Your weekly economic update from the team at FXD Capital
Over the past year, the UK government borrowed £303 billion. For context, drawings the year before that were only £57 billion. A 5x increase in borrowing now represents 14.5% of annual GDP, due wholly to the Covid-19 pandemic. While some may think that the peak is here, the debt figures are only likely to go up as losses from the various business lending programmes gradually emerge.
I recently read The Deficit Myth by Stephanie Kelton; a book focussed explicitly on the concept of Modern Monetary Theory (“MMT”).
MMT is relevant in these times due to the volume of money printing enacted by governments in response to the challenges of 2020. I won’t go too much into the weeds, but the pretence of Kelton’s argument is that governments shouldn’t act like households, or businesses, in terms of believing they need to balance the books. You, or I, need to worry about our balance sheets because we are currency users – we can’t print money! For sovereign governments, who print hard currencies (USD, GBP, AUD, JPY), deficits are a state of mind – as they can print money, meet any obligation and even retire debt on a whim
Tax is the primary vehicle for controlling the economy in the mind of MMT. When the government raises or lowers interest rates, the effect on households is far less dramatic than it is to, say, a bank. The way rate changes seep through into mortgages and savings rates is idiosyncratic and not uniform. For example, some households would not have seen the base rate fall to 0.1% last year and think, “Even though the world is uncertain, I need to buy a house right now”. On the other hand, tax is direct and tangibly raises/lowers how much money households have to spend and is a far more visceral form of controlling an economy.
At first, the argument seems fanciful and brings to mind images of the Weimar Republic, Zimbabwe, Argentina or Venezuela. But for developed nations, when you look at all the debt incurred over the past year and how little inflation has responded or currencies devalued, you can see that perhaps in unison, this does work. If every developed country is printing money and increasing deficits, but investors are still buying government bonds, what happens next? Will Gold or Bitcoin be the safety net? Or are investors comfortable with the interest rate received and the guarantee that they have zero credit risk?
As a timely reminder to that, yesterday, President Biden announced plans to change capital gains taxes in the US, and the stock market immediately fell 1%. That’s because, unlike interest rates, the jeopardy of tax increases directly affects sentiment, and now investors will be selling to harvest gains before the raises come through. Consumer (household) behaviour can be controlled far more directly through taxes over interest rates.
Retail sales grew faster than expected last month, with clothes and gardening products leading the way. ONS data printed a 5.4% rise in the month of March, beating Reuters’ poll estimate of a 1.5% uptick. Consumer confidence data from GfK gave additional buoyancy to spending news, with its most recent survey putting optimism at its highest rate since before the pandemic started last year.
With consumers sitting on a reported £180 billion of savings amassed during lockdowns, the next six months will be fascinating to see what trends emerge. While some are looking to spend, others not: How much of that £180 billion is now in the stock market? Besides, while there may be a desire to buy, the supply shortages in certain areas are acute, which could further spike inflation. Anyone trying to buy a bicycle, furniture or BBQ will be all too aware of this.
As referred earlier, President Biden announced a string of tax rises targeted at wealthy Americans, principally income tax (37% to 39.6%) and capital gains tax (top rate to 43.4%). The goals of the raise are to support an initiative called the American Families Plan, which intends to extend child support, pre-school and community college funding packages.
The new Biden administration is pushing ahead quickly with its agenda. Alongside tax raises, a $2 trillion infrastructure bill is in the works, and Biden also pledged this week to cut US carbon emissions by 50-52% below 2005 levels by 2030.
After announcing plans to step up its bond purchasing programme in March, Christine Lagarde this week said that any talk of it tapering off soon is “simply premature”. While there is renewed optimism for the Eurozone recovering quickly from 2021 lockdown measures, support to maintain low borrowing costs will continue to be enacted by the ECB. The eurozone economy will likely have contracted in the first quarter of the year, and Lagarde expects only 1.3% growth in Q2.
All the best for the week ahead,
Our weekly column is written by Alex Graham, Economic Advisor to FXD Capital. Originally a bank treasurer, Alex’s weekly roundup intends to provide a conversational, top-down view of what is going on in world macroeconomics and how it impacts business on the ground level.
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