Liz Truss’s Historic Gamble With the UK Economy Is Already Unraveling

Liz Truss’ growth plan, which combines the biggest tax break in half a century with Thatcherian deregulation, is a pure gamble on Britain’s future, and before her Chancellor of the Exchequer had finished on Friday, the bet was starting to turn sour.

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(Bloomberg) — Liz Truss’s plan for growth, melding the biggest tax giveaway in half a century with Thatcherite deregulation, is a straight up gamble with Britain’s future, and even before her chancellor of the exchequer had even finished delivering it on Friday the bet was starting to sour.  

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The market’s verdict on the £220bn policy blitz outlined by Kwasi Kwarteng was swift and devastating. Sterling plunged below $1.11 for the first time since 1985, bringing its year-to-date plunge to 19%. Five-year gilts posted their biggest daily decline ever.

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“The markets will do what they want,” said Kwarteng, 47, when challenged in the House of Commons over the chaos he had caused.

Even before the Chancellor’s statement, former Bank of England policymakers were warning that Prime Minister Liz Truss’ determination to cut taxes regardless of the circumstances risked plunging the UK into a sterling crisis.

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There was still a sense of shock at how far her chancellor went, scraping the top rate of income tax in favor of top earners, and making cuts in corporate taxes, Social Security contributions and home-buying levies, all of which were pre-marked.

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The final total didn’t even include the full cost of capping household energy bills for the next two years. This could add another £100billion to taxpayers’ liabilities.

The tax cuts will cost the Treasury around £161 billion over the next five years. Another energy guarantee will add about £60billion to that total over the next six months, the only figure the Treasury has provided.

Those staggering numbers prompted analysts to reach to the history books to compare the package to famous policy blunders of the past. The reaction – the pound fell even as traders priced in steeper rate hikes to offset rising inflationary pressures – is the kind of move usually confined to emerging market currencies.

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“Investor confidence is eroding fast,” said George Saravelos, global head of foreign exchange research at Deutsche Bank. He called on the Bank of England to raise interest rates.

The reaction leaves Truss and Kwarteng in a terrible bind. Truss, also 47, took office less than three weeks ago. Her efforts to impose her authority on the government were interrupted by the death of Queen Elizabeth II, which halted politics for 10 days. And Truss is imperative to show she can lead Britain through the global energy crisis.

Because of her popularity with members, she was elected leader of the Tory party in the summer. But two-thirds of her MPs voted against her, and there were rumors of a possible vote of no confidence even before she took office.

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Investors fear Truss’ tax cuts will give the economy little more than a quick sugar rush, spiking debt and sending inflation skyrocketing before a crash that fails to provide any lasting improvement in longer-term growth leaves.

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Even government supporters were lukewarm in their support. Crispin Odey, a Tory supporter and founder of hedge fund Odey Asset Management, where Kwarteng once worked as an analyst, said: “They’re trying the right things but there has to be a risk that we get into a barber boom by… they push the button on inflation.”

This is a nod to the ill-fated 1972 budget created by Kwarteng’s Tory predecessor, Anthony Barber. Barber, like Kwarteng, delivered a massive package of unfunded tax cuts, which in his case caused the economy to overheat and inflation to spike, before plunging into recession. Barber’s boss, Edward Heath, was defeated by Labor opposition two years later and Britain had to apply to the International Monetary Fund for a bailout in 1976.

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What Bloomberg Economics Says…

“The measures announced in Chancellor Kwasi Kwarteng’s mini-budget will give the economy a sugar rush next year, but we seriously doubt they will deliver the growth spurt the government is banking on. That means it will raise inflation at a time when the Bank of England is trying to ease pricing pressures and put debt on an unsustainable path because the policy package is unfunded.”

– Dan Hanson, Bloomberg Economics. Click for the INSIGHT.

Truss should also have less than two years before she also has to call for elections.

Truss has made it clear that she cares about enlarging the economic pie rather than worrying about how it’s divided.

This boldness is most evident in the central gamble at the heart of the mini-budget. Success hinges on a single number: Kwarteng’s growth target of 2.5%, which is almost a full percentage point above the official forecast for the next three years and levels last seen before the 2008 financial crisis.

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If the government can boost GDP growth by one percentage point, the tax cuts will pay for themselves in five years, according to Finance Ministry documents released on Friday. At this point the government will have stabilized public debt, solved Britain’s productivity problem and given the country the competitive advantage of lower taxes.

Martin Weale, a former Bank of England rate setter, now at King’s College London, described the growth target as a “pie in the sky”. The government can’t be sure of delivering 2.5% growth, but can be sure that the tax cuts will put public finances in a dangerous position, he said.

The Resolution Foundation forecast that public debt as a percentage of GDP will increase net over the five years, adding a total of £411 billion to the existing £2.3 trillion debt mountain.

At the same time, the benefits of the tax cuts are being skewed in favor of top earners – who traditionally tend to vote conservatively. Someone making £200,000 will be better off £5,220 a year as a result of the tax cuts, while a worker earning £20,000 will only make £157.

“After 12 years at the head of the country, the Tories urgently need to set a delivery record fast if they are to remain in power,” said Ryan Shorthouse, chief executive of think tank Bright Blue. “The Prime Minister and the Chancellor are going all out.”

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