The shortest-serving Prime Minister. Presiding over the second shortest term of a chancellor. Causing a market meltdown with an ill-advised mini-budget. And then the humiliating episode with the iceberg lettuce that lasted longer than her.
It seemed like Liz Truss’s tenure as Prime Minister had made her a laughing stock and burnt her for any prominent office for the foreseeable future. So it was all the more surprising when she ended her self-imposed period away from the public eye only three months after her resignation in what seemed like early attempts to vindicate her premiership in February.
“I wanted to go for growth … and put the UK on a positive path. But this was not in line with the instinctive views of the treasury or the wider orthodox economic ecosystem,” she wrote in an op-ed for the Telegraph.
“I am not claiming to be blameless in what happened, but fundamentally I was not given a realistic chance to enact my policies by a very powerful economic establishment.”
Whoever is not with growth is against growth, Truss 20:22.
Ominous “forces”, “elements”, and “the economic orthodoxy” that thwarted the success of Truss’s plans — one would be excused to feel like her language is vaguely reminiscent of far-right conspiracy theories such as QAnon, whose supporters believe that former President Donald Trump is fighting a dark web of powerful villains.
The Truss universe seems to be dominated by two adversarial forces: an “anti-growth coalition,” as Truss has called it, and the “pro-growth agenda” that she wants to “be part of promoting” now that she left office — as if making public the existence of a secret slump-fighting Justice League she would be joining (maybe the “economic NATO” she has been speaking of). It is yet unclear if it has any members other than her.
But the former Prime Minister seems to truly believe that there is something going seriously wrong in policy, that is not yet acknowledged by others.
“Truss will try and position herself as that Goldwater-type figure,” Lewis Goodall, a journalist, predicted on the podcast The News Agents: “She wasn’t understood at the time; she wasn’t given the space — but she was an intellectual, visionary almost.”
Perhaps it’s time to dare to look into the crystal ball — what really caused Truss‘s downfall and could history prove her right?
Liz Truss revisited
There was one thing Truss certainly was right about. Britain has become a low growth country.
This has been a persistent obsession for the former prime minister, who more than 10 years ago co-authored the infamous “Britannia Unchained” book which advocated radical economic reform to free Britain from a “bloated state, high taxes and excessive regulation”.
So when Truss took office the direction of travel was clear.
The basic reasoning behind it is simple, if not to say, simplistic: low taxes mean that businesses and people get to keep more of their revenue. They will invest more, work harder and use the money in more productive ways than the state could, while also attracting business from abroad. The result is a rapidly expanding economy.
It’s more than contested that this actually works. Truss never got far enough to find out for herself.
Mini-budget, max borrowing
17 days after taking office, Kwasi Kwarteng, chancellor and a close Truss ally, presented the so-called mini-budget in the Commons.
If they had not just been tax cuts, it would have been a true bloodbath: Kwarteng…
- …CUT the lowest rate of income tax from 20% to 19%
- …ABOLISHED the top rate of 45% altogether
- …RAISED THE THRESHOLD for stamp duty, a tax on property purchases
- …also CANCELLED a rise in National Insurance contributions
- …CANCELLED a planned increase in corporation tax from 19% to 25%.
The problem with this mini-budget: lower taxes mean lower income for the government.
On top of that, Truss had announced that the government would pay for all households’ monthly energy costs in excess of £2500. And it still had to pay for the essential items the state had promised to deliver in the regular budget.
In other words: suddenly there was a lot less money and a lot more things to pay for.
Most likely, the government would not have enough money to pay for all its commitments after the mini-budget.
Understanding bond markets: where does the government get its money from?
The good news is that governments can get money somewhat easily when they fall short — the bad news is that it’s not as easy as simply printing more. Truss me, people have tried…
Instead, governments have to painstakingly raise each pound they want to spend every year anew.
They have mainly two sources to get money:
- Raising taxes
- Borrowing
Since the whole point of the budget was to cut taxes, borrowing really was the only option for Liz Truss to make up for the deficit between expenditure and income (the so-called budget deficit).
When governments want to borrow money they issue so-called bonds.
Issuing a bond is in principle not too different from taking out a loan or a mortgage. To the person who buys them, bonds are essentially a confirmation that they’re being owed, which they receive in return for a certain amount of money that they’ve lent to the debtor.
To make this unduly simple concept complicated, newspapers often call British government bonds gilts — because back in the day the OG British government bonds used to be gilt-edged.
The government issues and sells bonds in the primary market to hand-selected primary dealers or underwriters, such as banks, if it wants to borrow.
