176. Trump’s Tax Cuts: America’s Liz Truss Moment

26:28You can sign up for an account today. Only sole traders or limited company directors in the UK can apply. T's and C's apply. When we were last talking about this, Robert was painting an optimistic view that potentially this could be a reset in terms of the financial system and maybe good come from this, weren't you? I had two slightly contradictory views. One is if we were to get a trust moment for America, that would be the mother of all financial crises, like nothing we've probably any of us experienced, including even the global financial crisis. Because if you have a situation where people just lose all confidence in American assets, we're in real trouble.

27:11So we've got to all hope that, you know, in the end, Scott Besson and Donald Trump pull back sufficiently if we're heading for that particular cliff edge. But separate from that, and I think we are seeing this particularly in Europe, I've taken the view that in order to get out of the sort of economic stagnation that Europe, including the UK, has been in, you needed a big external shock. And Trump is that shock. And there are signs, I think, of more rational decision making when it comes to encouraging investment, whether it's regulation. I think throughout the European area, we're not there yet.

27:48And there are lots of vested interests pushing back. But Europe has enormous advantages on the whole stable democracies, on the whole respect for the rule of law, some very creative business people, so long as we can improve the flow of capital to those people. I want to think of the coming decade as potentially Europe's decade. I really agree. And I think there are really good signs that this isn't just hope that it's happening. I mean, the transformation that's happening in Germany on fiscal policy, you know, I sort of describe Europe and I apologies if I've used this before, but Europe, you know, has been so focused on the long term doing the right thing.

28:33We've been really focused on saving the planet and having climate regulations that works through all of our businesses and governments to make sure that we're paying the price of carbon, you know, we're doing our bit to save the planet. We've been not sending checks in the post in the pandemic. You know, we've been very moderate on fiscal policy compared to the US over the last 15 years. Germany, its level of debt since the financial crisis has gone down 10 percentage points, it's gone up 30 percentage points in the US. So we've sort of been behaving ourselves because we've been thinking very long term.

29:10And I think in Europe, there's this sort of realisation that maybe we've gone too far in that, you know, maybe we a bit of short term fun, you know, we've been so worried about the hangover, we didn't even go to the party. And so now we're seeing this loosening up and a bit more focus and an urgency on growth. And the reason I say we're seeing it, we've got this massive fiscal package, I mean, from Germany, the question only really is, can they possibly get the money spent, the volume of money they want to get spent? Is it too much to actually put into an economy all in one go? That's a nice problem to have.

29:43Our Chancellor, Rachel Reeves, would love to have that problem right now. But we're seeing lots of subtle things as well. I mean, there was a statement by the head of the EU, Ursula von der Leyen, who she came out of a meeting with the auto manufacturers. And, you know, she said there were some statements in there, which was like the time to act is now. She really has heard that message from the automakers that, you know, they can't compete with China who don't have climate regulations like we do. And therefore, if we are going to create our own products and our own jobs here, we've just got to help out.

30:16And then the EU-UK reset, you know, the subject of your last discussion. All of these positive things, there is an urgency in Europe. If we don't start to focus inwards ourself, if we don't focus on protecting our own economy and our own growth, then we're going to flounder. And it's provided a glue that's bound the region together, galvanized us into action. And I think it's really positive. So what does that mean then for Rachel Reeves in the sense of what should she do? Because obviously there's a lot of pressure on her at the IMF saying about, you know, you need to think about the fiscal rules and not go too wild.

30:54Stick to the fiscal rules, although maybe do something which actually I did talk about multiple times on this podcast, which is there should be an OBR assessment only once a year. I thought the fact that we had one earlier this year was absolutely nuts. And it's reassuring that the IMF is putting pressure on Reeves to change her approach in that way. I definitely think to have a forecast without the Chancellor's ability to act and adjust based on the news is unhelpful because what it leads to is just speculation. And that's what we saw earlier this year when she did her spring statement. Absolutely.

