December 7, 2022

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Larry Summers slams 'totally irresponsible' UK fiscal policy

Larry Summers slams ‘totally irresponsible’ UK fiscal policy

Larry Summers

Cameron Costa | CNBC

LONDON – Former US Treasury Secretary Larry Summers warned on Tuesday that the United Kingdom had lost its sovereign credibility after the new government’s fiscal policy deteriorated markets.

The British pound Hit an all-time low vs. dollar In the early hours of Monday morning, before recovering a bit on Tuesday, while UK 10-year bond yield It rose to its highest level since 2008 as Markets fell due to the so-called “mini-budget” of Finance Minister Kwasi Kwarting Friday.

In a series of tweets Tuesday morning, Harvard professor Summers said that while he was “extremely pessimistic” about the potential fallout from “completely irresponsible” policy announcements, he did not expect markets to give up so quickly.

“The strong tendency for long interest rates to rise with a depreciating currency is a hallmark of discredited situations,” Summers said.

“It happens frequently in developing countries but it happened with (former French president) Mitterrand before his transformation, in the late Carter administration before Volcker and with La Fontaine in Germany.”

The policy announcement issued by Prime Minister Liz Truss’s administration last week included a measure of tax cuts We haven’t seen it in Britain since 1972financed by borrowing, and an unabashed return to the “downstream economics” promoted by the likes of Ronald Reagan and Margaret Thatcher. Truss and Quarting stress that policies focus on driving economic growth.

The sudden sell-off in the British pound and the UK bond markets has led economists to expect further sharp interest rate hikes from Bank of England. The central bank said Monday night that it would not hesitate to move to bring inflation back toward its 2% target over the medium term, but would assess the impact of the new economic policy at its November meeting.

Summers noted that UK credit default swaps – contracts in which one party takes out insurance against a borrower’s default – still indicate “negligible probabilities of default”, but have risen sharply.

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“I can’t remember a G10 country with so much debt sustainability risk in its own currency. The first step in restoring credibility is not saying incredible things. I was surprised when the new chancellor spoke over the weekend about the need for more tax cuts,” Summers said on Twitter.

“I can’t see how the BoE, knowing the government’s plans, decided to act timidly. Suggestions that seem to have come from the BoE that there is something anti-inflationary about unlimited energy support are strange. Subsidies affect whether energy is paid directly or through Taxes now and in the future, not their ultimate cost.”

global consequences

Summers, who served as US Treasury Secretary from 1999 to 2001 under President Bill Clinton and director of the National Economic Council from 2009 to 2010 under the Obama administration, added that the size of Britain’s trade deficit underscores the challenges the economy faces. The The UK’s current account deficit has reached more than 8% of GDPas of the first quarter of 2022 – long before the government announced it.

Summers predicted that the pound would fall below par with both dollar and the euro.

“I wouldn’t be surprised if UK short rates more than tripled in the next two years and reached levels above 7 per cent. I say this because US rates are now expected to approach 5 per cent and Britain has much more dangerous inflation, and is seeking to More robust fiscal expansion and has greater funding challenges.”

UK inflation unexpectedly It fell to 9.9% in AugustAnalysts reset their horrific forecasts after the government stepped in to put an end to annual household energy bills. However, many see that the new fiscal policies lead to higher inflation in the medium term.

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“The financial crisis in Britain will affect the viability of London as a global financial center, so there is a risk of a vicious cycle where volatility harms fundamentals, which in turn increases volatility,” Summers added.

“A currency crisis in a reserve currency could have global consequences. I’m surprised we haven’t heard anything from the IMF.”

His warnings of global infection echo his warnings US Federal Reserve Official Rafael Bostic, president of the Atlanta Federal Reserve, told the Washington Post on Monday that Carting’s £45 billion tax cuts had heightened economic uncertainty and raised the possibility of a global recession.

Chicago Fed President Charles Evans told CNBC on Tuesday that the situation had been “extremely difficult,” given an aging population and slowing growth, adding that the global economy would need to further grow labor inputs and technology infrastructure in order to secure long-term stability. the long. .

Currency crisis in emerging markets

Sterling is down about 7-8% on a trade-weighted basis in less than two months, Strategists at Dutch Bank a job On Tuesday, note that the volatility levels for the British pound are “those that you would expect during an emerging market currency crisis.”

James Smith, ING’s developed market economist, suggested that mounting pressure, likely combined with comments from rating agencies in the coming weeks, could prompt investors to look for signs of a policy shift from the government.

Smith noted that “ministers may confirm that tax measures will be accompanied by spending cuts, and there are hints about that in today’s papers.”

“We would also not rule out that the government would look closely at imposing unexpected taxes on energy producers, something the Prime Minister has indicated she is opposed to. Such a policy would materially reduce the amount of gold bond issuance required over the next year.”

Comparing the UK to an emerging market economy has become more popular among market commentators in recent days.

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Timothy Ash, chief sovereign strategist at BlueBay Asset Management, said in a POLITICO’s opening Tuesday Rising inflation, falling living standards and a potential wage-price vortex, combated by tax cuts that will exacerbate “already bloated” budget and current account deficits and increase public debt, mean the UK is now like emerging markets.

“As expected, the market wasn’t convinced by the new government’s economic policy to rush for growth. The government’s borrowing costs have gone up, making its overall forecast now look unsustainable. Everything is collapsing, and crisis talk is in the air,” Ash said.

“All of the above sounds like classic emerging market crisis country. As an emerging market economist for 35 years, if you give me the basics above, the last thing I would recommend right now is a program of unfunded tax cuts.”

Howard of the Greater Amman Municipality says the Bank of England is right to delay intervention in the pound's decline

However, not all strategists are sold into emerging market narratives. Julian Howard, chief investment officer at GAM Investments, told CNBC Tuesday that bond selling has been a global phenomenon and that lower taxes and deregulation could be “extremely beneficial” in the medium term, but the market has “chosen to completely ignore” the he-she. “

“I think what has really happened is that sterling and gold have drifted into a broader global phenomenon… In the meantime, I think the UK might quietly get some growth over the next six to nine months, and that has been a painstaking effort to ignore.”

“There is a general inflation panic happening around the world and I think if it abates we could see more stability in the UK.”

Howard said talk of an “emerging market” economy was premature and “extremely tough” and suggested the BoE could delay raising rates further.