. The fiscal recklessness could be just beginning.