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With the Prime Minister, Liz Truss, having resigned today British economic policy makers must now decide whether the remaining major action is to raise bank rate by two percentage points to 4.25%, or thereabouts, or reintroduce austerity.
Unfortunately, we may be faced with an unsatisfactory mix of raised interest rates and renewed austerity.
Both actions deliver economic pain but the markets will not permit none to follow.
Interest rates have been too low for a decade. Raised rates will push up sterling, reducing import costs and thus diminish inflation.
Exporters are increasingly service businesses less sensitive to pricing than the now frankly too small manufacturing sector.
As a pace setter in higher rates, Britain would become a home for investment in the anticipation of further currency appreciation.
Austerity faces the great problem that there is mainly only muscle, not fat, to cut and it mitigates against future growth more than raised interest rates which can be lowered eventually in more favourable economic ciecumstances.
Global rises in interest rates have not, in all events, run their course and Britain would gain nothing by being a laggard.
The authorities should not permit the spread between bank rate and mortgage rates to be too great.
In the near term any required tightening of monetary policy by the Bank of England cannot be by selling part of its holding of gilts into the market. It has to be through interest rate policy.
Even though gilt issuance is mainly absorbed domestically some international demand for gilts will not be unwelcome, which should follow on from higher interest rates.
The central bank and the new Prime Minister will both be well aware that politics cannot wholly determine interest rates to the detriment of market perceptions but visibility that their policies are in step with one another will be necessary prior to major announcements.
21 October 2022
Large companies are there to meet demand and they will do so as best they can.
If they do not want to be in a country another will take their place to fill market demand.
They neither need nor respect governments continually fussing over their health.
Yields are about the markets, especially timing, and they should be played with full confidence.
We should not be falling into the 'Greece trap', with respect to that country which was left with insufficient choice by the EU, of making unnecessarily large fiscal alterations of too long duration because of market movements.
We do not seek to have a reserve currency but this is not how the U.S., China or Japan would play it.
The fiscal alterations that were most necessary were not cancelling the corporation tax rise to 25% and not subsidising big companies' energy costs any more beyond the winter - and that only because the EU may be doing it, not the U.S., China and Japan. Many a big company did not like the look of taking furlough money during Covid and so returned it.
The way to look at it is like this.
The following figures are not meant to be precise and we are not advocating Keynesianism but something that, if anything, is closer to monetarism.
Ignore the national debt - about £2.4 trillion - and the increase in debt service cost this year, say £20 billion more than last year, in deciding what to spend, cut and tax.
To take the debt service into account creates perpetual austerity in a period of rising interest rates.
Treat all national debt and debt service costs as if they were part of the capital account, even if they are not quite.
Then determine the average debt service interest across the £2.4 trillion debt - say 4%, though it is probably lower.
Determine a true rate of inflation - let us assume 10%.
Holders of the debt are therefore losing at around the rate of 6% this year.
The government, and indirectly the taxpayer, are therefore gaining £144 billion at the expense of the holders of gilts.
The government is supposedly in deficit, and it is in reality, but that deficit is exceeded by what it has gained at the expense of the markets.
Marx got it wrong - at least in relation to how we live in the 21st century - the problem with the political economy is not capitalism but incomeism. The peasant with a little capital but next to no income was usually better off than the industrial worker with an income but next to no capital.
Buyers of gilts will necessarily wish to close the gap between 4% and 10% but it does not mean they will be expecting 6% more because the expectation is that inflation will fall.
They do, however, want a sufficient yield to make gilts attractive relative to other asset classes and foreign bonds.
So interest rates need to rise.
Inflation inevitably produces adjustments in all asset classes - gilts, equities, property, mortgages and so on. Some of these have to be losers and loading austerity on the nation for the third time - the first time was by the post-war Labour government - will not prevent this and will weaken the nation.
The national accounts probably do need to be on track to eventually nearly balance excluding debt service costs. For balance to be achieved including them is clearly deflationary.
They are better treated as part of the capital account where either the government benefits at the expense of the markets or they do at the expense of the government, over the long term.
This may condemn Britain to a chronic interest rate premium but it is better than chronic deflation.
The good thing about Rishi Sunak, as the new Prime Minister, is that he has not yet nailed his colours to an ideological mast. He may yet develop an ideology of his own, like Thatcherism, shaped by events, but it does not matter if he does not.
We have four ideologies kicking around inhabiting the main two parties - Marxism, neoliberal centrism, libertarianism and austerity - all of whose economic aspects are zombies and the quicker we move on from their over-simplifications and escapes from reality the better.
Once again these figures are not meant to be precise.
The Chancellor has announced an Autumn Statement and it has a half-awake, yawning approval from the markets.
The interest rate on the national debt is around 4% - nearly £100bn debt service costs on £2.4 trillion.
