‘Voodoo economics’ is dead but won’t lie down.
The UK’s Chancellor, Kwasi Kwarteng, scythed a field of taxes last Friday, pushing the Pound Sterling almost to parity with the US Dollar, its lowest since 1971. That’s good and bad news – Britain’s exports have thereby become more competitive but its imports have got pricier; bad news for inflation, already nearly 10%.
The Sterling slump was the judgement of the financial markets – they think that Kwarteng’s tax cuts – the most sweeping since 1972 – in an effort to kick-start economic growth, will very soon run into a brick wall.
The last time the country saw such tax cuts was in 1972, when a pint of beer cost 14 pence (in London today the price is around £7) and the average house price was £5,158 (as opposed to today’s average of £292,000). As Kwarteng spoke, the gold price (in Pound terms) immediately shot up by more than 1%, from around £1,496 to almost £1,517/ounce. In early trading on Monday this week the gold price (in Pound Sterling terms) was around £1,534/ounce – up by 2.5% from the day when Kwarteng made his announcement.
Back in 1972, Anthony Barber was the (Conservative Party) chancellor. He slashed taxes in what became known as a ‘dash for growth’. Economic growth was indeed stimulated but inflation rose, many workers went on strike, the country was put onto a ‘three-day week’, the economy fell into stagflation, and the Conservative Party lost the general election in 1974. Not an example Kwarteng wants to follow.
Kwarteng’s tax cuts will be funded by borrowing – the Institute for Fiscal Studies, a British think-tank, estimates that the UK’s borrowing will rise to £190 billion this year, the third-highest peak since the Second World War. Prime Minister Liz Truss reckons the tax cuts will stimulate economic growth of 2.5% a year over the medium term, confident that the money not snaffled up by the government will ‘trickle down’ into the wider economy.
It’s essentially the same plan adopted by the 40th President of the US, Ronald Reagan. Its roots go even further back, to the 1890s, when it was called ‘Horse & Sparrow economics’, the idea being that if you stuffed your horse with more oats than it could digest then its manure would contain undigested oats, which sparrows could pick at. The 29th US President, Warren Harding, used Horse & Sparrow Economics to tempt voters in 1920, promising to cut the then 91% tax bracket to 25%; he won the election, the ‘Roaring 20s’ resulted. Reagan reinvented Horse & Sparrow economics and called it trickle-down economics. Very little is new under the sun.
Reagan’s supply-side policies involved very favourable tax cuts for the richest Americans in the belief/hope it would promote economic growth as society overall became richer. A subsequent President, H. W. Bush, sceptically called Reagan’s policies “voodoo economics”. Prime Minister Liz Truss and her Chancellor are now trying voodoo economics all over again. “Lower taxes lead to economic growth, there is no doubt in my mind about that”, said Truss. She’s out of step with US President Joe Biden, who has said he is “sick and tired” of trickle-down economics and that “it has never worked”.
Biden shares the almost universal scepticism that the extensive tax cuts Kwarteng announced will bring about 2.5% economic growth. The UK has had more than a decade of sluggish growth; between early 2008 and early 2022, trend growth of output per UK worker was 0.5%/year. Reversing that trend will be difficult and take much longer than the two years the Truss government may have before it faces a fresh general election.
Moreover, this massive fiscal stimulation is being criticised for other reasons: it’s seen by trade unions and special interest groups as extremely unfair. Those earning £1 million a year will have £54,400 ($60,700) extra in their pockets while those earning £25,000 ($27,900) will benefit to the tune of about £280 ($312). The government has also removed the cap on bonuses for bankers, who many believe escaped serious punishment for their role in the Great Financial Crash of 2008.
Social divisions will be fuelled; the UK is already racked with inequality, and is the fourth most unequal state in Europe according to the Organisation for Economic Cooperation and Development (OECD). Making the wealthy even wealthier is ‘unfair’ but by definition the poorer in society spend a proportionately higher amount of liberated money on immediate consumption; the hope is that the richer will do more investing with their much more ample extra cash.
But the biggest contradiction inherent in this latter-day Horse and Sparrow economics is that it flies in the face of the Bank of England’s mission to foster price stability. With inflation in the UK currently almost 10% – five times higher than its target – the Bank is already struggling. The Bank has just raised its base interest rate to 2.25%, making mortgage, credit card, and other debts more expensive – and squeezing many people already anxious about how they can pay their bills. Cutting taxes at any level is bound to throw some fuel on the inflation fire.
Whether it’s dressed up as ‘supply-side’ economics, ‘trickle-down economics’, ‘voodoo economics’, or ‘Horse and Sparrow economics’, the bottom line is that the Truss government is going for broke. Martin Weale, the academic economist who served at the BoE from 2010 to 2016, said it will “end in tears” and a run on the pound – which has already started.
Willem Buiter, a former Bank of England rate-setter and Citi’s chief global economist until 2018, said Kwarteng’s plans to ramp up borrowing were “totally, totally nuts”.
“I think the UK is behaving a bit like an emerging market turning itself into a submerging market… I think Britain will be remembered for having pursuing the worst macroeconomic policies of any major country in a long time”. That’s the view of Larry Summers, former US Treasury Secretary. He called the Truss policies “naïve” and “wishful thinking”. He could be wrong. Let’s hope so.
The instant judgements that journalism specialises in have been harshly negative about Kwarteng’s economic plan, arguing that trickle-down economics fail to improve economic growth and merely enrich the already wealthy. Special interest groups will inevitably protest about this social engineering. However, it may be argued that inequality is at the heart of our society and Kwarteng’s moves simply reinforces what we already live with. Taxation per se can be seen as rank unfairness, legitimised theft by the government to pay for services we deem socially necessary.
Yet the highly educated Kwarteng (Eton, Cambridge and Harvard universities) seems unaware of academic research that also condemns voodoo economics. In the Socio-Economic Review of April this year, a study of 18 countries between 1965 and 2015 belonging to the OECD found that tax cuts for the rich “do not have any significant effect on economic growth or unemployment. Our results therefore provide strong evidence against the influential political–economic idea that tax cuts for the rich ‘trickle down’ to boost the wider economy”.
A much more serious worry is that this gamble, experiment, whatever you want to call it, will fail. The sugar rush of these massive tax cuts are likely to push up the costs of government borrowing, will give a fresh boost to inflation, and drive the BoE to put rates even higher. Ruth Gregory, senior UK economist at Capital Economics, spoke for many economists: unless the gamble to boost the underlying growth rate works, “today’s fiscal package just means more inflation, higher interest rates and a higher debt ratio in the future”.
In such a context of government gambles, the likelihood of even higher inflation and a further sinking of the value of the Pound, the options for self-defence are few. Gold has lost value in Dollar terms this year, as the Dollar and Dollar-denominated assets have been relatively strong while all else has weakened. But in Pound Sterling terms the gold price has risen more than 8%. Since Anthony Barber tried his ‘trickle-down’ experiment the Pound has lost more than 90% of its purchasing power; this year alone it will have lost some 10% thanks to inflation. The pounding of the Pound will do UK plc no good; but it has already benefitted the gold price when measured in Pounds.
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.