31:34And speculation can be really harmful because what happens is therefore everybody fears every single tax that might happen. I mean, we saw this in our industry of when we approached the autumn budget, because there was this concern about some of the wealth taxes, capital gains taxes, etc. You've had people withdraw their entire investments and park them in cash on a fear that they were going to get charged to capital gains. And then, you know, in the event it didn't happen, and then they're suddenly, you know, have missed out on this enormous opportunity of having their cash well deployed, invested, not just sat in the bank losing money because of inflation.

32:13And that was because of the fear of the tax. And so I think it's completely right. And we're in that world, aren't we, already of we're building up to the autumn. How is she going to balance the books? Is it going to be spending cards? Is it going to be tax rises? And that's really unhealthy. So I think you're right. However many times the OBR set are forecast, it should be aligned with. And I think once a year is plenty. I mean, I wouldn't want to be Chancellor because she is really guided by and stuck with, you know, she's got these fiscal rules. So this is day to day spending, you know, taxes must cover day to day spending by the end of the parliament, which has given her a tiny headroom.

32:49That's probably been wiped out now by everything that's gone on with Trump, etc. But yet if she does anything like announces, for example, the rowing back of the Winterfield payments or there's talk now of changing the limit on the two child benefits, then the markets will react and go, you can't afford it. So what are you going to do? So then how do you navigate through that? Well, I think the first question is, do I stick to my fiscal rules at all? Do I keep this envelope that I'm working? And she keeps saying she's going to. And she keeps saying she's going to. I mean, I think the one thing that now having worked in number 11 and the Treasury for a period, you know, I did that before this role, is what I realized in that experience is we sort of think the fiscal rules are created for the markets.

33:32And they're actually not. I mean, the market, if I asked a single investor in UK gilts, what is exactly the fiscal rule in the UK? I would be amazed if anyone could tell me. You know, we've changed them on average every two years. So it's not the rule itself and what it says to the market. The rules are actually important in terms of managing your internal conversation. It's when the Department of Education comes and says, I need this for, you know, the teachers. And then the NHS comes as it does every single month and says, I need this additional money. It's her way of saying I'd love to, but I haven't the fiscal rule.

34:10So it's actually much more of an internal diplomacy exercise, I would argue, discipline. It's a scary thought for anybody listening out there. But let's just pretend that I'm a massive bond investor and I'm thinking about where to allocate my money around the world. Presumably one of the big numbers I'll be looking at is actually what kind of appetite for bonds will the British government have over the next year? And I presumably will look at, you know, essentially how much they borrowed in previous years, then I'll compare it with what's coming up. So that must matter enormously. But then do I also worry, okay, so the national debt is now roughly 100 % of national income.

34:55That's huge by the sounds of recent decades, you have to sort of go back, you know, something like 50 years to be at those sorts of levels of indebtedness. I presume I think a little bit about that kind of affordability issue. I might think about the growth rate of the UK, therefore its ability to generate taxes and pay that debt. Those presumably would be the big numbers I would think about, rather than whether or not at any particular moment in time you're going to hit or miss the fiscal rules by a few billion quid. Yes, I think all that's largely right. I mean, I think you have to remember that bond investing these days is sort of the ugly beauty contest.

35:35It's who's the least ugly rather than. So everybody's in a pretty bad state in government finances. Germany was the sort of one bastion of prudence out there. And as we discussed earlier, is loosening up. In some ways, it's simpler for investors. I think they look at an economy and just say, do they have a sensible long term plan? You know, does the government have the ability to have the conversation with its electorate about what it can and can't afford? And does the electorate understand that? What pressure are they going to be under to do silly things? And that's where I actually think, you know, when I'm having that conversation then with clients about what bonds are attractive.

36:21Gilts are actually pretty high on my list at the moment because I feel like our fiscal conversation is quite well advanced. You know, we know the government hasn't got abundant money. I know for certain I'm not going to get an income tax cut or any kind of tax cut coming. And so some of those conversations with the electorate aren't quite as well advanced in other parts of the world. So it's not so bad for us here, actually. So when the IMF says something like Reeves must stick to the fiscal rules or there'll be market backlash, do you agree? I don't think the fiscal rules itself. I think if she said, so suppose we came to the autumn and the UK economy had really weakened.

