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Category: Bullion Bulletin

Bullion Bulletin: New leader, old problems

In the UK, Prime Minister Liz Truss takes office "with the economy in as dire a state as it's been since the 1970s" says Bloomberg. Inflation is at...

11 September 2022

Gary Mead

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In the UK, Prime Minister Liz Truss takes office “with the economy in as dire a state as it’s been since the 1970s” says Bloomberg.

Inflation is at 10.1%; next year it might breach 20%, for the first time since 1974. Interest rates might rise to almost 5% by May next year. Energy bills (now capped at huge cost) were looking like pushing many as 14 million households into fuel poverty. The Bank of England (BoE) expects a recession by the end of this year. Trade unions are talking of a national general strike, which would be the first since 1926. The Pound Sterling is at its lowest in almost 40 years; investors might be starting to think the UK’s economy is in trouble – which it is. The UK’s trade deficit (the difference between the value of its exports and the cost of its imports) was £27.9 billion in the second quarter of this year, the largest quarterly deficit since 1997.

What can Truss do to tackle these problems, any one of which would cause an almighty migraine for a Prime Minister? She gets full marks for bullishness, proclaiming “we will deliver, we will deliver, we will deliver” as she was declared the winner of the contest to be the Conservative Party’s new leader (and thus, de facto, Prime Minister). But what will she deliver?

Early in her campaign to be selected by the 172,000 or so members of the Conservative Party she pledged massive tax cuts – which might stimulate economic growth but only in the long term. Truss said her tax cuts will cost £30 billion a year, but others put the cost at almost double that. All the UK’s problems need responses now.

Prime Minister Truss has chosen a short-term option to tackle the rising tide of household and business energy costs, giving an “energy price guarantee” (effectively a retail price freeze, no matter what wholesale prices do) to households or two years and six months to businesses. She obviously hopes this will give her Conservatives a chance of winning the next general election, which might not be until 2024. Government officials have not said what the gross cost of this price freeze will be, but estimates have put it at about £150 billion; it could be much higher, with the taxpayer massively exposed to possibly rising wholesale gas prices. The risk is that kind of mammoth handout – far more than made during Covid-19 – will vastly increase government borrowing. Simply servicing the UK’s existing national debt will cost around £100 billion this year.

Debt interest spending was forecast to reach £83 billion next year (2022-3), the highest nominal spending ever and the highest relative to GDP in more than two decades. It’s nearly four times the amount spent on debt interest in 2020/21 and exceeds the budgets for day-to-day departmental spending on schools, the Home Office and the Ministry of Justice combined.

Populism – the need to win votes – struggles against economic reality. The UK government’s gross debt has risen astonishingly rapidly in just six years, from £1.731 trillion in 2016, to £2.382.8 trillion in 2021. As a proportion of debt to gross domestic product (GDP, what the UK produces) it has risen from 85.8% in 2016 to 102.8 last year. There’s no simple guidance as to what the GDP/debt ratio should be – Japan’s for instance is 260% but investors consider the likelihood of a Japanese sovereign default remote. The key is credibility – are the important institutions, such as the central bank, robust and independent? – and the relative strength of the economy. On that score the UK is weak. The National Institute of Economic and Social Research said in June this year: “In the three decades since the Second World War, the average annual productivity growth rate (output per hour worked) was around 3.6%. The following three decades saw this fall to around 2.1%. From the start of the financial crisis in 2007 to 2019, this declined even further to 0.2%…if productivity had continued to grow at two per cent per year in the last decade, it would have meant an extra £5,000 per worker per year on average”. Truss has said she is a “great believer” in the independence of the Bank of England, but she has also said she will “review” the bank’s mandate.

In 1976, a previous Prime Minister, the Labour Party’s James Callaghan, told his party’s annual conference: “We used to think you could spend your way out of a recession and increase employment by cutting taxes and boosting government spending. I tell you in all candour, that option no longer exists”. That year the government, struggling against a variety of internal (a stagnant economy) and external shocks (including rapidly rising energy costs: sounds familiar?) was forced to borrow £3.9 trillion from the International Monetary Fund (IMF).

The road ahead for the UK economy is thus littered with risks. Former Chancellor of the Exchequer Philip Hammond says “I’m sceptical about whether we’ve got room for big increases in spending and tax cuts…The UK economy is perhaps more fragile than many UK citizens understand”.

Where does this leave gold? Because gold is priced in US Dollars, when the Pound Sterling falls against the Dollar then gold costs more in Sterling terms. But this works both ways – as the stronger Dollar has made gold more expensive for buyers in other currencies, gold in currencies other than Dollars has done remarkably well in 2022; in Pounds Sterling for example the gold price has gained more than 9% this year, despite ups and downs.

The risks for the UK economy may defeat Liz Truss. One of those risks is baked in, which is that the Pound is set to lose at least 10% and maybe 20% of its purchasing power. Perhaps the biggest risk for individuals is failing to try to hedge, to take safeguards, against what is likely to be a stony road. Gold remains one of those safeguards.

At Glint, we make every effort to demonstrate a balanced conversation between gold, crypto and fiat currencies when it comes to purchasing power and, while we strongly believe that gold is the fairest and most reliable currency on the planet, we need to point out that it isn’t 100% risk free. While we have seen a steady increase over time, the value of gold can fall, which means that its purchasing power can also decline.

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