UK Grieves as the Economic Crises Approach

Blain’s Morning Porridge, September 15^th 2022: UK Grieves as the Economic Crises Approach

“Give ‘em the old razzle dazzle, give them an act with lots of flash in it..”

This morning– As London grieves we’re not paying much attention to politics and markets – but we should. The outlook is deteriorating. Confidence is declining and will likely get worse if the new government’s lack of awareness and sensitivity continues.

London this week has been extraordinary. It will become more so as literally millions of us are prepared to queue to pay our respects in whatever the weather throws at us. The great affection in which the Queen was held, and our hopes for King Charles, have come to the fore – giving the whole nation a sense of quiet dignity that has been lacking over the turbulent years of Cameron’s confabulations, May’s mayhem and Boris’ buffoonery. We Brits do pageantry rather well – politics? Not so much.

Unfortunately, dignity and waving flags do not pay the bills. Gentile national poverty could be around the next corner. Disneyland may yet get the chance to make a distressed bid for Ye Olde England Theme-park… Boris may be gone, but Government is still flolloping around like a mattress in a swamp… with all the massive implications for the economy that entails.

It’s all about confidence and communication.

When markets lose confidence in a nation – bad things happen, and can happen fast. The “Virtuous Sovereign Trinity” model describes how a nation with a well-run political economy (effective politics and a functional economy), a stable currency, and a strong and efficient bond market, will likely succeed in multiple ways such as attracting inwards investment, fostering strong labour/management outcomes to drive productivity and wealth creation, and avoiding inflation.

Get it wrong and the consequences explode, meaning it can all go to rack-sh*t in a heartbeat.

• The collapse in sterling is not just a function of dollar strength, but genuine concern on where the UK is going post Brexit, Boris, Covid, Ukraine and now, Truss. A weakening sterling fuels inflation – which is why the UK is now expected to underperform Europe.
• Doubts on the political economy are highlighted by raising industrial tension as workers demand pay rises to combat the cost of living crisis, and years of rising income inequality where wages barely increased but house prices rocketed. The UK is ill-prepared for the consequences of higher interest rates on consumer-debt, the housing market (the traditional gold standard of how the economy is faring) and commerce.
• The recent rise in Gilt yields (the UK govt bond market) raises doubts on just what the UK will have to pay to finance itself.

Just over a week ago I wrote “Liz Truss has a week to avert a confidence crisis in the UK”. She has been given extra time by the Royal succession – but we are still asking: what is the programme? Bearing in mind she was predicted to win the Tory leadership back in June, and given all that time to prepare… what grand, carefully considered plan to restore the UK has she brought with her to Downing Street?

Er….

Truss, and her partner in the top spot, new Chancellor Kwasi Kwarteng, still sit uneasy around her new Downing Street throne. She does not have a solid majority of MPs, or even the party. Lest we forget… she is the fourth Tory Prime Minister since 2010 – the rest having been dumped. Truss is not a great communicator – which is one reason tensions are rising.

Give Truss and Kwarteng credit for the broad-brush policies announced so far: the Energy Cap Bailout last week –a promise to support the economy from the effects of the Ukraine energy shock. Businesses will be offered “equivalent support” for 6 months and ongoing support for vulnerable industries – which will, apparently include pubs. A new round on oil and gas licences will be announced, and the production of UK shale gas. We will get a new Nuclear power outline that will generate 24 GW by 2050.

But all the above are just words.

We will get details on how it’s going to work after parliament reopens in October, including how energy bills at an average price of £2,500 will be frozen. The papers are leaking it may be November before businesses start to see money come in to cover their huge cost increases. We have no idea what the Treasury analysts believe the likely sums required to support industry and consumers will be.

There is also the problem the new Energy Cap bailout looks and is blindingly regressive– freezing energy bills at an average price of £2,500 won’t stop the poorest 6 million households in the UK remaining in fuel poverty after prices rose earlier this year. It will give a sop to Tory-voting middle classes who will be inconvenienced but can afford it. As the Tory’s have said before: no point fertilising fields that won’t vote for us. (As said about Liverpool – 1982.)

There were other less regressive and less expensive ways to address the crisis – windfall taxes, progressive energy subsidies forcing the rich to pay more and consume less, and schemes to limit energy to each household, meaning the rich pay more to consumer more. All have flaws and raise problematical consequences, but each is probably better than the simple.. “Don’t worry, we can fund it all through borrowing to buy the next election..”

