Author: davidajepson

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How bad can it get?

The Bank of England’s (BoE) £65bn inoculation fund does not seem to have protected the bond markets against the impact of LizKwasi-22. Indeed the virus seems to be spreading. Yesterday the Bank announced the fund would also be used to purchase high grade corporate bonds and this morning index linked government bonds have been included in the vaccination programme after what the FT called a brutal collapse in their values.

Is there a risk the BoE will be unable to act as market maker of last resort? Will the Chancellor have to bring his statement forward yet again? His credibility is sinking with the values in the bond market.

If gilt values are not stabilising what is happening to the pension’s liability driven investment (LDI) strategies? Is LizKwasi-22 mutating in other parts of the financial system which so far have not displayed any symptoms?

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Could the recently discovered LizKwasi-22 virus become a pandemic?

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.

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Truss overrules Kwarteng on number of UK investment zones | Financial Times

Truss overrules Kwarteng on number of UK investment zonesPrime minister dismisses Treasury concerns over loss of £12bn tax revenueLiz Truss and Kwasi Kwarteng at a construction site in Birmingham. Truss insisted the UK should not set a limit on the number of applications for low-tax investment zones

Peter Foster and George Parker in London and Jennifer Williams in Manchester

Liz Truss has overruled her chancellor and insisted the UK should not set a limit on the number of applications for low-tax investment zones despite internal Treasury concerns the projects could cost billions of pounds in lost taxes.

The flagship policy designed to turbocharge UK investment is a key plank of Truss’s “dash for growth” but Whitehall insiders said that it had caused serious misgivings in the Treasury.They added that before September’s “mini”-budget chancellor Kwasi Kwarteng twice tried to persuade Truss to limit the number of zones to 40 — with Treasury officials warning the prime minister the zones could create a tax liability of “up to £12bn” a year — but was overruled by Downing Street.

Source: Truss overrules Kwarteng on number of UK investment zones | Financial Times

 

Northern Comment Editor – Which bit of “Fiscal Responsibility” does Liz Truss not understand? Just as there is some sign the markets are regaining confidence the PM throws in another reduction in the Governments revenue.

At the very least this will make the Chancellor’s job of balancing the budget even harder, up to £12bn harder. At worst it adds to the perception of fiscal incompetence in the markets and may lead to further increases in government, and therefore everybody else’s, borrowing costs.

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A Rock and Hard Places

In securing her position as leader of the Conservative Party Liz Truss spoke with fervent determination and committed to overturn the existing orthodoxy which was about the distribution of wealth and not its creation. Her overriding commitment would be to “growth, growth, growth”. And the way to secure that would be by reducing taxes and regulation which was choking entrepreneurialism.

Those that challenged her approach were quickly labelled the anti-growth camp. A camp which has grown to include Treasury mandarins, most of the economics profession, the Bank of England, the IMF a range of think tanks, obviously all the opposition parties, indeed, now one feels left out if not included in the anti-growth camp.

Leave aside the fact that few, if any, have said they are anti-growth. “Growth, growth, growth”, like “education, education, education” and “health, health, health” are slogans few people take exception to. Questioning whether low tax and light regulation lead to such growth, and also if it does whether it results in all boats floating is not the equivalent of being anti-growth. However, that is for another time.

The cack handed first steps toward implementing this break with orthodoxy has created widespread concern and a sharp focus on how the PM is going to resolve a problem of her own making.

She now has to explain how she is going to fund the debt created by the promises she has made. That is going to be tricky. She is caught between, on the one hand, the rock of investor demands, and on the other a series of hard places in voter and party members raised expectations.

Investors will not be bothered whether the funding of debt is through increases in government income, (higher taxes), or cuts in government expenditure, (austerity 2.0). One thing is certain, it is unlikely they will give much credence to the growth fairy. Unlike the long suffering British public they care nothing for the promise of jam tomorrow.

However, there are conflicting and powerful constituencies opposing or promoting both of these options. The public, and a large part of the Conservative Parliamentary Party will be very concerned with a second round of austerity when public services are already struggling. On the other hand, a large part of the Conservative Party membership and her close libertarian supporters within the party will not want to see tax increases.

Her strategy has not got off to a great start, to put it mildly. However, over the next few weeks as she wrestles with this dilemma it is set to become a whole lot more fractious. The only bright spot is that her claim she would be resolute in the face of opposition is not looking strong.

To misquote her hero, “U-turn if you want to. I’ll turn whenever I have to!”