Olivier Marty / Nov 2022
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Recent financial and political events in the UK have constituted stimulating food for thought for political economists. Sterling’s sharp moves, gilts’ rates rollercoaster variations, and British pensions funds woes came out as logical illustrations of markets’ reactions to unsound macroeconomic policy making and subsequent corrections. Likewise, the dismay of the public, press, and opposition parties, to the Conservatives’ “mini-budget” were also terribly revealing. As Prime minister Liz Truss has now resigned from her office and been replaced by Rishi Sunak, I draw the following observations of what happened.
The UK cannot hide it has engaged, for several years now, on a worryingly declining path. Despite the continued strength of its soft and smart powers, which were so impressively exposed during Queen Elizabeth II’s funeral, as well as its strong assets, the country has become more isolated, politically and socially unstable, poorer, and by many accounts much less “sovereign”. Larry Summers, a former Secretary to the US Treasury, persuasively called the UK a “submerging country”. In fact, Britain is still very much tormented by the conundrum of internal crises that have been catalyzed in the Brexit process.
Contrary to what many thought in the Tory party’s ranks, Brexit does not allow for complete freedom in public policy. We already knew that the prospect of diverging from EU rules would be matched by threats from the bloc to retaliate on trading arrangements and to hamper post-Brexit negotiations in crucial fields, such as trade in services and finance in particular. We also witnessed confirmation that negotiating trade agreements was harder for a relatively small country alone. For their part, events in recent days have recalled that running unfinanced deficits was not wise, not because the EU forbid it, but because markets did.
Financial markets do not just remain very astute in signaling risks pertaining to the economy and the financial system (thereby raising usual concerns about the location of real power and democratic accountability) - they are, also, not really irrational. Indeed, the blatant miscoordination of the UK’s government fiscal and monetary policies as well as the poor effects the initial measures would have on growth were correctly gauged. It is also noteworthy that markets have, in fact, provided support to a more robust macro consensus in defense of public investments, tax fairness and broader economic policy cooperation.
When it comes to economic growth, magic potions are as unsuccessful as anticipations and confidence levels of economic agents are important. In the case of the UK, fears of a currency crisis and bloated consumption levels have logically fueled higher inflation expectations while interest rate hikes heralded debt crises and depressed economic prospects. More importantly, the public’s acute feeling that the main elements of the “mini budget” (including the Energy Price Guarantee) were evidently unfair on social terms could only fuel resentment and popular unrest and thus aggravate the political, financial, and economic storm.
The risks pertaining to the global financial system are still very much there. As the Bank of England’s intervention to halt the collapse of parts of the UK’s pensions industry recalled, the non-bank financial sector is very vulnerable to cash crunches. Stronger liquidity buffers for funds are needed while more accurate data from the different jurisdictions and liquidity stress testing exercises are to be collected and conducted. While the 2008 global financial crisis had improved the overall security of the banking sector, the “shadow banking” system remains a worrying concern for all.
(21 October 2022)
