In 2022, Liz Truss was prime minister for just forty-five days. The key to both her initial popularity amongst some of her peers, and to her rapid downfall was the same: the 2022 mini budget.
The mini budget was a radical tax cutting proposal. The idea was that a reduction in tax rates would spur growth and that this growth would eventually pay for the tax cuts. This was the main reason some members of the Conservative party supported her. Unfortunately (for her), the bond and currency market reaction to her mini budget was also the cause of her having to resign less than two months after taking over.
At the time when the mini budget was announced, the UK had a government debt to GDP ratio of just under 90% and a budget deficit of around 5%. According to The Institute of Fiscal Studies the tax cutting plan would have added around 5% to government debt as a percentage of GDP in the short term. The implication was that the UK’s debt to GDP ratio was going to rapidly rise to over 100%, with a budget deficit of between 7% and 8% in the near term. Rather than waiting to see if this would work, financial markets took spectacular fright. Just ahead of the mini budget, the UK 10 year government bond yield was almost exactly 3% but, as details of the plan came out, yields rose rapidly to well over 4% At the same time the pound slumped by almost 20%. The increase in bond yields pushed up mortgage rates and the housing market froze: the Liz Truss government was over.
In hindsight, most journalistic commentary proposes that either the mini budget was simply a bad idea or perhaps that it was introduced too fast. However, the market reaction strongly implies that the issue was actually one of sovereign debt viability.
So, what are the implications of all of this today? 2024 is going to be a significant year for politics in the UK and in the US. What is notable going into these elections is that no one is seriously talking about cutting spending. The IMF estimates the US budget deficit over the next few years to be between 6.5% and 8% of GDP. The US’s government debt to GDP ratio is 130%. These are levels of spending, and levels of debt, which have only historically been seen in times of war and this is all before the various election promises that both Biden and Trump are likely to make ahead of the autumn election. Even before these promises, the US budget deficit and debt trajectory is worse than Truss and Kwarteng’s mini budget would have produced.
If Biden were to win the 2024 US elections, would he be likely to get the economy control or would he continue with ‘Bidenomics’ (i.e. more government spending)? Alternatively, if Trump wins, we may be looking at large tax cuts and higher military spending. Either way, whether politicians are right wing or left of centre, they all want to keep on with, or even expand, the already large levels of deficit financing. No-one is building the case for austerity, spending cuts and tax increases. It is still the case that no country in history (that we are aware of) has dealt with excessive levels of government spending and indebtedness until a crisis has forced them to do so. Elections, this year, in the UK and US may therefore mean we are about to see a repeat of what happened to the UK economy as a result of Liz Truss’s, but potentially on a much, much larger scale. Unless they are careful, whoever is going to be the next prime minister, or the next president, may come quickly to regret their election.
In the end, debt must be paid, but it takes a crisis for it to become politically expedient to build the case to do so. A Western solvency crisis could be the most significant and potentially shocking surprise for 2024. Politicians may not always tell the truth, but the numbers do not lie.