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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!”

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Can the Tories Retain Truss t?

No matter how much they talk about global economic forces or try to present the energy cost
intervention as a sign of how they are focused on the needs of working people, the current
government has lost credibility with both the British electorate and lenders.

Last Friday the Prime Minister and her Chancellor launched a “special economic operation”,
which was to lead a national charge to growth, securing this within sufficient time for it to
pay for the reductions in taxes that were needed to achieve it. It was not a budget, so there
was no need to have it independently reviewed by the Office for Budget Responsibility,
despite its enormous scale.

To be fair, it was not a budget. Anyone who looks at a household budget knows it has two
sides. One side is about expenditure and the other about income. And as Mr Micawber in the
Charles Dickens novel David Copperfield said: 
“Annual income twenty pounds, annual expenditure nineteen pounds nineteen and six,
result happiness. Annual income twenty pounds, annual expenditure twenty pounds
nought and six, result misery. “

We seem to have gone for the latter option, although we have added many, many noughts to
the excess of expenditure over income.

Elsewhere, I have made the point that there are fundamental differences between national
finances and household finances, the most obvious being that households do not print money,
governments do, via banks. Governments can run up significant deficits and even fund some
of these which is what Quantitative Easing is partly about.

However, governments that simply print money are destined for high, higher and eventually
hyper inflation. So some recourse to the reality of the money markets is necessary, and this
means borrowing money from investors. And, like all credit agreements, the small print, or
quickly delivered “terms and conditions apply”. This means lenders will charge a premium if
they feel your ability to repay or, more broadly, your credibility as a borrower is weak.
If your strategy for repaying the loan is based on a recoupment of investments at Aintree,
Cheltenham, Newmarket or Goodwood they may feel obliged to charge a significant
premium.

If we look back when Liz Truss was selected as Conservative Party leader she announced,
after one week, a massive support package for domestic energy consumers costing tens of
billions of pounds.

This did not spook the markets. Investors could see that urgent action was needed and that
any responsible government would have to respond to the twin problems of genuine hardship
for its citizens and economic damage to its businesses.

What spooked the markets was that this logical action was followed by radical tax cutting,
further expenditure, and an explicit statement that this would all be covered by borrowing
with no evidence-backed explanation at all as to how it would be paid for.

It seemed growth was the problem but it was also the solution. However, the magic formula
that had eluded governments around the world about how you secure the transition from
problem to solution was not forthcoming.

But worse than this, the people who may have been able to provide an assessment of the
credibility of the borrower were either sacked, as in the case of Tom Scholar the most senior
civil servant in the Treasury with direct experience of dealing with the 2008 financial crisis,
or told their help was not needed (the Office for Budgetary Responsibility, obviously the clue
is in the name) or denigrated as slow to act (the Bank of England).
It seems that they did not want to study the form, listen to the tipsters, or even count the legs
on the horses. They just wanted to go all in and bet the farm on black. Unfortunately, what
came up was red; red warning screens in the currency markets, the inflation predictions, and,
worst of all, in the cost of government borrowing.

The scale of the incompetence triggered a problem in the pensions industry as the Liability
Driven Investment strategies had the rug unceremoniously pulled out from under them. The
response of government spokespeople that this was an arcane technical issue in the structure
of the pension funds ignores the fact that it relates to some £1.5 trillion. That is a big number.
Roughly, two thirds of GDP.

The risk attached to this was so significant it could have spread problems to other parts of the
global financial markets. And we know how quickly problems can snowball once they start in
finance which is all about trust. The International Monetary Fund (IMF) was already
concerned about contagion.

Liz Truss must have had the shortest honeymoon period of any Prime Minister. In less than a
month she has lost the trust of the financial markets, lost the trust of the British people, with
polls giving Labour a 33% lead over the Conservatives, and she is fast losing the trust of her
MPs.

Boris Johnston was not Donald Trump and Liz Truss is not Vladimir Putin. The latter
individuals are in a class of their own in terms of moral degradation. In terms of
incompetence however, the PM is giving Putin a run for his money.

It has taken Putin eight months to destroy any trust the West had in him. His “special military
intervention”, which began life as a dash for Kiev, failed. He has been forced to change his
objectives but stubbornly persists in a strategy which is ruining his economy. And now he is
starting to loose the trust of the Russian people who are leaving the country in droves. Despite
being a ruthless autocrat his chances of remaining in power reduce by the day.

Constancy of purpose and determination are good things in leaders. Unless, of course, that
constancy and determination are focused on doing the wrong thing. If you dismiss those who
are experts, precisely because they are experts, or see those who challenge you as closet lefties simply trying to undermine your strategy, you may be right, but you may be wrong.

And when you are playing with a nation’s future you need to be damned sure you are right.
It looks as though Liz Truss is wrong. Worse, she does not seem to see this or is not willing
to recognise it.

There are only two credible options. One is to reverse the tax cuts in a humiliating
climbdown. The second is to implement another round of austerity which would be breaking
promises and is probably impossible to deliver politically.

Whether this would recover the PM’s credibility with the markets is a moot point. It is
unlikely to recover the trust of the citizens of the UK. This means it is unlikely to recover the
trust of the Conservative’s Parliamentary Party other than the extreme fringes of the right.

Either, Liz Truss knows something that the vast bulk of those that ought to know about these
things (the Treasury, the Bank of England, the IMF, the economics profession) do not know,
or she is wrong. Are those who think she is right willing to bet their house on it?

Rather than a triumph of determination leading to a national growth rate of 2.5% per annum,
last Friday is likely to be seen as the day the Conservative party lost the trust of the British
people in their economic competence. And it may be the day which marked the start of their
loss of Truss.