37:04And it was pretty clear that if she then stuck to the rules by hiking taxes into a weakening economy, that wouldn't be seen actually as sensible medium term policy. And actually the market wouldn't like it. There was a little bit of discussion about that in the autumn. There was a bit of a concern that actually there would be tightening into weakness and that's not seen to be good. So the circumstances matter. The specific rule doesn't matter. But I think it's what the rules symbolize against the backdrop that's important. So if as we approach the autumn, inflation is still sticky, because that's our problem here in the UK, actually.

37:44Inflation is just still stubbornly persistent. Inflation is still a bit sticky. The economy is fine. For all the bad news out there, we've just had a 0.7 % growth rate. We haven't had one of those for a long time. And so if the economy is looking fine broadly and she's not sticking to the rules, that's when the market would take issue. that will be the market saying you have a fiscal challenge you've got to work out how you constrain the size of the government against the tax envelope the uk population is willing to give you you need to work that out so that's why you need to stick to a fiscal rule because this economy doesn't obviously need your help that's the process the market goes but if sorry but let's just talk through what a sensible chancellor would do in circumstances that are certainly plausible right so it is plausible that the trump effect is only sort of i mean i don't think there's evidence that we're in recession in the uk but i think most of us would say that 0.7 percent is probably not sustainable into the second and third quarters because the impact of trump's tariffs and chaos is bearing down on people's spending decisions and businesses investment decisions.

39:02So let's just say it slows down a bit. But inflation is sticky. And she does miss her fiscal rules. There is a deficit on her both projections for current spending and the national debt five years hence. I happen to think these rules are absolutely nuts. But anyway, those are the rules. In those circumstances, and let's only look at it from a market's point of view rather than because there are other considerations, but let's just narrow it down to what, for example, bond investors would be looking for. In those circumstances where she's got to fill a hole, would they prefer tax rises or spending cuts?

39:48Good question. But it needs to go one level deeper of what nature would the tax hikes and spending cuts be. Because what the market will be looking for is what within what she can do is going to be best for growth, but at the same time, not problematic for inflation. Because I think that's where the autumn budget has created some issues because the nature of the tax hike on companies, employer, insurance contributions added to costs. And it does seem to have added into the inflationary pressure. And that therefore limits the Bank of England's job as well in generating growth and supporting the economy.

40:29So I think what the market will be looking at is what type of spending cuts would she focus on? If she starts to slash investment spending or things that they believe are very growth friendly, that would be seen as negative. If it's more medium term restraint on spending, I think that that is where the market would probably view the best as such decision. if it's we're not going to really mess around with the cash flows tax and spending in this year because clearly the economy is going through some difficulties but we've got a really credible plan for example for how we're going to cope with our aging population and actually get the medium term onto a sustainable path.

41:12If you talk to for example pretty much anybody in the Tory party This is also something that you would say is not true of all Labour MPs, but it's probably true of the government. Consensus is now that the only way of saving money on the public spending side of things is through welfare reform. Do you agree with what seems to me to be a deceptively simplistic view? I think the challenge in the UK that we are seeing, which is affecting all of our problems, the economy, productivity and the public finances, is we have had this dramatic fall in number of people working post-pandemic. It's recovered a little bit, but we've got particularly this youth cohort that aren't engaging in the workforce.

42:10And I don't know why that is. I've got a bit of a theory just from the basis of having a business where we employ lots of young people is because a lot of them now are just staying at home and are living with their parents and they it's a bit of a sweeping generalisation but we're finding that a lot of them will come and work and then be like actually I don't really like work and then they don't have the pressure because they just go on and they're mum and dad not saying well you've got to make a contribution well no obviously this is not every young person but we're finding that honestly a lot of them just are like they don't actually need to work because there was a time there definitely was a time mum and dad said all right you live at home but you got but you got to hand over some money but so that doesn't happen anymore obviously i certainly will i can't wait for mine to turn 16 i've already laid out what their rents will be but the point is there are there are this cohort of people but it's hugely problematic of course when the young don't enter the workforce for whatever reason i mean mental health has been part of the conversation about why because then that's affecting the disability payments that comes into the welfare discussion, for whatever reason, you don't want these people to be a lost generation.

