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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.

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Getting the Box to Work

(Correction – The following is a reworking of a recent blog in which I misspelt the name of the Chancellor Kwasi Kwarteng for which I apologise.)

When I was a child we had a black and white television with vacuum valves which had to heat up
before the set would operate. A common fault was when the horizontal hold failed, causing the
image on the screen to roll up or down making it impossible to watch.

At the back of the TV there were some small knobs that you had to twist to try to resolve the
problem. This, however, was fiddly and the turning so sensitive that the image rolling down the
screen would pause before changing direction and rolling up the screen.

When this happened, my dad, who had no training in electronics as far as I know, would start to
tap the side or the top of the TV. I often tried to identify a sequence to the tapping but it seemed
to me to be completely random, except that the longer it took to stop the image rolling the harder
the tapping became until my dad gave the set a solid slap to both the top and side.

The result of all this tapping and slapping was rarely positive. Turning the machine off and
allowing it to cool down, and then turning it back on again sometimes worked. But more often
than not we had to get the TV repair man out to fix the problem.

I was reminded of all this by the budget, which dare not speak its name, on Friday. Mr Kwarteng
seemed to be adopting my dad’s approach to fixing economic growth. However, he seemed to
have missed the gentle tapping stage. He went straight for the slapping stage and then
augmented this with a hammer.

Very occasionally my dad’s approach seemed to work. His disdain for the technical levers of
change and the approach of technicians, and his sharp rejection of advice were rewarded by the
sudden stabilisation of the picture…for a while.

If my dad’s engineering strategy failed and broke the telly the worst that would happen was that
we would miss Bonanza or Sunday Night at the London Palladium. Mr Kwarteng’s risk appetite
appears to be much greater. What is more he has made it clear he has not finished hitting the
black box of the economy, Friday was only the beginning.

We can only hope his unconventional approach, disregarding the views of the economics
profession, Treasury officials and basic arithmetic, works. However, I never had much faith in my
dad’s approach to fixing the TV. I have a lot less confidence in Mr Kwarteng’s approach to fixing
the economy.

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Pickling Dinosaurs

The current leadership competition within the Tory Party is the second in 4 years to cause an interregnum in the governance of the country. It is perhaps symptomatic of a Tory party which has lost its way and is incapable of providing the leadership needed in what are incredibly dangerous times.

Rishi Sunak and Liz Truss are like two dinosaurs battling for supremacy, completely focused on securing victory. Both, seeingly oblivious of the massive meteorite hurling toward them in the shape of the cost of living crisis. Much less aware of the mega meteorite following it in global warming.

Like bad generals they are fighting the last war. Showing no sign of being aware, much less competent to deal with, the unprecedented challenges the country and the world faces.

Jeremy Corbyn was accused of being irrelevant because he was pickled in the politics of the 1970’s. However, Liz Truss is equally stuck in a bygone age. Her world is that of the Thatcherite 1980’s and her prescriptions the same. Lower taxes and the rising tide of economic growth lifting all boats. Wealth trickling down rather than being provided through handouts.

Rishi Sunak has a more balanced one nation Tory approach but very much set in economic prescriptions of an orthodoxy which has shown itself to be increasingly irrelevant. Economic forces seem to be operating in ways not covered by the standard theories of the profession. Increasingly, attempts to analyse what is happening fail to reconcile conflicting indicators providing what some have characterised as humbug economics.

Both candidates seem to be set on reducing the size of the state. This is a necessary presumption of Truss tax cuts or Sunak deficit reduction. However, in whatever direction you look, the public sector is in crisis, from the administration of justice, the delivery of health and care services, education at all levels, utility infrastructure and costs and much more. When this is combined with increasing demand in all these areas the reduction in the role of the state looks a very optimistic idea.

The sound and fury of the competition has probably done more for the prospects of a Labour or progressive alliance victory at the next election than secured the future of the Conservative leadership.

For all the noise there remains an absence in the realm of political debate. A failure to focus on issues which are becoming existentially critical. Issues which call for integrated national and international resolution.

In the broadest terms they relate to equality and justice and are set to be driven by the issue of climate change. This will involve the radical restructure of national and global economics, voluntarily or otherwise.

Sunak and Truss are both desperate to tell their electorate what they want to hear. Leadership is about telling them what they need to hear. Even if that is unpalatable and potentially career limiting.

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On the QT

Since March 2009 the Bank of England (BoE) has been engaged in an experiment to stimulate the UK economy. The experiment was commenced in the aftermath of the credit crunch when banks stopped lending to each other because they were no longer certain of the creditworthiness of their counter parties, ie. other banks. The economy was in recession with negative GDP growth at -4.3%, and inflation at -0.53%. The Bank had reached what it felt was the lower bound of what it could do with interest rate policy having taken Bank Rate down to 0.5%.

Enter Quantitative Easing) the experiment which involved the BoE creating money and using it to buy assets, overwhelmingly, government debt. The goal was to increase the level of liquidity, ie. money, in the economy. Buying government bonds (government debt) from banks achieved this in two main ways:

First, it increased the cash banks held as they sold the bonds they held to the BoE which theoretically would encourage them to lend the cash to secure a return.

Secondly, by increasing demand in the bond market it pushed up the price of bonds which had the impact or reducing their yield, broadly the fixed rate of interest paid on the bond which obviously goes down if you pay a higher price for the bond and up if you pay a lower price.

As bonds are seen as virtually risk free the rate for bonds effectively sets the lower benchmark for all interest rates thus putting downward pressure on rates making borrowing money cheaper. The benefit of this is that, in theory, it encourages people to borrow and invest in productive assets thus stimulating growth in the economy.

In the years that followed the UK economy did begin to revive peaking at 3% GDP growth in 2014, slowly falling back to 1.7% in 2019 then collapsing with the advent of Covid. Given the patchy and declining performance and subsequent collapse of the economy, QE was continued and now amounts to a £895bn of bonds on the balance sheet of the BoE.

Interestingly, £875bn of the total, or 98%, is government debt, ie. bonds issued by the UK government. Given that the bank is wholly owned by the UK government this appears to mean that c37% of the government’s national debt is owed to the government! Interesting debate with Modern Monetary Theory around this.

However, we are now in a changed economic environment dominated by rising inflation and the spectre of stagflation. Given this the BoE has had to change direction and is “unwinding” QE, replacing it with Quantitative Tightening (QT). No one seems to know what the effect of this will be. Some worry that the market for bonds may be undermined and their price fall dramatically. This would have the reverse effect of the purchase programme pushing interest rates up throughout the economy. To some extent this is the intention but the fear is that it may not be a process which can be regulated. Once the tap starts to be turned the market will jump.

The problems this might create are compounded by the long period of ultra low interest rates. Cheap money looking for a home often finds one which is riskier than the investor thinks. When rates go up and the tide of money recedes they are caught swimming in the buff. For businesses this is more than embarrassing, it is a matter of life and death.

If QT happens on the QT everything may be ok. But if suddenly you start to hear a lot about it we could be in even worse trouble than we are at the moment.