Rachel Reeves has made tax rises inevitable
This Wednesday, Rachel Reeves will be in the firing line once again.
The event in question will not be a Budget, or even a mini-Budget, but rather a spending review. But such is the pressure on the public finances that the political and economic ramifications will be significant.
On the face of it, this review is meant to spell out the details of departmental spending within the overall totals that have already been set to 2028/29 for current day-to-day spending and to 2029/30 for capital spending.
Such reviews are not, therefore, meant to be the vehicle for announcing major changes in fiscal policy.
There is now supposedly only one major fiscal event for this purpose, namely the autumn Budget, with a subsidiary event, the Spring Statement, which was delivered in March.
That said, it would not come as a surprise if the Chancellor increased the spending totals on Wednesday.
After all, if defence spending is increased to 3pc of GDP (costing over £17bn per annum by 2029/30) and spending on health increases by 3.4pc in real terms per annum, this would imply that other departments would have to suffer an average real terms reduction in their budgets of 1.8pc per annum out to the end of the review period.
Good luck with selling that to the Labour Party.
Admittedly, although at one point increasing defence spending to 3pc of GDP was supposedly a 'commitment', more recently it seems to have been downgraded to an 'ambition'.
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Mark my words, we're headed for a monster debt crisis
All things fall apart. Orders, whether domestic or geopolitical, eventually collapse. So too do monetary cycles, typically rising and falling every 80 years or so. The big cycle that began in 1945 is coming to a close as the bond markets begin to crack. Bookmark this piece: a debt crisis is coming. Let me explain what's happening. The yield on government debt is the measure of how much interest people expect to receive to lend the government money. This goes up when the market loses confidence in the government's economic plans or think the Chancellor is going to borrow plenty more. We saw yields shoot up under Liz Truss. But after Rachel Reeves's budget, yields on the UK's 30 year bonds peaked at 5.58 per cent, up from the previous 4.99 per cent peak on the worst day of the mini-budget fallout. More worryingly, the term premium, which is the part of the yield which prices the additional risk that borrowers are taking by holding the Government's long-term debt, has risen far more sharply in the UK than in America, Germany and many other developed countries. If Reeves thought Liz Truss crashed the economy, how would she describe her own failure? The markets have concluded that Reeves's plans to stimulate growth are thin – indeed, fatally contradicted by her jobs and investment destroying tax rises – meaning she will inevitably turn to yet more borrowing to fund huge spending splurges. Borrowing for the year 2024-25 was forecast to be £87 billion in Jeremy Hunt's budget of March 2024, but over this financial year Reeves's Treasury has spent £152 billion more than it received in revenue. To put this in context, in 1976 when the UK was bailed out by the IMF the national debt to GDP ratio was running at 50 per cent. Now it is around 100 per cent – and unfunded public sector pensions take it to over 200 per cent of GDP. That's before you include huge, unquantified liabilities currently swept under the carpet, like nationalising the rail and steel industries. Some will paint my warnings as fearmongering: haven't we been in worse straits before? After WW2, UK government debt peaked at around 270 per cent of GDP and dropped steadily to 50 per cent over 30 years. The truth is that we are now uncomfortably close to that level of debt, but unlike those post-war decades we have no growth to manage our way out of it. The financial repression that was possible post-war required capital controls and fixed exchange rates under Bretton Woods. Today, aggressive measures of this kind would only lead to capital flight, currency depreciation and all manner of other knock-on effects. How might this crisis unfold? Typically in a bond market crisis the most indebted countries are targeted first by bond vigilantes who sell their bonds, force their prices down and the premium up. Buyers of newly issued bonds dry up, demanding ever higher yields. The UK is exposed and the markets sense it. The US has certain advantages as the world's reserve currency, but even it is heading for trouble. In Washington, the latest debt fuelled spending spree has attracted fierce criticism from the likes of Elon Musk. If passed it would set the US on a path to record debt. Even the world's biggest economy cannot be immune from the laws of fiscal gravity forever. So worried are some in Trump's circle that in the so-called Mar-a-Lago Accord and elsewhere, Scott Bessent, now Secretary of the Treasury, and others considered how the US could reduce debt by devaluing the dollar, and even renegotiating debt to force down its liabilities. The backdrop to this is a highly unstable geopolitical world. A quarter of our debt is foreign held. China and other adversaries hold many of the cards. Not that there are friends when it comes to the markets making decisions. As Truss discovered, when there is a loss of confidence in a government's ability to service debt, markets ruthlessly intrude upon democratic government. They effectively dictated the reversal of almost all measures in the mini-budget and removed a Prime Minister. A future debt crisis would see the markets demand spending cuts of a magnitude and scale we've never known before. They will despatch Reeves back to her old job in customer relations in no time. The woman who once preposterously posed as the Iron Chancellor is now seen by the markets as a spendthrift with no growth plan – and unable to resist the unaffordable demands of her backbenchers. Egged on by Nigel Farage, she wants to fork out billions more on benefits by lifting the two-child cap. The economic growth needed to fund this debt boom is not materialising – she is funnelling money to the public sector and crushing the private sector, the engine of growth. Industrial energy prices are now the highest of any developed country, decimating the ceramic, petrochemical, glass and car industries. If Reeves can't persuade the markets she has a plan, and quickly, yields could rise even higher. She is dancing on the edge of a precipice. Of course, the roots of the present challenge go back some way. Covid lockdowns and the money printing that paid for them cast a long shadow. Unlike many who cheered the opening of the spending taps, I warned in Cabinet of the inflationary impacts and sought to run a tight ship in my department. Even before the pandemic hit, the Bank of England's QE had created the illusion that deficits could be financed without end, and that hard trade offs could be avoided. That was fantasy economics. The UK will hit the rocks if we don't change course. There is too much debt because there is too much spending. Labour may try and offset that with more taxation, but they can't do that without crushing growth altogether. If you thought you knew the depth of anger and resignation about the mismanagement of the country, you haven't seen anything yet.
