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January 9, 2025 - 4:00pm
Don’t make promises you can’t keep. Worse, when it becomes apparent you can’t keep them, don’t double down on them because nobody will believe you.
Someone should have given Chancellor Rachel Reeves that advice during the election campaign last year, when she promised to repair public services, restore economic growth and balance the books. This, impressively, all without raising income taxes, national insurance or value-added tax, thereby ruling out the bulk of the country’s revenue-raising sources. Anyone doing the maths could tell it was, to say the least, optimistic. It was safe to assume that she would have to drop at least one of those pledges after the election, the most likely candidate being the commitment not to raise taxes.
But she stuck to her guns. So to meet the funding goals of her other ambitions, she delivered a budget that leaned heavily on business taxes, with a predictable impact on investment. Businesses now report they plan to meet their added expenses by cutting jobs, reducing wages and raising prices. The first two measures will slow the economy, the third will raise inflation, possibly giving us the dreaded combination of stagflation.
The international backdrop is further complicating her task. With the world awash in debt since the pandemic, investors are demanding a higher return for the money they lend to governments, driving up interest rates on long-term instruments. The main driver of this trend is the US, whose huge deficit shows no sign of abating. As investors drive down prices on US bonds, which raises their yield — effectively, their interest rate — the effect spreads globally. Since the dollar is the global reserve currency, everyone is willing to park their money in US Treasury paper, which means money is flowing stateside from all over the world, and thus leaving other countries.
Britain is just one of many victims of this American flight. But unlike other countries, whose interest rates are getting dragged higher by US bonds, Britain is now pulling away from the pack. UK gilts pay, by some distance, the highest interest rate of any G7 country, and the gap has been widening. In part this is due to the persistently higher rate of inflation in the UK. However, there are signs that investors are losing faith in the government’s fiscal strategy, and thus demanding a premium on the money they lend to it.
While not as rapid an increase in interest rates as was seen during the Liz Truss episode, when gilts leapt by over a percent in just a few weeks, the scale is worse, with interest rates now at levels last seen at the time of the 2008 financial crisis. The danger for Reeves is that she may now have trapped herself in a self-reinforcing downward spiral. As interest rates rise, government debt payments go up. That reduces the money available for other programmes. If the government won’t raise taxes, it must therefore cut spending. That in turn, risks slowing the economy, and with that, tax revenues. If tax revenues go down, so too must spending. And on the cycle might go.
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SubscribeBring her chancellorship into question? Plenty of people predicted this would happen after her budget. It’s GCSE stuff – raise taxes and hand money to the public sector. How on God’s Earth will that create growth? The government’s no. 1 priority, apparently.
Add to that the outright lies she’s told everyone about her employment history, and qualifications, and I think most of us are well past bringing her chancellorship into question.
Plenty of people predicted this would happen after her budget.
It was pretty clear long before that.
All this – literally all of it – is straight out of the Labour playbook since at least the 1960s.
The recent election included the votes of many who won’t remember (or choose not to bother finding out about) those times, especially the denouement in the late 1970s. To those of us who do, none of this economic illiteracy comes as any surprise whatsoever.
The pace of life has changed since 50/60 years ago, hence the more rapid downward spiral once these dumb-ass statist policies are introduced. There is simply no way back for Reeves or her utterly incompetent boss.
I’m not criticizing you here but all of the economists on mainstream media seem to think that this is simply a political choice between raising taxes or cutting spending as if both of these policies are equivalent. This is nonsense. She has to cut spending. If she raises taxes further then confidence will collapse.
We’re.already in stagflation. Talk to any SME business owner.
To the best of my knowledge this is incorrect or at least incomplete. During the pandemic deficits were increases but it is much more relevant to mention that central banks bought the debt on a mass scale. They injected the economy with trillions using “quantitative easing” and this is mostly what pushes down the interest rates on bonds/gilts. They also did this after 2008. Recently they have reversed that process a bit, however, most of the printed money is still in the economy, mostly stuck in assets causing massive asset inflation. It is responsible for unaffordable housing and – partly because of that – a huge increase in inequality. Nobody in power seems to care about that thought. It was only when a bit of inflation in the real economy occured that they raised interest rates.
In any case, the entire narrative that governments have to borrow from private investors is just not true. Governments and central banks create money and if anything they have pumped way too much in the asset economy and, compared to this, way too little in the real economy which causes rent seeking, inequality and stagnation.
The bond market vigilantes are merely limbering up on this. If you pitch yourself against the bond market there is only ever one winner.
The term vigilante minimises the role Reeves has played. It suggests bad actors are deliberately hurting the UK.
Whereas the truth is the UK relies on foreigners to buy UK debt. Each month the UK must auction off tens of billions of debt to fund living beyond our means. Many foreign debt buyers are rightly shying away from the UK because we look like a terrible prospect and so all sterling assets look less attractive. With fewer foreign bidders for our debt, the auction price of gilts is falling, so the effective interest rate is rising.
This isn’t vigilantism. It’s investors looking for better, safer prospects.
Surely foreigners should not discriminate. It is not equity is it? They should take into account that we have been brought up with rotten economic policies and seek to give us a leg up. We haven’t had a role model like Musk to aspire to. It’s just not fair! Those rotten vigilantes!
It was a proud day when I finally grasped the easentials of bonds and the inverse relationship of cost to buy and interest rate etc. A stretch for a Fine Art BA Hons
Just don’t ask me too many questions …and I can’t remember now which bit is called the coupon…
However, I owe it all to MikeMaloney, Alasdair Macleod, Peter Schiff and Egon. Thanks guys x
Well done – i started the journey about 5 years ago. You’ve got a list of gold bugs there. In case it helps people I now follow include Luc Gromen (macro), Mike Green (passive flows). Jeff Gundlach (bonds), Michael Howell (liquidity), and Russell.Napier (financial repression). I often have to listen at 0.75 but I get there in the end!!