Former Treasury Secretary Larry Summers speaks at the Spring Meetings of the International Monetary Fund and the World Bank in Washington, DC, on April 16, 2015.
NICHOLAS KAMM/AFP via Getty Images
The UK’s plan to cut taxes is “utterly irresponsible,” Larry Summers tweeted on Monday.
The former US Treasury secretary predicted that short-term rates could soar above 7%.
The pound could also fall below parity with the euro and the dollar, which could impact the global economy.
The UK’s tax plan could lead to Britain spiraling into an economic crisis, with short-term rates soaring above 7% and pound volatility leading to global turmoil, Larry Summers warned.
In a Twitter thread, the former US Treasury Secretary criticized the UK’s plan to slash taxes on the wealthy and prevent future corporate tax hikes, emphasizing that such a move has damaged the UK’s credibility as an economic superpower amid worldwide inflation panic.
“I was very pessimistic about the consequences of utterly irresponsible UK policy on Friday. But, I did not expect markets to get so bad so fast,” Summers tweeted on Monday. “A strong tendency for long rates to go up as the currency goes down is a hallmark of situations where credibility has been lost.”
The pound plunged 5% in Asian trading after the announcement of the new budget, and then fell another 1.8% when the Bank of England said it would continue to monitor volatility in its financial markets. It hit a record low against the dollar before recovering.
A reaction of that magnitude is more characteristic of a developing country, not an advanced economy such as Britain. That reflects a loss of confidence in investors, according to economist Paul Krugman – and it’s largely driven by the fact that tax cuts have historically led to economic stagflation, similar to the cuts made by Regan and former UK prime minister Margaret Thatcher in the 80s.
And the possibility of stagnation is particularly concerning, considering that Britain is running a large trade deficit and is struggling to get inflation under control. Prices soared above 10% in July and have only started to cool slightly, with inflation clocking in at 9.9% in August.
British markets have started pricing interest rates to climb to 6% over the next year, but Summers said he “would not be amazed” if short-term rates tripled to above 7% over the next two years, given the gloomy economic backdrop. He added that the pound could continue to plunge below parity with the euro as well as the US dollar, which could set off a chain of consequences in the global economy, with a crisis in a reserve currency carrying global implications.
“Financial crisis in Britain will affect London’s viability as a global financial center so there is the risk of a vicious cycle where volatility hurts the fundamentals, which in turn raises volatility. A currency crisis in a reserve currency could well have global consequences,” Summers warned.