The Tories are not daft. They know they’ve been in power for 12 years, meaning it’s too long ago to blame the last Labour Government for the present crisis in the economy. They have a narrative to build before the next election – which is due sometime before Dec 2024. That narrative is overlaid with talk about growth, growth, growth, a refocusing on cutting red-tape and inefficient government spending, and “making Brexit work”. (I hear we are about to announce a massive new trade deal with Tonga.) There is also a clear message to convey – cover up the failings of 12 years of Conservative dither by stressing the mantra: “A Labour government will be a disaster for the economy and markets”

Historically, not true. Strip out the last 12 years, and the record shows Labour and Conservative governments are pretty evenly matched when it comes to mismanaging the economy. They have both presided over booms and busts. But to be fair, the last 12 years have seen the longest period of anaemic growth – despite low interest rates, the lowest productivity gains, slowest internal investment, fastest widening of the inequality gap and income inequality, a widening in health outcomes between the poor and rich, and more families on low wages than since the industrial revolution. Hey, at least we got Brexit done!

I am quite sure Truss and Kwarteng understand what a poisoned chalice they have been given, but I would ask – who is advising them?

As I’ve said above – confidence in the Gilt market is absolutely critical for the nation. If the gilt market melts down, and rates rise (because the price is the price is the price), then the Virtuous Sovereign Trinity will tumble. The massive fiscal spending programme Truss and Kwarteng envisage (to enable them to cut taxes) has profound consequences.

But, there has been, as yet, no guidance on how the UK’s Debt Management Office (DMO) should factor in the sudden massively increased funding requirement into its carefully planned Gilt issuance strategy. The DMO is one of the UK’s greatest financial secret assets – running a very effective UK’s government Gilt issuance market. As I’ve written above – a properly functioning Government Bond market is a prerequisite to a strong economy.

Truss and Kwarteng could ask their civil servants in the Treasury office – but they won’t.  Its increasingly clear Truss understands what she wants to understand. Chancellor Kwarteng, has been described as “a man so fond of his own voice that his ears have been given a redundancy notice.”

Which means we should not be surprised the first act of the new Government when it took power on Tuesday last week was to sack the most senior civil servant at the Treasury, Sir Tom Scholar .. pour le encourage les autres, apparently. Kwarteng has lectured them about growth as their only priority.

There is nothing more British than a very angry letter to the Editor of The Times;

 “The sad fact is that in sacking Sir Tom Scholar, one of the ablest civil servants of his generation, the prime minister and chancellor have sent a clear message to the civil service that they are not interested in impartial advice and intend to surround themselves with “yes” men and women. That is a sure route to bad decision-making and weak government. It is also another small step on the road to politicising the civil service. It is disappointing that the cabinet secretary, whom the prime minister apparently now intends to retain has acquiesced in the sacking and once again failed to stand up for the values of the civil service.”

Sir David Normington, Home Office permanent secretary 2006-10; first civil service commissioner 2011-16

The UK faces a fundamental crisis in terms of its Virtual Sovereign Trinity – a potential collapse in the bond market, further weakening in sterling, and a failure by government to address the multiple crises facing the nation can only make things much, much worse. So how have the Tories approached it? By sacking one of lynchpins who understands how the system works, and alienating the staff.

Demonstrating just how deaf he is, Kwarteng’s second act as chancellor is proposing to scrap the Banker Bonus Cap imposed by the EU following the last Global Financial Crisis. He argues it will make London a more attractive place to base financial businesses. Goldman Sachs is applauding the move – the local food bank, less so. The man is politically deaf – but he wasn’t listening anyway.

Clever.. Not.

Five Things To Read This Morning

FT – Kwarteng will struggle to hit 2.5% growth target, warn experts

BBerg – Chancellor Kwarteng Seeks to Scrap Banker Bonus Cap

BBerg – Ray Dalio Does the Maths: Rates at 4.5% Would Sink Stocks by 20%

WSJ – SoftBank considers Launching a Third Vision Fund

Guardian – EU expects to raise €140 bln from Windfall tax on energy firms

Out of time, and back to the day job…

Bill Blain

Strategist – Shard Capital