[The Soup Nazi]

...cont'd

Yet on Friday, the Truss government announced plans for big tax cuts, notably a 5 percentage point cut in the tax rate on top earners and cancellation of a planned tax hike on corporations. Unusually, these plans were described as a “fiscal event” rather than a budget, allowing the government to avoid presenting any detailed fiscal or economic projections — projections that would surely have been either dire, ludicrous or both. But officials still insisted, despite all the historical evidence to the contrary, that their tax cuts would do great things for the British economy.

Obviously, I don’t believe their assurances. More important, neither do financial markets. Interest rates soared on the prospect of increased government borrowing, while the foreign exchange value of the pound plunged.

Either of these market movements would, on its own, have been a signal that investors don’t think the Truss government knows what it’s doing. But their combination is especially ominous.

You see, when advanced countries run big budget deficits, we normally expect their currencies to rise. That’s because we expect their central banks to raise interest rates to offset the inflationary impact of the budget deficit, and these higher interest rates tend to attract increased foreign investment. That is in fact what happened under Reagan, where a surging budget deficit — caused by tax cuts and increased military spending — led to a very strong dollar:

 

When deficits strengthened the dollar
FRED

But right now, British markets aren’t acting like those of an advanced country. They are, instead, behaving like those of a developing country, in which investors tend to see budget deficits as a sign of irresponsibility and a harbinger of future policy disaster.

The markets may be overdoing it. Britain isn’t Argentina, and it surely has the economic, the administrative and, I think, the political capacity to turn things around. But the fact that markets are treating it as if it were Argentina shows just how extraordinary a crisis of confidence Liz Truss has managed to create within days of moving into No. 10 Downing Street.