September 25, 2022

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Emergency Budget: Kwasi Kwarteng

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This week, the eyes of the world will be on the UK, but the day after tomorrow, attention will shift from the spectacle of splendor and sorrow to the harsh reality of how her new government will seek to restore the national economy and its finances.

From this side of the Atlantic, the backdrop of Kwasi Kwarteng’s emergency budget next Friday looks pretty bleak.

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The dollar holds high as a safe haven in turbulent times, and the pound is well, it’s been hit hard by falling below the level it was against the dollar when it was kicked out of the European Monetary System on Black Wednesday 30 years ago. back.

It made George Soros a fortune, ruined the reputation of John Major’s government, and paved the way for New Labor in 1997. It’s a painful memory, and the stakes are high now.

The immediate political judgment will be made in Britain, but in some ways the financial and economic judgment of the rest of the world will matter more. If this government can convince the world’s finances that this budget will revive the economy, then it stands a chance of a happier outcome than the one that followed Black Wednesday. And when it comes to global finance, read the US, because that’s where the money is. So what will the big money look for?

Well, first of all, it should be said that the fate of the pound sterling does not occupy much space in America. The important next decision of the Federal Reserve – can it raise rates by a whole point, and not just 0.75%? – Is the bottom of a bear market in stocks, the prospect of a global recession, and so on.

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British assets is a niche market with some interesting opportunities, but it remains out of fashion. Fashion is changing, but before that happens, there must be a general restoration of confidence, and this is the challenge the new chancellor faces. We don’t know the details, of course, but we know enough about the thrust of his proposed policy to see the root of the problem.

The first task will be to convince global investors that the increase in the budget deficit will be temporary. They will only be willing to finance it at an affordable cost if they see an opportunity to return to a deficit of, say, 2 percent of GDP.

There is no ideological opposition to tax cuts – how can there be in America? In any case, what seems to be proposed is basically not to increase the taxes planned by Rishi Sunak, the increase in national insurance premiums and the corporate tax. But there must be a medium-term plan for the numbers to add up.

The second challenge will be to put enough flesh on the bones of this Big Bang Two idea to induce US finance to invest more in the UK. I find the branding of the second Big Bang a bit silly. The initial restructuring of the city’s securities markets in 1986 came about because London was under a regime different from that of the United States – separation of speculators and brokers, prohibition of foreign investment in stock exchange firms, etc. – and this way of managing affairs became unstable.

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There are some regulatory changes that can be made now that the UK is no longer a member of the EU, but they are tiny in comparison. Take, for example, this case that there is no longer a cap on bank bonuses. What actually happened was that the banks had to increase the base salaries of their stars to make up for the ceiling – from their point of view, this is unpleasant, but does not change the rules of the game. One useful change is the idea that regulators should pay more attention to the city’s international competitiveness.

Promoting London’s financial services used to be part of the Bank of England’s informal mandate when it was the main regulator. He worked hard on this, in particular organizing the reorganization after Big Bang. This role has disappeared, so there is a return to past practice.

The third issue, and I think the decisive one will be whether the government can significantly increase the underlying growth opportunity to 2.5 percent. It should be achievable.

But the world of finance is a cynical place and will not be impressed by policies that set growth targets. If serious efforts are made to reduce or remove the barriers to growth that have been imposed, often by governments, then global markets will be impressed. If it’s just pomposity, they won’t. In many ways, it’s a big week ahead.