Prime Minister Liz Truss was forced to resign in 2022 after presenting the first budget in decades that truly focused on recovering the fragile private sector with targeted tax cuts, focusing the government's policy on strengthening businesses, giving families some of their hard-earned money, and attracting investment.
The presentation of the budget coincided with significant bond market volatility, and the UK 10-year bond yield rose to 4.5%. The media immediately blamed the budget on the financial market turmoil.
"Her plan for 45 billion pounds of unfunded tax cuts led to economic panic, caused chaos on the financial markets, and forced her to quit her job," The Conversation stated.
However, market data and a recent report by the Bank of England refute the myth that a budget with a tax cut of 45 billion pounds in a 2.2 trillion-pound economy running a structural deficit due to elevated spending creates chaos in financial markets.
Both the yield on the Japanese 10-year bond and the French 10-year bond experienced a similar 20% increase during this period. UK, Japanese, and other developed economies’ bond yields soared due to the mistakes of central banks.
Monetary authorities were wrong about inflation in 2020 when they increased the money supply by more than 25%. They failed to predict the inflationary burst caused by excessive money printing, failed to act when they stated that inflation was "transitory," and continued with excessively dovish policies.
When they realized in 2022 that price increases were not due to supply chain disruptions or transitory, they created the market turmoil that persists in certain parts of the bond market to this day.
"Unfunded tax cuts"
The concept of "unfunded tax cuts" is humorous, as I have rarely encountered the term "unfunded spending increases." Tax cuts give back money to those who earn it. Spending increases take money from taxpayers.
Stating that a deficit is positive when it comes from higher government expenditure and negative if it arrives from tax cuts is simply a socialist dogma that assumes that money must be spent and administered by politicians.
In October 2022, the annual rate of inflation in the United Kingdom was 11.1%, and the 10-year bond yield rose to 4.5% as markets woke up to the reality of persistent inflation and the mistakes made by central banks with ultra-loose monetary policy.
It is absurd to attribute the drastic move in a 2.5 trillion-pound market to a tax cut of 45 billion pounds
UK bond yields did not rise due to Liz Truss’ budget, but because investors had to sell duration rapidly after accumulating risk in long-term bonds expecting a rapid disinflation process.
A month later, Jeremy Hunt announced 55 billion pounds of fiscal tightening to placate markets. Reuters stated that Hunt took this action to reassure markets following former prime minister Liz Truss's pledge of “unfunded tax cuts."
It is absurd to attribute the drastic move in a 2.5 trillion-pound market to a tax cut of 45 billion pounds. Furthermore, it is even more absurd to claim that tax cuts cause market turmoil, while years of overspending and stifling economic growth with higher taxes are perfectly acceptable for markets.
Prime Minister Truss was compelled to resign due to the opposition of investment banks and economic powers to tax cuts and their preference for government spending, which leads to increased money printing, continuous quantitative easing, and financial asset inflation.
No one resigned
We have seen a similar reaction to the United States economic programs. Mainstream Keynesians immediately criticized Trump’s tax cuts as a policy that would increase the deficit.
However, when Harris pledged to add an additional $1.5 trillion in spending to an already $2 trillion deficit budget, most mainstream Keynesians either remained silent, praised it, or offered only mild criticism.
In the UK, Mr. Starmer’s Labour government has presented a budget that increases planned public spending by an average of 69.5 billion pounds, or 2.2% of GDP, a year from 2025-26. Furthermore, two-thirds of the increase will go to current spending.
The budget adds £40bn of tax increases that will further cripple investment and private sector development. After the news, the UK 10-year government bond yield soared to 4.55% in a month with annualized inflation below 2%. No one resigned.
Truss was forced to resign because Gilts rose to 4.5% with 11% inflation, but no one resigned with Gilts at 4.55% and inflation at 1.7%
Wait a minute. Truss was forced to resign because Gilts rose to 4.5% with 11% inflation, but no one resigned with Gilts at 4.55% and inflation at 1.7%.
Rachel Reeves should have abandoned. However, all we seem to read are excuses defending her confiscatory tax proposal and unsustainable increase in unproductive spending.
Even worse, we read Keynesian economists praising Labour's new debt disguise strategy, which involves subtracting the alleged value of assets neither sold nor properly valued.
Starmer should have resigned as well. Clearly, the financial impact on the UK finances is worse compared to 2022, and the real yield on the UK 10-year bond has increased since Truss' forced resignation.
The Truss tax cuts, if they had been implemented, would have shaved just 25 billion from 1,100 billion pounds of government receipts in 2026–27.
Even the most conservative assumption of a positive impact on the private sector would have resulted in higher receipts due to improved investment, consumption, and economic growth. Truss should have announced a set of budget cuts.
However, at the time, she and her team likely also believed in the monetary authorities' analysis of rapid disinflation, the transitory effects of higher prices, and a very dovish monetary policy. Indeed, most market participants held this belief until the impact of monetary inflation became evident.
Markets create a perverse incentive to support socialist policies
The key takeaway is that markets create a perverse incentive to support socialist policies, regardless of their detrimental effects on the economy. The neo-Keynesian dogma has overtaken financial media, some banks, and most sell-side analysis.
When a government announces a significant increase in the size of the public sector in the economy and a significant reduction in the private sector, financial market participants anticipate increased quantitative easing, multiple expansion, further asset inflation, and a subsequent positive impact on equities and bonds from the decline in the purchasing power of the currency.
If the UK doesn’t return to the low tax, small government, if governments don’t abandon neo-Keynesianism, the UK will stagnate and impoverish further - Daniel Lacalle
The "bad is good" market action exemplifies the profoundly anti-social and anti-economic behavior that occurs when economic figures worsen. Two generations of market traders, who have only witnessed multiple expansions due to central banks' easing, interpret it as a "buy" recommendation, even when government policies result in increasing debt and economic stagnation.
Conservative politicians and libertarians should beware of the contradictory “market logic” that rewards government squandering if it entails central bank printing.
There is a perverse incentive to promote socialism even if the economic consequences are disastrous, as anyone has seen when the economy stagnates, prices rise, and citizens are made poorer, but equity indices rise due to multiple expansions.
Market participants should begin to comprehend that incentivizing a continuous increase in government size within the economy is paving the way for a destructive force that will undermine financial markets and their crucial role in economic growth.
Defending socialism to avoid backlash from leftist media is being a coward. Defending socialism to gain a short-term financial benefit from insane monetary policy is unforgivable.
Implementing the Truss budget would have significantly improved the UK's current situation. Instead, the Conservative government succumbed to a mild socialist agenda, resulting in a situation where the UK now suffers from both extremes.
If the UK doesn’t return to the low tax, small government, and supply-side measures that made the country flourish, if governments don’t abandon neo-Keynesianism, the UK will stagnate and impoverish further, just as it did in the seventies.
