The United Kingdom’s disastrous September minibudget that ended up claiming the scalps of its prime minister and treasurer left the world’s sixth largest economy scrambling to reclaim its global reputation. How could a formerly great power get it so wrong, so quickly?
At least the UK political and economic trainwreck of the past two months that forced the resignation of both their prime minister and treasurer did Australia’s prime minister and treasurer a favor. It showed them, just as they were putting the final touches on their first Budget, what happens when a nation’s political leaders try to defy economic gravity.
The UK’s dance with disaster started when Kwasi Kwarteng, the new UK treasurer – known as the chancellor of the exchequer – presented a minibudget to the parliament that promised a raft of unfunded spending promises and tax cuts that would be funded by increased government debt.
Global bond market immediately labelled the minibudget reckless. Within days UK government Treasury bond yields surged from 3% to 5% before settling back to 4% and the pound, which had been in strategic decline against the USD for months, dropped like a stone to almost parity, its lowest level ever.
Surging yields from gilts – as UK Treasury bonds are known -caused a collapse in bond prices so severe that the Bank of England had to intervene in the UK bond market to restore calm, announcing they would buy government bonds. Forcing their hand was panic among UK defined benefit pension funds that the value of their bond portfolios had collapsed so savagely they may not have enough liquidity to make pension payments.
UK defined benefit pension funds hold an estimated three-quarters of their assets in fixed interest bonds, meaning that when gilts crashed in value by 30-50% they were in deep trouble. UK bond indexes that at end September were declaring average 12-month performance returns of -26%.
At least we can sure this wouldn’t happen in Australia because there are almost no privately run defined benefit pension funds and of the ones still operating they have much lower fixed interest allocations. Plus, Australia’s government leaders would never be so foolish to announce a budget that was so ineptly planned out as what the UK had just done.
UK banks meanwhile became so worried about what this might mean for the nation’s interest rates that many of them suspended loan offers to new borrowers, declaring they couldn’t price them because they no idea how high interest rates might go.
Market disbelief in the economic plan of UK prime minister Liz Truss and her treasurer just added to the simmering view that the Bank of England hadn’t been aggressive enough in fighting inflation noting that official interest rates in the UK are only 2.25% compared to 3.5% in the US.
There were concerns about massive UK sovereign risk. The International Monetary Fund issued a none-too-veiled rebuke to the UK government and large-scale US investors and former US Federal Reserve officials warned that the UK was behaving like an emerging-market economy.
These fears were tangible because the UK government budget deficit was already high at £100 billion being 3.9% of GDP just as UK gross government debt is equivalent to 100% of GDP. By way of contrast, Australia’s near trillion-dollar debt is only equivalent to 45% of our GDP. And following Australia’s October 25 Budget, this figure is already on its way down below 40%.
Then prime minister Truss and chancellor Kwarteng unsurprisingly tried to sheet much of the blame for their nation’s economic woes onto the inflation surge that followed the energy price spiral caused by the Ukraine war. But with only 2% of UK electricity generated from coal, 15% from nuclear energy, 33% from natural gas and a whopping 56% from renewables and alternatives, the real story may be that the UK decarbonized its electricity grid too rapidly and this made their economy vulnerable to geopolitical shocks.
And let’s not forget that all this has been on top of the economic cost of Brexit that some analysts are estimating has cost the UK between 3% to 5% of its GDP due to lost trade, reduced national income and foregone taxation revenues.
Against this background and the ferocious market reaction to the minibudget, the UK Chancellor of the Exchequer soon walked back plans for many of the unfunded tax cuts. But other unfunded massive spending plans, including £150 billion to pay for the energy price cap and to double UK military spending by 2030 still stood. So too did bond market skepticism that the UK government has a serious plan to get out of the fiscal mess that it created for itself.
But this wasn’t enough to stem the fallout. Within weeks, prime minister Truss had forced the resignation of her treasurer, who was a long-term friend and political ally. In his place, the new treasurer she appointed, the political moderate but experienced former health minister and foreign secretary, Jeremy Hunt, quickly began restoring economic calm as he set about undoing most of the minibudget and abandoning its tax cuts.
Prime minister Truss herself followed suit a few weeks later when she herself resigned, passing into national ignominy to become Britain’s shortest-serving prime minister ever. One week later, the former chancellor of the exchequer who had warned of economic disaster before Truss’ implemented her plan, Rishi Sunak, was appointed prime minister.
Sunak, aged just 42, is the UK’s youngest ever prime minister. He is their first prime minister to have Indian heritage, is a former hedge fund manager and the wealthiest person ever to lead Britain. Jeremy Hunt is still the treasurer. They have both just announced plans for across-the-board tax increases.
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