While the economy is still reeling from the impact of Covid-19, which
undermined government receipts and massively expanded its expenditure,
another viral challenge has appeared, LizKwasi-22.

The symptoms of this aggressive disease include a feverish increase in the
temperature of financial markets, political delirium, and public nausea. It results
in a weakening of national finances, accelerating economic decline, and national
despair. The cause appears to be a new strain of the BrexCon-16 virus which has
already mutated twice, each time becoming more deadly than before.

The latest variation seems to involve the ill thought through application of blunt
force trauma to national finances. So far attempts to overcome it with evidence
and common sense have had limited success. Indeed the virus seems to
continue to promote itself in new areas of economic policy.

One of the big lessons of the 2007/08 contagion was how incredibly interlinked and
fragile the national and indeed global financial system is. Problems in one area
have a habit of spreading quickly causing mayhem in areas thought to be unconnected.

Few people had ever heard of Liability driven investment strategy (LDI) prior to
last week. Those that had might have assumed, given it was to do
with pensions, that it would be a sleepy, low risk part of the market. Much like
home finance was assumed to be before 2007/8.

So when the Liz/Kwasi-22 fiscal intervention first struck it looked as though the
impact was all about a massive increase in the costs of public debt and,
consequently, mortgage costs. Over the weekend, however, the problem
metastasised. The increase in yield (effectively the interest charge) on
government bonds (gilts) is made to happen by pushing down the value of the
gilts.

Unfortunately, gilts were being used as security for sophisticated (ie. risky)
financial products to enable pension funds to manage the swings in value of their long term liabilities to pensioners.

As the value of gilts went down lenders to the pension funds demanded cash to
address the fall in their security. To fund this pension funds sold off gilts pushing
the price even lower creating a vicious circle of falling values and growing cash
calls. There was a growing risk of a £50bn fire sale of gilts which would have
taken Britain to the brink of financial crisis.

Staff from the Bank of England and the Treasury worked through the night of 27 September to create the £65bn support package which steadied the gilts market when announced the following
day.

If one wanted to see a benefit in this whole episode it might be that it had shone
a light on a massive part of the financial system (£1.5 trillion) where effective
regulatory inoculation does not exist.

Despite this near death experience Liz/Kwasi-22 continues to undermine the
health of the financial system. The latest outbreak related to the rejection of a
proposed limit on the number of low-tax investment zones. It is feared that this
may create a massive (£12bn) loss of government revenue, further undermining
investors’ confidence in the capacity of the government to pay its debts.

At least with Covid-19 there were sensible people around the world working to
identify a cure and a vaccine to inoculate the world. Sadly, LizKwasi-22 not only
causes damage to the bodies economic and political organs, it insidiously
undermines attempted cures by discrediting the doctors. Indeed it also “lays the
ground” for its further growth by destroying the regulatory vaccines that impede
its progress.

At the moment the main damage is confined to the UK, however there are well-
founded fears of contagion with the transmission of the disease to the global
economy. The IMF has already indicated it is keeping an eye on matters. Let
us hope it doesn’t have to declare LizKwasi-22 to be a pandemic.