The institutionalisation of the British Treasury goes back beyond the 11th century, before the Norman conquests. Across the Channel, one of the first centralised forms of taxation, the Danegeld, was created by the Saxons to protect them from the Vikings. In exchange for this protective tribute, the northern clans spared the British coast from their bloody raids, which they then redirected to the Breton coastline.
On the white chalk coasts of Albion, it is now the investors’ longships that have been raiding, as a consequence of the “mini budget” of the new Chancellor Kwasi Kwarteng. Because it has shown no effort to cut spending in the face of its massive tax cut programme (the biggest since 1972!) at a time when its finances are already fragile, the Treasury has drawn the ire of the Vikings of the capital markets.
Tax collection is the primary regalian prerogative of the state: historically, it is through it that money is minted, the army and military campaigns are raised and financed, and above all, it is through it that credibility with private or public lenders is assured. Beware of the state that can no longer convince people that it has the means to live beyond its means…
Faced with slipping interest rates and the sinking of nearly 30% of 30-year Treasury bonds, mistrust was such that the lender of last resort, the Bank of England, had to intervene. In the emergency, it was not the monetary policy committee but the bank’s management, which manages day-to-day operations, that reacted without consulting the Council of Nine.
But at what cost? After starting its rate hike schedule late, the BoE, which was supposed to start cleaning up its balance sheet, is now mired, against the rest of the world, in a new quantitative easing programme that does not bear its name. In fact, in order to correct what it called a malfunction in the gilt market, the central bank conducted securities purchases in the market. In this context of assistance to the Treasury, its independence, acquired in 1997, could be challenged.
The UK is now facing a real crisis of financial confidence. It is reminiscent of the 1970s, when the country asked the IMF for help. Almost $4 billion was provided, the largest credit line ever opened by the institution.
The UK’s situation is certainly special. The Brexit has amplified the logistical crisis, the deficit of workers and inflation compared to the rest of the world. Today, the tense relations with Northern Ireland add a territorial and commercial component to the fiscal crisis the country is experiencing.
Faced with this particular case, the action of British institutions is more incoherent than elsewhere. Monetary policy contradicts itself: it is restrictive on interest rates and expansionary on the balance sheet. The monetary austerity required by the surge in inflation is now faced with a widening public deficit through a reduction in taxes without any adjustment in spending. However, despite the particular characteristics of the UK case, it should not be assumed that the clear message sent by the markets does not apply elsewhere. At a time of declining growth, structural challenges, rising inflation and rising interest rates, the time for the largesse of the last two years is over. International capital will not finance public action as blindly as in the past. They will no longer tolerate nominal rates that are significantly lower than the sum of potential growth and long-term inflation, whose regime is evolving. By their reaction, the bond markets are telling us that the idea of a minimum borrowing rate required to lend to governments is no longer a ghost of the past and that it is time to turn the page on structurally low or negative rates.
This is why governments must pursue a fiscal policy that is in line with monetary policy. The primary objective of monetary policy today is to curb inflation. This will not happen without a struggle. Governments lacking the courage to accept it (by taking refuge in promises of lower taxes or therapeutic treatment of the economy) risk passing on an even greater burden to their citizens. In doing so, the UK government has put the country’s pension system at risk, as pension funds are among the largest holders of Gilts. The fall in the currency coupled with the rise in yields, in turn, is exacerbating and accelerating the risk of recession.
Thomas Planell, Portfolio manager – analyst at DNCA. This article was finalised in Septembre 30th, 2022.
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