James Campbell: What Australia can learn from UK’s economic fire

The UK’s Chancellor of the Exchequer shocked the political world by announcing plans to borrow £70 billion to pay for unfunded tax cuts, but what are the lessons for us, writes James Campbell.

Most of the time when politicians screw up, the consequences for us and them take a while to become clear.

Order the wrong sub, illegally hound people for debts they do not owe, and the chances are it will be someone else who has to clean up the mess and probably years later.

Rarely does comeuppance arrive within the space of a week, let alone within minutes.

Even more rarely still do the consequences of mistakes-past arrive at the station at exactly the same time as mistakes-present.

Which is why the past nine days in the UK has been so incredible to watch. Two Fridays ago the Chancellor of the Exchequer Kwasi Kwarteng made a statement to the House of Commons outlining the new government’s economic plan.

Britain's Chancellor of the Exchequer Kwasi Kwarteng during an appearance on the BBC's 'Sunday Morning' political television show.

It’s only new in the sense that both he and the Prime Minister Liz Truss have only been in their jobs for less than a month, the Conservatives have been in office for 12 years.

Kwarteng was expected to announce about £30 billion in tax cuts and more detail on a massively expensive – £150 billion a year – plan to subsidise soaring energy bills.

Instead he shocked the political world, and it turned out the financial markets, by announcing the government planned to borrow £70 billion to pay for, among other things, unfunded tax cuts including the abolition of the top rate of income tax from 45p to 40p in the pound.

The cuts, along with yet to be announced plans to improve productivity, were meant to boost economic growth 2.5 per cent over the medium term.

The verdict of the markets was immediate, savage and ongoing.

No sooner had he sat down than the pound began to sink.

The pound hit an all-time low at $1.0350 on Monday, with traders spooked by a UK tax giveaway they warned could further fuel inflation and significantly ramp up British state borrowing. Picture: Daniel Leal

When markets reopened on the following Monday, it kept sinking, getting close to parity with the US dollar and though it has since recovered, it is tipped to drop over the next six months.

Far more damaging was the effect on the bond markets which fund the UK’s debt. By Wednesday the Bank of England had been forced to step in and buy up £65 billion in UK Govt bonds because spiking interest rates they were paying were in danger of crashing the majority of the country’s pension funds.

Meanwhile, out in the real world, building societies and banks began withdrawing from the housing market, pulling 40 per cent of mortgage products by last Friday, because of interest rate uncertainty.

Worse, far worse, may be yet to come. UK house prices were already flatlining and if interest rates jump from their current 2.25 per cent to 5 or 6 per cent as the markets are predicting, this will become a rout.

The rate jump is likely because the injection of money from the tax cuts – along with the money unexpectedly printed through the bond purchases – risks driving inflation higher than the eye-watering 9.9 per cent it is today.

The Bank’s stabilising bond purchases are only intended to calm the markets until October 14, which means that if Kwarteng and Truss are to avoid panic returning, they have a fortnight to come up with a plan.

Prime Minister Liz Truss is seen returning to Downing Street on September 27, 2022 in London, England. Picture: Rob Pinney

Unless they decide to reverse course, which doesn’t look likely and would probably see them both out on their ears, the only thing they can probably do in the short-term is to freeze – read cut – spending.

The people who will bear the brunt of that will of course be the poorest and those who need the country’s health service. All in all, a fine mess, but not entirely their fault.

While the current crisis may have been sparked by a plan to borrow billions in unfunded tax cuts, you can sort of understand why they thought they could get away with it.

After all, ever since the GFC governments around the world have been printing money – even Australia joined the fun.

But what Rudyard Kipling called The Gods of the Copybook Headings – those ancient pieces of wisdom that though we try to escape them eventually come back to bite us – decreed that all this extra money would cause inflation. And though almost 15 years there was asset price inflation, we got away with it.

The shock to the world’s supply chains caused by the pandemic followed by sudden rise in global energy and food prices caused by the war in Ukraine, put an end to that.

Central banks need to get inflation back under control, which means no more cheap money.

Picture: Justin Tallis.

So if you want to run a budget deficit of 8 per cent of GDP as Kwarteng and Truss do, you are going to have to pay for it.

Are there lessons for us in this?

Our budget deficit, though tipped to get worse, was last year only 1.4 per cent of GDP.

What we share in common is woeful low productivity growth and though there’s been a lot of talk, little evidence we know how to improve it.

But the real lesson is that the laws of economic physics have not been suspended or as Kipling put it: “As surely as Water will wet us, as surely as Fire will burn, The Gods of the Copybook Headings with terror and slaughter return!”