43:16You want them for their own sakes as much as the economy. So that's where I think the welfare, and as I say, I'm not enough of an expert to know whether it is generosity of disability. I don't think anybody receiving these payments would feel they're generous, and I don't want to imply that at all. But some understanding of why we've got this low participation amongst this cohort and it's not happening in other parts of the world so we can't blame our smartphones and you know all of these gaming and all these things I battle with my preteens um because it is specific here to the UK we've got to understand that and we've got to get that situation sorted I mean certainly and it sort of relates to what you were just saying Steph I mean the big bone I have to pick with the government on how it's going about welfare reform and particular, you know, reform of these payments to people who are disabled, either mentally or physically, is I think they are massively putting the cart before the horse.

44:15I mean, obviously, the increase that's actually happened, but also forecast to happen in these payments is very significant. You know, tens of billions of pounds, but they are in parallel doing something perfectly sensible. I asked the former boss of John Lewis, Charlie Mayfield, who I had a long chat with the other day, to come up with some ideas about how to persuade employers to keep on their books people who become ill. Because one of the great problems we have in this country is partly that employers don't want to take on disabled people, whether they're mentally or physically disabled. But the other problem is they struggle to keep them on their books once they fall sick.

44:56And I mean, you know, he's done some work which shows that if you simply significantly reduced the flow of people out of employment, that in itself would have a very significant impact on the welfare bill. But he's only midway through his review. So why announce welfare changes before you actually have some constructive proposals that will help very, very large numbers of people to remain in gainful employment? I think that's the point about if we had like investment now in the short term to change things in terms of education and welfare and everything. If you kind of had that big boost now to just reset it, then in the longer term, that's got to be good for the economy.

45:44But the markets will then react on that overspend at the beginning. So they won't do it. I mean, as you and I kind of discussed many times before, there's a very odd view in the Treasury, which goes back decades. which is because of the so-called fungibility of money, investors don't make enough of a distinction when they see borrowing for investment and borrowing for day-to-day spending. Most of us, if you take any interest in economics, know that borrowing for investment, so long as that investment is productive investment, it helps the growth rate of the economy and is actually good for the public finances in the long term.

46:21But because the Treasury does not make enough of a distinction between the types of borrowing. Fiscal rules now do. They have been changed. They have been changed so that the new fiscal rules, in theory, distinguished between, in a significant way, borrowing for investment and borrowing for day-to-day, that should change. But I just hark back to the beginning of austerity after George Osborne became Chancellor. I still think that one of the more significantly damaging things that he and David Cameron did when they were in office was because it was politically easier to cut investment spending.

46:55That's what they did. I think it did long-term harm. I certainly think that more generally, one of the things I say to clients all the time is markets or investors obsess about what the central banks are doing, whereas actually fiscal policy, what governments are doing, often for economic growth, is much more important. And I do think the multipliers on government investment are large. They're sizable. and maintaining that aspect of spending. I do think though, markets, we've got this vision of evil men in basements, that investors do look at the minutiae of what governments are doing. And actually, if you look at the day-by-day playthrough of the Liz Trust episode, the first package that she announced was large, but was fine for the market because it was seen to be sensible.

47:45The first package on the Friday was a sizable payment to support people with their energy bills because it was when we're going through the energy crisis and it was some investment spending so it was a large deficit that actually the market went that seems to be good for long-term growth and if you're spending money that the market says well if that's going to generate growth that's then going to generate future tax receipts so it will pay for itself that seems sensible where it all unraveled was then over the course of the weekend where it was and there's more to come and then the market sort of went oh oh oh i don't know about that so i do think you know the market does look at the different tax spending decisions that are being made the nature of it and the filter is is the package of what's being decided today good for growth not going to give me inflation but it's going to be good for growth that's going to give me tax receipts in the future that's okay.

48:41I'm going to ask about a slightly technical and hidden aspect of the fiscal approach which is actually something you alluded to earlier and you were saying one of the good things about the UK was the approach taken for years by the debt management office which is the arm of government that decides not how much to borrow because in the end that is set by the chancellor but ultimately makes decisions about how long to borrow for a bit like if you're taking out a mortgage do you fix it for two years or do you fix it for you know uh five ten or whatever and the debt management office borrowed sums of money for longer maturities over a period of time and as you say the average uh maturity of british debt what is it still something like 14 or 15 years something like that which means that which means that on average when you put all the debt together.