In return for lending money, creditors receive an annual interest rate payment from the government, the coupon rate (here, 2.5% of the buying price).
This goes on top of the money they are owed. Coupons are paid until the bond has to be paid back in full, until it has matured. For example, a month before the mini-budget, Britain used to pay a coupon of perhaps about 2.5% for a bond that had to be paid back after 30 years.
So if someone bought a British bond for £1,000 with a maturity of 30 years, they would get…
- …£1,000 back after 30 years
- …£25 every year for 30 years (2.5% of £1,000)
A guaranteed annual payment every year and a high probability of getting all the money you invested back is a pretty safe deal. Buying bonds as an investment is thus normally popular with risk-averse investors.
Meanwhile, for the government, the coupon rate represents the cost of borrowing. The higher it is, the more it has to pay. So, it always wants to keep the coupon rate low.
In the mentioned case, the cost of borrowing would amount to the extra £ 25, paid every year for 30 years: £750 in total. That’s an extra 2.5% on top of any money the government borrows that year (at least via the means of 30-year bonds). This is quite a large sum of money for the government if it borrows billions every year.
It sets a coupon rate that is high enough to make the bond profitable for those dealers, who will then go on to resell the bond in the secondary market.
In the secondary market, primary dealers set a price that allows them to make maximum profit from it.
The new buyers, such as other banks or even ordinary people, then also receive the £25 coupon payment issued by the government, which is 2.3% of the slightly higher resale price.
Those are the yields holders receive from the bond.
That much about the backdrop. Back to the main story.
Writing cheques she can’t cash: the meltdown
The main accusation against Truss and Kwarteng was that their mini-budget made the cost of borrowing, bond yields, shoot up — which led to a big market crash. Here is how it happened.
Firstly: the more a government borrows, the lower the value of their bonds in the secondary market…
Like in every other market, when the supply goes up, the price goes down. Sellers have to set the price low enough to find enough people willing to buy the flood of new bonds. And it was immediately obvious that the mini budget meant lots more borrowing.
Secondly, if a government seems unstable, the value of its bonds goes down in the secondary market…
Investors buy bonds as a stable asset. But a chaotic government means more risk. It makes it just a tiny bit likelier that the government will not be able to pay the bond back — because it is chaotic. And if demand does go down, so does the price as prices have to be lower to find enough buyers.
The mini-budget with its huge amount of unnecessary borrowing wasn’t exactly what economic competence looked like to most investors. It seemed like another erratic policy pivot in a country that had changed its Prime Minister three times in the last six years. This wasn’t helped by the fact that Truss and her chancellor publicly questioned institutions which are supposed to provide stability, such as, the Bank of England. Kwarteng also refused to coordinate the mini-budget with the Office for Budget Responsibility.
There was moreover the barrage of negative economic reviews. Paul Johnson, the director of the Institute for Fiscal Studies, a research institution, claimed the tax cuts didn’t even show the “semblance of an effort to make the public finance numbers add up.”
In short, a public image emerged of Britain as an unstable country pursuing unsustainable fiscal policies.
When the resale price of bonds falls in the secondary market, secondary buyers get more out of it. They get the same coupon payment as the primary buyer but at a lower price -> the yield they get from the bond rises.
Our bond earlier cost £1,000 in the primary market. After the extreme loss of value due to the mini budget, it might now only find buyers at £500 in the secondary market.
But the buyers would still receive 2.5% of the original £1,000 every year, so £25.
Yet £25 are a full 5% of the £500 the new buyer paid. So the bond yields in the secondary market factually shoot up from 2.5% to 5%.
When that happens, the government must offer higher rates in the primary market too: the cost of borrowing rises.
A coupon rate of 2.5% on a £1,000 bond is not profitable for the dealers anymore when they have to resell at a lower value to provide yields of 5% in the secondary market. Nor is the prospect of buying bonds from an unstable government. So, the government has to offer a higher rate to engage the primary dealers for its bonds to get more money.
Right after the mini budget, British bond yields spiked, showing a phenomenal loss in investor confidence.
When the government’s borrowing costs spikes like this within just a few hours and just won’t stop going up, it has consequences…
…each one of which deserves its own explainer.
It was a classic downward spiral: the value of the pound fell, reducing purchasing power and increasing inflation. Higher inflation prompts the Bank of England to raise interest rates and in expectation people wanted to have even less to do with the British economy and sold tonnes of bonds.
Meanwhile, everyone and their dog weighed in with criticism:
“Given elevated inflation pressures in many countries, including the UK, we do not recommend large and untargeted fiscal packages at this juncture,” the IMF lectured Britain.
