How the Brexit Killed Britain’s ‘Pay as You Go’ Policy

There go George Osborne’s dreams. Whatever the other consequences of the June 23 Brexit vote may prove to be, Britain’s ever-embattled chancellor of the exchequer just lost his long war for deep spending cuts, reduced social services, and annual surpluses in the national budget.

Osborne has been the Western world’s single most ardent advocate of rigorous austerity policies since Lehman Brothers went belly-up eight years ago. And austerity, to put the point another way, isn’t going to survive Britain’s exit from the European Union.

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In a speech last week in Manchester, Osborne caved on his signature goal of bringing Britain’s budget into the black by the 2019–20 fiscal year. “We must be realistic about achieving a surplus by the end of this decade,” he told the storied city’s business leaders.

Those Brits are ever ready with an understatement. It’s a moment, surely, when the national treasurer has to “reassure markets that he will not inflict further austerity,” as the Financial Times put it—inflict being just the word.

Brexit marks Osborne’s third (and biggest) retreat from the front lines in the war on Keynesian stimulus and deficit spending. The budget he presented last March included no provision for reducing government debt as a proportion of GDP. He had earlier stepped back from his promise to continue his already severe cuts in social services spending.

During the heated Brexit campaign, Osborne had threatened a “Brexit budget” of $39.8 billion in emergency spending cuts should Britons vote to leave the EU. That’s a goner. Instead, Bank of England Governor Mark Carney anticipated Osborne’s speech by a day with strong intimations that the BoE is about to cut interest rates to help restore stability in the British economy.

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In a supreme irony, Carney’s “whatever is needed” remark puts him in the bin with none other than Mario Draghi, the European Central Bank’s president, who still travels on his “whatever it takes” promise in response to the Continent’s financial crisis four years ago.

So the money flowed last week. Investors are relying on a prolonged regime of lower interest rates and a judgment that the British economy cannot bear any more demand-crippling austerity.

The bond markets turned in the most remarkable performances. Two short-term British government issues went into negative territory; 10-year gilts, as the English term sovereign bonds, finished the week at a yield of 0.78 percent, down from 1.35 percent pre–Brexit. (Bond yields drop as investor demand rises.)

In the U.S., yields on benchmark 10-year Treasuries momentarily fell to 1.38 percent, matching a low reached four years ago this month; 30-year bonds hit an all-time low of 2.19 percent.

Related: What the Brexit Vote Means for the US Economy

This is an easy read of the tea leaves. Fed Chair Janet Yellen and some of the central bank’s regional presidents—though not all—have been clear that the Brexit vote decreases the likelihood of a rise in U.S. interest rates.

Notably, many investors say they expect global rates to drop further. This appears likely for one simple reason: At issue in the post–Brexit environment is economic growth—in Britain, obviously, but also in the U.S. and elsewhere. “What I’m worried about is that the Brexit vote could be the straw that breaks the back of the U.S. growth picture,” Thomas Costerg, Standard Chartered Bank’s New York economist, told Reuters the day after the referendum.

There’s only one problem with this new focus on interest rates and the buyers flocking to the bond markets. Many analysts (this columnist included) argued long before the Brexit vote that central banks had wrung all the juice they could out of interest rates as a response to sluggish growth.

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Low rates weren’t enough last spring, when demand emerged as the true problem inhibiting global growth, and there won’t be enough now. Nothing brings this home more forcefully than Osborne’s new predicament.

As soon as the Brexit vote was announced, the Institute of Directors, a British association of board members, began a three-daysurvey of more than 1,000 senior executives. Here’s the gist:

• Nearly two of three companies see the vote as bad news for hiring and new capital commitments.

• A quarter of those surveyed intend to freeze recruitment of new employees.

• 5 percent will fire some of their staff.

• More than a third is going to cut back investments plans.

• 20 percent intend to move part of their operations out of Britain.

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On the anecdotal side, the FT’s Brexit Business Tracker says EasyJet plans to acquire an operating certificate on the Continent that could allow it to relocate its headquarters out of Britain.

Pre–Brexit (when scare mongering was common, it’s to be noted) HSBC, JPMorgan, and Goldman Sachs were among the numerous institutions asserting they’d have to move parts of their operations across the Channel.

We have to wait and see what any company doing business in Britain will do. But the tilt is plainly in the direction of a reduction in the UK presence, by way of either relocation or cuts in capital investment and expansion.

Two questions worth asking: Does Osborne’s brand of austerity have a place in this economic environment? Can policy responses anywhere be limited to interest-rate manipulation?

Answers: No and no.