In Defense of Deficits

It’s a year of elections: in India (currently in the final stages of its lengthy democratic process), in Mexico this weekend, in my mother-country of Belgium in a couple of weeks, then in the UK, then the US (and many more beside). In all, 64 countries representing 49% of the world's population will be eligible to go to the polls this year. In the past, the markets knew more or less how to read elections, with one side likely to be more friendly to management and capital, the other on the side of workers and their unions. One side was about high taxation and rampant deficits, the other championed fiscal responsibility.

As we digest the news of an imminent UK election, my mind is drawn to previous campaigns, when a well-rehearsed dance played out in which the Conservatives would paint Labour as the party of tax and spend, too committed to their Socialist vision of the world to be responsible stewards of the country’s finances, while presenting themselves as the only politicians grown-up enough to dole out the necessary medicine of balanced budgets.

The Conservatives of David Cameron’s premiership (2010-2016) feel like the last of a breed for many reasons – it was before Brexit, before the tensions and controversies that now threaten to rend the party in two, before the chaos of four leaders in three years. One thing that defined Cameron’s time at the top (and not those of the governments that followed him) was a steadfast commitment to the idea of a balanced budget. Chancellor George Osborne pursued a campaign of austerity that saw swingeing cuts to public services, all in the name of fiscal responsibility.

I invited Stephanie Kelton to speak at our Man Alternative Investment Symposium in Oxford in 2021. Kelton was Bernie Sanders’s economic advisor and a leading proponent of Modern Monetary Theory (MMT), a neo-Keynesian movement that asserts that there ought to be no theoretical limit to a country’s ability to borrow, providing that it is in control of its own currency. Kelton and Sanders were near-perfect exemplars of the kind of “fiscal irresponsibility” (as their opponents would see it) that Conservatives (and, indeed, conservatives) like to hold out as a warning. Joe Biden, resolutely of the center, friend to the markets and the banks, was able to position himself as a far more rational and responsible alternative.

As with much in the world, the clarity of these previous divides has blurred in recent years. It feels like, when it comes to budgetary restraint, the left and right have found themselves meeting on the far sides of their respective extremes. While the political inclinations of the short-lived dynamic duo of Liz Truss and Kwasi Kwarteng (in power for just 43 days) could not have been more different from Kelton and Sanders, the Keynesian thinking that underlay their unfunded tax breaks and grandiose spending plans (if not their vision of a Britain unfettered from the constraints of regulation and international law) was remarkably similar.

With the news that Michael Gove is stepping down at the coming election, I’m reminded of his famous comment about Britain having “had enough of experts”. It was a phrase that captured the spirit of that wild period in the post-Cameron era, when Brexiteers were triumphantly shaping the country in their image. It feels like the decision by Truss and Kwarteng to ignore the advice of both civil servants and centuries of economic thought sprang from the same well. They went ahead with their plans despite the warnings of experts and – as Truss has been so keen to remind us in recent weeks – they were brought down not by the voting public but by another shady cabal of experts: the markets.

All this brings us to a chart from the dependably brilliant Gerard Minack, whose Downunder Daily never fails to stoke conversation on the trading floor. You should never ignore a chart with an r-squared above 0.9, and this one makes a convincing point. Biden has, it seems, quietly learnt the lessons of his erstwhile rival for the Democratic candidacy. Italy has never been shy of a healthy budget deficit, but usually that appears accidental, rather than linked to what is now an economy racing ahead of many of its more conservative northern European peers. The markets who came down so hard on Truss and Kwarteng appear far more willing to indulge those economies who, rather than trumpeting their deficit spending as a point of political dogma, have got there under the radar.

As Keir Starmer and Rachel Reeves fix numbers 10 and 11 Downing Street firmly in their sights, there’s a message here for the broader world as they face down their own election conundrums: about the enduring power of Keynesianism and the significant growth that can be engendered by deficit spending.