US President Joe Biden noted in passing at a press conference that Britain’s fiscal policy had been “a mistake.”
Petrol for the bond value-torching flames. And an utter humiliation at that.
Collapsing bond values threatened the liquidity of pension funds…
…which depended on the value of British bonds for even more complicated reasons (it’s got to do with an investment practice called liability-driven investments (LDIs)). Many of them were pushed to the verge of default, which would have blown up the savings of millions of pensioners and pensioners-to-be as well as the value of other British assets.
I was getting some very serious warnings by senior officials about a potential market meltdown and I needed to do as much as I could to indicate that things were different.
Liz Truss in a Spectator interview on firing Kwasi Kwarteng.
In this emergency situation, Liz Truss finally backed down. She sacked the chancellor and replaced him with Jeremy Hunt, who immediately started reversing the mini budget’s key measures in order to balance the budget. The Bank of England stepped in too, buying £65mn worth of bonds to raise demand and thus the price — which was ultimately paid for by the taxpayer.
Some projections claim the added cost of borrowing caused by this episode ran up to an extra £10bn annually — a hole in the budget that Hunt filled with painful spending cuts.
Devoid of the agenda she had been elected on — albeit only by Tory party members — Liz Truss gave up just six days later.
Clearly, a large part of Britain’s crash was not a direct result of her mini budget. It came down to a rapid loss of investor confidence.
The general mood of scepticism of tax cuts, open criticism by the economic intelligentsia, the media, and even the US president made ever fewer people want to trade British bonds and the government’s budget unaffordable.
Truss is not wrong when she blames a hostile climate for the failure of her budget and ultimately her resignation. The investor panic that made bond prices drop and borrowing costs skyrocket was grounded in a self-fulfilling prophecy that her plans would not succeed.
“Animal spirits” is what the economist John Maynard Keynes called those often emotionally driven factors that cause investors to make decisions.
In his words: “If the animal spirits are dimmed and the spontaneous optimism falters, … enterprise will fade and die; — though fears of loss may have a basis no more reasonable than hopes of profit had before.”
Not quite a conspiracy, but the meltdown certainly wouldn’t have spiralled to this extent if it hadn’t been for wide-spread public scepticism.
Are we right to miss-Truss Truss?
But it’s hard to argue with the fears of investors when their doubts about the profitability of tax cuts are backed by hard mathematical facts and economic professionals with credentials — which Truss is clearly lacking.
That didn’t stop her from doubting in her recent PR offensive that the calculations of the doomsayers were correct. The cuts, she argued, would have served as a positive signal to the wider economy, kick-started growth, and boosted tax returns. The cuts would have basically paid for themselves.
The evidence in favour of this equation in the past decades of economic history is murky at best — partially a reason why this policy is nowadays largely shunned.
But even if Truss were right — which is difficult to assess — she is ignoring what growth-boosting investors really appreciate: a stable, predictable political environment. A Prime Minister, let alone a chancellor, who did not foresee that rapid fiscal transformations against the recommendations of the economic syllabus could rattle investors, or who ignores them despite knowing better, has to face questions about their competence. It doesn’t matter how serious the consequences actually are. The concept of animal spirits is taught in every entry-level economics class.
Truss will continue to argue that she had everyone against her (she sort of did). But that might have been for a reason — it’s hard to dismiss that she acted irresponsibly.
You have won the battle…
…is what Truss must be thinking, though.
Less than a year after her humiliating resignation she is, if not omnipresent, then at least given a platform again.
Aside from promoting her low tax agenda, she seems to be meddling in particular with the issue of China, sticking out her head every now and then at speeches and conferences. There was also a highly publicised visit to Taiwan, where she met the island’s president.
Conservative media have cautiously returned to promoting her, testing the waters for something of a stab-in-the-back myth. The Truss-cheerleading Telegraph published a number of subtly glorifying headlines (see “Three big calls that Liz Truss got right”). GB News broadcast her first post-premiership TV interview in June while its prolific presenter Tom Harwood — whose qualifications mainly lie in being a former Brexit activist — wrote a blog entitled “No, Trussism was never really tried”.
All that might be dismissed as culture-war noise. But some of Truss’ terminology and ideas have crept back into politics — at the latest when Hunt presented his “Budget for growth” in March. It did not have much on Truss’ nihilistic tax massacre. Yet Hunt did try his hand at scaled-back tax breaks. Her idea of investment zones — places across the country to benefit from special tax regimes and government funding — was also recycled.