49:38You don't have to repay the lot, as it were, for some years. But the new boss has announced that she will be borrowing more at the short end. So she will be borrowing at shorter maturities, money that has to be refinanced or paid back over shorter timescales because the interest rates at the short end are lower. It saves money for the Chancellor. We should be under no illusion about this. There are risks that come with that because if you are borrowing at shorter maturities, you have to pay it back near the short term. And if your public finances are then perceived by markets to be in a mess, that can cause something of a crisis.

50:16So I suppose what I'm asking is, for years, we had this slightly sensible approach to taking on long-term debt. Should we be at all worried that the debt management office is saying, actually, we're just going to go for the advantage of lower interest rates and borrow more short term? No, I think it was a really good decision. I mean, I think our debt management office are a bit sort of unsung heroes. We don't talk about them very often, but they are terrific. They have to place billions of pounds of debt a day. And they are so good at navigating the market sentiment. Where is their appetite? How are all the buyers of debt changing their behaviours, the big pension funds, the insurance funds, global investors?

50:58What do people want? And they're very in tune with working out when they can get away with all of that long term stuff, issuance. And then maybe when there's a bit less appetite and they're pushing the boundaries a bit hard and maybe they want to just stay shorter term. And I think they're doing exactly the right thing. Actually, everyone's doing it. The Japanese, they're doing it. So everybody's sort of saying that there's a lot of there's a lot going on. There's a lot of pressure. We've got this situation in the US, which is through no fault of any of our own, putting pressure on the long end.

51:31Let's ease off there for a little bit. Now, it is, as you say, Robert, a slightly risky strategy in that, you know, like your analogy to taking a mortgage is the right one. If I take a two-year fix rather than a five-year fix, it's on the expectation that in two years' time, I'm going to be able to refinance at a lower rate. So, there is the hope that within a short, within a, you know, a period of time, those interest rates will come down, the conditions, the financing conditions will improve. But I suspect they're right. We're going to, I suspect, over the next 18 months, still be in this world where Trump's doing an awful lot of things.

52:07There are this concern, but then we'll get beyond the midterms. That will probably be a defining moment in terms of what we start to see coming out of the US, maybe easing off. And then that strategy could be readdressed. But no, I think it's very good debt management. Yeah. And in that time, we'll have got you back at least five times to talk to you about it. I can only hope, Steph. And I wonder who you'll meet on your way in because when Karen came in this morning, she was over the moon to see Ian Wright, as were you, to be fair, Robert. You had a good old chat. I'm a great fan. And actually, this is not sort of core rest is money territory, but you'll empathise with this.

52:41So, you know, as a lifelong Arsenal supporter, I was absolutely ecstatic to see Arsenal women in the European Women's Champions League. this is a massive achievement they're the only British club ever to win the Champions League they've won it twice yeah yeah yeah right and I assumed that the borough of Islington which is where Arsenal has its home would you know honour them at the town hall there'd be that open bus thing where they parade it didn't happen and actually if you're listening Islington Council would you please tell us why you are discriminating against you know Arsenal women an amazing achievement yeah it's a really good point actually I have to say though, actually, it's Steph's the bigger name in our house because I said to Steph on the way in that my 10 and 12 year old sons, I never ever impressed them.

53:32But when we sat and watched Bear Hunt together and I said, I know Steph. And they said, no, you don't, mum. And I said, and I showed the last time I was on the podcast and you very kindly introduced me very nicely as well as a friend of the podcast. And for once, I impressed my preteen sons. There we go, Robert. I'm impressing the teenagers. Let's be absolutely clear. Your ego isn't big enough. So I'm so pleased that all happened. Thank you very much. Thanks, Karen. Made my day. Yeah, good. We will see you again soon and hopefully do the same then. Absolute pleasure. Thanks for having me. Right.

54:04That's it from us on The Rest is Money. Bye-bye. Goodbye.