The spectacular reversal of economic policy by British Prime Minister Liz Truss in a few weeks illustrates the influence of the markets on governments to bring them back into budgetary orthodoxy, sometimes at the risk of restraining them too harshly.
What happened with the government of Liz Truss “is a somewhat extreme example of the reaction of the markets when a change in policy appears not to be credible”, notes Antoine Bouët, of the Center for Prospective Studies and International Information (CEPII), interviewed by AFP.
After a decade of low interest rates and low inflation since the 2008 financial crisis, “we are witnessing the return of the bond militias”, observes Kay Neufeld, of the economic think tank CEBR, referring to the nickname of the market brokers of the debt.
From the exit of the pound from the gold standard in 1931 then in 1992 from the European exchange rate mechanism, passing through the Asian crisis or the turn of the forced rigor of the government of François Mitterrand in 1983, it is not the first time that governments have come up against the verdict of the markets.
The presentation on September 23 by the former British Minister of Finance Kwasi Kwarteng of budgetary measures combining support for energy bills and tax cuts targeting the wealthiest, all financed by debt in the midst of a surge of inflation, caused fear Investors.
The pound fell to an all-time low and UK government borrowing rates soared, a sign that investors were selling off these sovereign debt securities.
The Bank of England had to intervene to avoid a financial crisis, and the International Monetary Fund (IMF) called on London to change course.
Three weeks later and after only five weeks in office, the Chancellor of the Exchequer Kwasi Kwarteng was sacked, replaced urgently by Jeremy Hunt, who is doing the exact opposite of what Liz Truss had promised: he is canceling almost all tax cuts, cuts in energy aid, and warns of “very tough decisions ahead” on public spending.
Antoine Bouët believes, however, that the markets do not force governments to follow the economic policies in vogue in financial circles at the time.
“There is a relatively large room for maneuver left to governments on condition that they do not completely get out of the nails”, assures Antoine Bouët. In other words, they have more veto power than dictating political or economic direction.
For him, if there had been lower tax cuts, or more targeted protection against energy prices rather than a universal subsidy, “perhaps there would have been corrections on the markets but on a smaller scale.
“There, it was brutal because of major inconsistencies,” he continues. Liz Truss’s budget package was seen as medium-term inflationary and therefore the opposite of what the Bank of England was trying to do, namely to calm inflation above 10%.
“Intimidating Everyone”
Russ Mould, strategist at AJ Bell, recalls that Bill Clinton adviser James Carville once joked that he wanted to reincarnate in the bond market, because “you can intimidate everyone”.
The bond or foreign exchange markets, purring in calm weather, are of such magnitude that they can “turn everything in their path upside down” in heavy weather, adds Russ Mould.
Except when, like then-ECB President Mario Draghi during the European debt crisis in 2012, you threaten to save the euro “whatever it takes,” he notes.
Speculators had ended up throwing in the towel, defeated by the ECB’s determination to use its powerful weapons (asset buybacks, interest rate cuts, etc.), but the euro had weakened for a long time and policies of austerity measures imposed subsequently had plagued several countries of the European Union, in particular Spain and Greece.
“Markets are sometimes wrong and so are economists. During the European debt crisis, it is regrettable that they pushed so much for budgetary austerity which had far too strong a macroeconomic impact,” admits Antoine Bouët.