On Wednesday, Hurricane Ian bore down on Florida’s Gulf Coast, closing schools and airports, prompting evacuations and adding to the problems of the hardworking people of the Sunshine State.
At the same time, a different kind of hurricane was engulfing Britain, this one with a cone of impact that stretched all around the world. And entirely of human creation.
Precisely why the inexperienced new British prime minister, Liz Truss, and her inexperienced chancellor, Kwasi Kwarteng, have suddenly caused such a mess takes some explanation. On the face of it, all they did was take out a pair of jumper cables hoping to shock the economy into growth. Among other things, this meant cutting the top rate of personal taxation.
This is hardly a new playbook. It has much in common with so-called Reaganomics and the monetarist philosophies long associated with Milton Friedman and the University of Chicago. Indeed, this page has argued for generations that citizens can be better trusted to spend their own money than governments. And markets tend to share that view.
But the issue here is not so simple. One problem is that the economy is operating with what economists call supply-side constraints, a fancy way of saying there is not enough stuff to meet demand. That’s an inflationary hangover from COVID-19 and its infamous bottlenecks, not to mention the energy-related stresses caused by Russian leader Vladimir Putin’s war in Ukraine. The second, simply put, is that this new and incautious government is doing what no other wealthy nation is currently doing. It has stuck out its neck. Demonstrably, much too far.
That neck is being chopped off not by the new King Charles III, but by the equivalent of the Federal Reserve, the Bank of England. And by the International Monetary Fund, which, in a rare direct intervention, pointed out that such a demand-stoking, and apparently unfunded, tax cut was not recommended. To say the least.
And then, of course, there is the matter of the pound, which has been pounded by all the above, approaching parity with the dollar on Wednesday. That’s great for Americans vacationing in London, now very much on sale, but lousy for British businesses that buy their raw materials priced in dollars, as most of them do. And it hurts U.S. businesses, such as Apple or the Chicago-based United Airlines, with substantial revenue originating abroad.
All of this is causing U.K. interest rates to rise rapidly. So what, Americans might say, the same thing is happening here.
But the crucial difference is that most Americans have 30-year-fixed mortgages. The rise in interest rates does not immediately cause most people’s payment to rise. What the increases do in the short term is disincentivize people to sell their homes, which holds inventory and prevents a price collapse. Most Brits, though, have floating, adjustable mortgages, meaning that the new rates kick in fast, and just as European energy prices are going through the roof, too.
That’s not a good mix; on the contrary, it’s a world of hurt.
Then there’s the pension problem. Most pension schemes in the U.K. invest heavily in government bonds. Those were socked in the teeth by the Truss announcement, raising the specter of imminent pensions default.
All of this is causing further contagion in the U.S. stock market, offering as it does further evidence of global instability and diminishing the likelihood of vanquishing inflation, which is a global problem.
What lessons can the U.S. glean from this British mess?
No. 1 is that the age of deficit spending with relative impunity, a favorite of both the Trump and Biden administrations, is over. Governments will have to live within their means for the foreseeable future unless they want to be kicked in the teeth by market forces.
No. 2 is that there is an underappreciated downside to the Fed’s aggressive interest rate hikes, which is causing huge strength in the dollar but agony for the currencies of several other nations. In the end, this stoking of massive instability, this precipitous need for nations around the world to intervene to defend their currencies, is not good for anyone.
No. 3 is yet another reminder of the interconnectivity of the global economy and the perils of going against the flow, especially at a time with so many complex crises that precious few of us can keep track of it all.
Finally, it’s a reminder of just how badly the Biden administration and its enablers missed the boat on attacking inflation when it was still more easily tackled.
The current Fed panic, born of necessity, not only is shrinking balances in 401(k)s and delaying retirements but increasing instability throughout the world.
In short, the situation is not looking good most anywhere. As in all these macroeconomic crises, bargain hunters are looking for a bottom. But that’s hard to find right now.
Back in the U.K., Truss faces a horrific set of choices. She could stay the course for growth and risk things getting much worse: potentially, house prices crashing, small businesses going bust, retirees losing promised pensions. Or she could reverse the unfunded tax cut that turned global investors apoplectic and take it on the chin. Frankly, that’s her best, if most humiliating, option.
Truss swung for the fences, all right, but the markets have told her that she missed. They’ve also pointed out to anyone paying attention that we are not currently living in a stable world. If she persists, this might be one of the shortest, and most damaging, prime ministerships on record. The honeymoon ended, and the hurricane started, right after she shook hands with the late queen.
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