SA’s Godongwana to UK’s Kwarteng: Welcome to the emerging market club

27 Sep 2022

In many ways, the UK is starting to develop the characteristics of emerging market economies, the features of which will be all too familiar to South Africans.

The state of sterling has been the talk of the markets over the past few days as the UK’s currency approached parity with the dollar. The trigger event over the past week was the new UK administration’s decision to go full-on Reaganomics by cutting taxes and relying on a grand, supply-side push to propel the stuttering UK economy forward, as opposed to boosting demand, which is the Keynesian solution to dire economic situations.

The financial markets, in their inimitable way, responded brutally to the mini-budget proposals of Kwasi Kwarteng, the new UK finance minister, to decrease taxes and hike borrowing. Nothing in gilt markets in the past 35 years — not the UK’s ejection from the Exchange Rate Mechanism, 9/11, the financial crisis, Brexit, Covid or any Bank of England move — compares with the price movements in reaction to the chancellor’s mini-Budget, writes economics commentator Toby Nangle in the Financial Times.

The commentariat has now gone completely bonkers. Former US Treasury Secretary Larry Summers’ verdict was that “the UK is behaving a bit like an emerging market turning itself into a submerging market”.

And you can see his point. In many ways, the UK is starting to develop the characteristics of emerging market economies, the features of which will be all too familiar to South Africans. One of the characteristics of emerging market economies, writes John Cassidy in The New Yorker, is that investors tend to be more sceptical about public finances and demand additional compensation for holding their government’s debt.

The UK’s bond market responded in a characteristically emerging market way to Kwarteng’s announcement. The yield on 10-year British bonds jumped from 3.46% to 4.28%. The usual variation is two- or three-hundredths of a percentage point. That is equivalent to the entire global market saying, we just don’t think your trickle-down economics idea is going to work.

Another characteristic feature of emerging markets economics is that currencies fall even when interest rates are increased. Technically, an increase in interest rates ought to be supportive of the currency, because it makes a country’s debt more attractive, which tempts investors. Last week, the Bank of England raised interest rates for the seventh time in a year. But the pound continued to slide.

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And there is more, as Nangle points out. In typical developed-economy economics, a weaker currency makes exports cheaper and imports more expensive. Since 2007, the pound has lost a quarter of its value against the euro and almost half of its value against the dollar. That has hurt UK imports, but it hasn’t improved exports on a commensurate scale.

The whole unravelling of the UK’s economic position conjures a sweet image in my mind of Kwarteng and SA’s finance minister, Enoch Godongwana, sharing a late-night tipple at the club, complaining about those godawful running-dog imperialist amorphous markets.

Of course, it’s easy to get carried away here. The UK is still the world’s sixth-largest economy. The other difference is that Kwarteng’s proposals are night-and-day different to any Budget ever proposed by the ANC, all of which hugely favour disastrous tax-and-spend policies. If Godongwana and Kwarteng do ever share a wee dram, my hope would be they would share more than fury at the indeterminacy of financial markets and Kwarteng would convince his counterpart about the desirability of decreasing state overreach a little.

The other reason not to get too carried away is that all currencies, including the euro and the rand, are really getting thumped by the dollar. In the “risk-off” environment, money managers tend to hold their now-enlarged cash holdings in the currency least likely to decline, and that’s the world’s reserve currency, the dollar.

But the extent of sterling’s decline is telling us something else. Janan Ganesh, also writing in the FT, has an interesting theory that the UK, particularly on the right, has become overenamoured with US politics, despite the fact that Europe is concretely much more important to the UK’s economy. This is partly because of the distorting effect of language, he says. “Because the UK’s governing class can follow US politics as easily as their own, they get lost in it.”

Prime Minister Liz Truss and her cohort of Tories “have none of that snide, but ultimately healthy, distance from the US. Take her vaunted supply-side revolution. Like all armchair free marketeers (she has never set up a business) she believes her nation is a blast of deregulation away from American levels of entrepreneurial vim. It isn’t.”

It’s an intriguing theory, but I think there is more at work here. If you look at the actual position that the US economy was in at the time of Reaganomics and the actual position that the UK economy is in now, they are just not comparable.

In the US, the state had become pretty overbearing when Ronald Reagan was elected president. For example, the top marginal tax bracket for personal income tax at the time was a sweltering 70%; Reagan brought it down to 50%. The UK’s top marginal rate is now 45% (before Kwarteng’s proposed decrease to 40%) — the same as SA’s; it’s hardly a global outlier.

It’s arguable that what the markets are indicating is not so much a distaste for supply-side flexibility, but rather a belief that after 13 years of Conservative Party rule, the main features of Reaganomics — tax decreases and deregulation — are already largely baked into the cake. The marginal gain from intensifying Reaganomics, already much debated as a tool, will necessarily yield lower returns.

The markets are also responding to a sense that the new UK government is, in that wonderful Afrikaans description, ’n bietjie kortbroek — a little lacking in the experience department. That will change in time, but you can’t go through five prime ministers in a decade without coming up a bit short.

In the meantime, we in SA can savour, just for a moment, the week in which the UK joined us on the reserve bench of global economics. DM/BM

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