This article was written by Richard Horswill. All views and opinions expressed are strictly his own.
In the September of 2022 something of a financial crisis erupted following the mini-budget of the new Truss led Conservative government. The details of which, in simple terms, proposed un-funded measures to deliver an income tax cut to the basic rate, a reduction of the highest rate of income tax, reversing a proposed increase in corporation tax, and reversing an increase in National insurance. All of these measures were designed to provide a growth dynamic; however, after being throughly attacked as a highly inappropriate budget by unelected institutions such as the IMF, the budget was somewhat rowed back upon, but by this time the markets were intent on their pound of flesh leading to the pound crashing, gilt yields rising sharply, and ultimately the end of the Truss government. It must be said that the Bank of England was somewhat culpable too, as their management of the highly leveraged LDI (liability-driven investment) pensions schemes and the heavy losses incurred as yields spiked led to the Central Bank effectively bailing out the pension funds via a QE (quantitative easing) measure. That said, the UK finds itself in something of another bind this time led by the red team! The Labour governments autumn budget has certainly put the cat amongst the pigeons as UK growth has stalled completely. The main measures have basically attacked the business community, which in essence should be the engine of the UK economy. What will be the consequences for the UK economy should these policies persist, and the growth strategy that was intended by them for economic growth does not materialise?
The bedding in process since the 30th October 2024 when the budget was announced has been sterling negative as the pound has come under significant pressure, but has also led to the benchmark 10 year gilt yield hitting levels not seen since 2008. The institutions and mechanisms that may well be affected by these sharp moves are going to be tested to a significant level as was the case in 2022. This is particularly relevant for the Bank of England who will need to help steer confidence in UK PLC. As in the case of LDI, the UK banking fraternity could well be very much on the hook for potential bond holding losses since the 2020 pandemic issuance of government debt at very low rates. Long dated bond yields seem to be reacting to the possibility of a period of stagflation suggesting that the BoE might be more inclined to keep the base rate higher for longer due to the temporary inflation that may erupt due to the weakening pound. However, should they persist in hindering the economy as they have done by keeping front month interest rates too high for too long, they are in danger of creating the circumstances for a serious recession as homeowners, renters and consumers alike take the brunt of this unfavourable policy, driving disposable incomes to the brink. The move at the long end of the curve should really represent growth expectations for the future, and should not really be driven by short term speculation. That aside, this move in interest rates may create some short term liquidity issues for banks which could well lead to the BoE needing to initiate a QE stance should the banks need immediate liquidity. This will signal the emergence of yet another financial crisis and could well lead to another run on the pound which effectively would lead to an economic doom loop that could trigger policy reversals, blowing the new Labour administration’s credibility to pieces.
The circumstances that the UK finds itself are in are not entirely unique. Currency crises are occurring in India, Brazil and Europe - to name but three locations - and the global growth dynamic is clearly not stable. Part of the United States growth story, that looks to have bucked the trend, has principally been down to government deficit spending to the tune of one trillion dollars every one hundred days. They can seemingly get away with this as US treasury bills underpin the global financial system which are the prime collateral used within the repo banking system. Sadly the UK cannot act in an equivalent way as the US due to the necessity of dollars that are required for global trade along with the collateral that secures the underlying debt. All the UK can currently do is hope that the economy stabilises, all be it with a weaker pound. The inflation narrative that Central banks have pursued, in my opinion, will burn itself out as living standards further crater. This outlook can be viewed across much of the global economy, but is particularly prevalent in the first world nations who are sitting on huge debt burdens. Frankly, the only way to stabilise the global economy is if Central banks recognise the need for lower rates by focusing on the economy rather than inflation. Supply chain inflation is something they cannot control, so why bother? They need to be honest about their inability to influence the supply chain and tackle the area they can assist with which is demand. If these policies were considered, they would be following in the footsteps of China who have the lowest interest rates they have ever seen as growth has contracted internally due to a real estate crisis and externally with the export market having crumbled. Due to the policy errors post Covid and the geopolitical crises of war, and then oil cartel decisions helping to maintain high energy prices that are too high for growth to be consistently achieved, the global economy is in danger of a collapse moment. Talk of tariffs will only exacerbate the pain and lead to a further contraction of global trade with a knock on effect of a stronger dollar. Nothing good will come from a strong dollar due to the amount of global dollar denominated debt that needs to be repaid, and could ultimately lead to delinquency, default and a global banking crisis to boot. No country is immune to the knock on effects of a globally synchronised downturn, not even the United States.
The world is a tale of two stories. The mainstream narrative of a global soft landing or even a no landing, AI boom, stock market boom, and a new world post Covid. The other side of this story is what we, in the UK, are experiencing in the here and now. Low growth, a lack of private investment, an inability of government to spend to invest due to already high debt loads, increasing cost to service the debt and plummeting confidence. So, is the UK in line for another financial crisis as the title of the article asks? I believe that we will. The BoE will again take centre stage using its non mark to market balance sheet to soak up any non-performing debt, in turn increase its “reserves’ balance, which will be seen as printing money and therefore “highly inflationary” leading to further asset price inflation and subsequent inequality. The only mitigating factor for the UK is that these actions will not be UK centric, as Europe will be doing the same as will many other countries who are all facing the downside of the post Covid supply shock. Japan started the “debt spiral” downward trend in the 1990’s, and I believe we will follow the same path until the global energy transition has been fully integrated, so that limitless cheap energy is available which can restart the global growth dynamic. Unfortunately, this transition will likely take many decades to happen, so in the mean time we must accept that the living standards of the next generations may not be as privileged as the one we have lived through for the last forty years or so. On a brighter side, I can’t think of one other than to wish everyone a happy and healthy 2025.
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