The Chancellor has said that the deficit should aim to be no more than 3% of GDP, a figure we ourselves have proposed before when it was around 2% and which we considered too low to keep a modest level of inflation in the economy and head off unnecessary tax rises.
We now have some unnecessary tax rises in relation to personal allowances although they do signal that everyone should belt tighten hence the acquiescent yawn - markets prefer quick measures and move on not gloom till 2028.
The markets would have preferred the original N.I. rises which the Opposition helped scupper, making maket discontent worse during the interregnum. An Opposition patently naive about business and markets.
3% of GDP is around £75bn. The Bank of England holds around 30% of the national debt because of QE. Since the nation owns the Bank, the near £30bn that the government pays it as interest on its QE gilts holding should be taken out of the equation. That means the better debt service number is £70bn.
So at 3% of GDP, which we have not yet reached, the budget would be balanced, in effect (meaning the amount that flows to the capital markets in interest is balanced by the government's deficit. For more to flow than the deficit would be deflationary. It is better to let long term inflation erode what is owed in real terms, within limits, from the taxpayers' point of view, than to seek to bring the debt total down. The markets, usually, are happy to pocket the interest as their part of the bargain.)
We do not agree with balanced budgets other than as a temporary aspiration to right the ship. They are a gold standard which even Germany and the ECB learned to abandon during the euro crisis.
A form of monetarism that allows a 1% to 3% of GDP additional margin, to allow for growth, is what is called for now. This means that the Chancellor could spend £25bn - £75bn more than his 3% target.
The Bank's QE is water under the bridge. It should hold the gilts acquired to maturity when it should get close to nominal face value and not book losses now paid for out of taxation.
The Fed sets the direction of world interest rates and sterling cannot opt out.
The markets will be looking at the Bank more than the Chancellor.
MOVING INTO THE 2020s
Reviewed by ANDRE BEAUMONT
3 April 2020
We need to dispel once and for all the myth that when a government runs a big fiscal deficit grandchildren pay the bill.
They do pay part of it but the greater part they do not.
There is only so much output in a country in a fiscal year.
When in an emergency, as now, the government borrows a great deal, it arrogates more of that output to itself.
This year that is necessary because the money is being used as life support to the economy. Government finances in future would be much worse if it did not do so.
The government bonds that are issued to obtain the money are willingly bought by our very efficient financial markets.
They have money that they must place on deposit or invest somewhere and to place it anywhere else than with the state exposes then to the risk of loss, default or exchange rate fluctuation.
They know that the real rate of return may be paltry or non-existent and that in the long term this may not be the best investment but they willingly take the risk.
Once purchased most of the risk no longer lies with the government or 'the grandchildren' but with the holders and their successors in title to the bonds - with the markets.
The government stock, War Loan, illustrates the point.
This was issued in wartime so as to take more of total output to direct to the war effort. The corollary was that private comsumption was reduced which was desirable in the circumstances.
The purchasers largely bought it for patriotic reasons not knowing if it would be a good investment. If not necessarily for them, if they sold before the 1960s, but for most of their successors in title it proved not to be.
Decades later governments redeemed it at a fraction of the GDP it had consumed in wartime due to later rampant inflation diminishing the debt's value in real terms.
The reason for purchase is largely irrelevant. Once government had sold it the risk was with the holders. These days it will be with the financial market institutions not small holders.
Today, should the markets not buy our government stock the Bank of England will through quantitative easing. The governments of 2010-2016, partly taking their cue from the preceding government were, in nominal value terms, the largest deficit financers in the history of the British state. QE mopped up much of the stock.
Were the Bank of England not to buy, the real rate of return can be raised. World class financial markets in London will always do business with the government and one day a future government will redeem on terms favourable to 'the grandchildren' and sensible governments will roll over the debt till then.
It is this year's output that is being pre-empted not theirs.
The second myth than needs dispelling is that cleaners paid a higher percentage of their income in tax than hedge fund managers.
Do the sums properly for the time the statement was made and you will find it is fake news.
When Nigel Lawson proposed having capital gains tax rates at the same rates as income tax there was only about a 4% separation between the two so it would have been administratively convenient but it was still a bad idea like shadowing the ERM, another of his ideas.
Now, with Covid-19, you can see why.
If you set up a business there is about a one in six chance that you will still be there in a decade's time. It is like playing Russian roulette with cartridges in five of the six chambers.
If you put up a quarter of million to set up a good restaurant and Covid-19 forces you into bankruptcy the loss is 100% yours. It cannot be offset against anything else. There will not be another restaurant or even employability.
You probably never paid yourself much and your only real hope was to sell it on for double your investment when your dreams of making a name for it were realised.
Subject your gain to the same rates as income tax, if you spin the barrel 'right', and the conclusion is clear: do not go into business.