Scathing comments aside, Truss’s performance is no joke. For 10 days, the British pound has balanced dizzyingly from weak to extremely weak to just weak again. Long-term government bonds, maturing in 50 years, lose a third of their value in one stage, recovering from that without precedents dive only when the The Bank of England intervened. Foreign watchdogs, from the International Monetary Fund to the rating agency Standard & Poor’s, have condemned Truss’s unfunded tax cuts, which triggered the defeat.
Clearly this is bad for Britain. Truss’s net approval rating has collapsed from negative 9 percent to negative 37 percent in the space of a week. But Truss’s situation also reflects a larger problem. In supposedly advanced economies, the return of inflation has magnified the risk of extravagant political gestures. For the most part, however, politicians have missed the message.
For 23 years, the period from the 1998 collapse of the Long-Term Capital Management hedge fund to Biden’s 2021 stimulus, quiet inflation allowed central banks to cushion policy failures. Weak regulation could allow finance to spiral out of control; but in 1998 and repeatedly thereafter, rapid interest rate cuts cushioned the blow. Politicians may neglect preparing for a viral pandemic, but central banks bought government bonds for trillionsproviding politicians with the cash to boost battered economies with stimulus checks.
The return of inflation has changed all that. The main mission of central banks is to stabilize prices, so that the money in your pocket approximately maintains its value. Money is supposed to be a store of wealth and a unit of account: when it stops performing these functions, the economy’s operating system crashes. Because of this inflation-fighting imperative, central banks now have to think twice about endorsing political expediency. The bailouts involve cutting interest rates and buying government bonds. The control of inflation requires the opposite.
Britain’s crisis illustrates the pain of this transition. In announcing his program of unfunded tax cuts, Truss Chancellor of the Exchequer Kwasi Kwarteng behaved like a startup spending money like water, complacently assuming that venture capitalists will supply endless liquidity. With interest rates at zero, the principal apparently costs nothing. Investors would put money into almost any project because of the principle TINA: There is no alternative.
Well now there is an alternative. The Federal Reserve has interest rates rose to combat inflation. Investors can store their cash in US mortgage bonds and collect 6.7 percent, more than double what they would have obtained just a year ago. Like a startup that burns through money without generating revenue, a government that cuts taxes without cutting spending can no longer count on the leniency of the markets. RIP TINA, and hello MARA. The markets are rational again.
But around the world, politicians have yet to adapt. like the economist indicated Recently, leaders responded to the energy crisis of the 1970s by telling people to wear an extra layer and cut fuel consumption. “We are not going to starve,” the West German chancellor calmly observed. Today, on the contrary, politicians launch subsidies to consumers and suspend taxes on gasoline. When the oil crisis hit in 1973, the real value of Britain’s profit bill hardly changed. This time, the government is throwing away 6.5 percent of gross domestic product (GDP) to protect citizens from fuel costs.
And the reflection of the rescue extends beyond the energy sector and Europe. In the United States, the government guarantees bank deposits and mortgages, subsidizes health care, and more; now President Biden is proposing to spend hundreds of billions of dollars to pay off student debt. Adding up the government’s contingent liabilities, The Economist calculates that Uncle Sam is in trouble for debts worth more than six times GDP and that this ratio has skyrocketed of late. In 1979, the bottom fifth of US wage earners received means-tested benefits equal to about one-third of pretax earnings. By 2018, it was about two-thirds.
Thanks to the 23-year inflation vacation, wealthy societies have gotten used to the idea that government can fix things. This remains true to a significant extent: the Bank of England backed up government bonds last week, albeit for a limited time. But to preserve their ability to help in extraordinary times, politicians must exercise restraint in ordinary ones. Inflation holidays are over. Adapting is going to be painful.