Liz Truss’ Disastrous First Month By


By Geoffrey Smith — Most political leaders have a honeymoon period. Not Liz Truss – and she has only herself to blame.

Britain’s new prime minister and his finance chief, Kwasi Kwarteng, have managed to offend, anger or disappoint just about everyone in the country in a chaotic and reckless first month in office.

In doing so, they also unleashed powerful forces in global markets that had been dormant for a decade. For the first time since the financial crisis of 2008-2009, there is a strong scent of systemic risk in the air.

With its lavish promises of unfunded tax cuts and energy subsidies, the central bank had to step in to prevent the collapse of much of the UK pension system.

For a few hours last week, a destructive vicious circle formed in which pension funds had to sell their gilts to meet margin calls on long-term interest rate swaps. The selloff then pushed the funds’ hedges even further out of the market, requiring more margin and more liquidations.

The sight of hidden systemic leverage exposed by a sharp adverse move in interest rates was reminiscent of 2007 and the first foreclosures in subprime credit markets that led, a year later, to the biggest financial crisis in 70 years. It was an instantly recognizable sentiment that inevitably made people think that similar weaknesses might be lurking in the Eurozone and US financial markets (not to mention the Japanese and Chinese markets), just waiting for the right catalyst to trigger them.

The BoE operation is still ongoing – at a final cost of £65bn. But even if he does succeed, the government’s sloppy and tone-deaf way of doing business has all but destroyed his credibility with financial markets.

Truss inherited an economy with a small number of acute short-term problems (skyrocketing energy bills and runaway inflation) and a large number of simply serious but chronic problems: the pandemic hangover, low productivity and of growth, the lack of access to neighboring markets caused by Brexit and the need to move to net zero carbon emissions, to name but a few. The task at hand was to mitigate the more pressing emergencies while striving to resolve the longer-term ones.

Instead, Truss and Kwarteng have pulled more than £100billion in tax cuts and energy subsidies out of nowhere, in a thinly veiled effort to boost the economy just enough for Truss to survive. until the next elections in 2024.

Nobody bought it: not the electorate, who were outraged by the skewed priorities of tax cuts for the top 2% as much of the country struggles to choose between warming and to feed ; not the Tory MPs who won their seats last time out on Boris Johnson’s starkly different agenda of prioritizing deprived regions, and certainly not the financial markets, which have gutted the pound and driven up the borrowing costs of the government by more than half a percentage point in one day.

Truss and Kwarteng have since backtracked, rescinding the announcement to cut the top income tax rate, but the damage has been done. Indeed, they added to it, sowing confusion about whether they will cut public spending to limit all their further borrowing, and contradicting themselves in public on the idea of ​​the ill-fated tax cut at the highest rate. Remarkably, in an interview Wednesday before her conference speech, Truss declined to answer a simple question about whether she still trusted Kwarteng to make the right decisions.

Benchmark gilt yields are now around 90 basis points higher than when Truss took office, a move that will cost billions of pounds in additional debt service charges if it persists. The money continues to languish, penalizing both importers and consumers. Short-term market rates rose to reflect expectations that the Bank of England will have to raise interest rates higher and faster than it otherwise would have. This will ensure that any benefit voters and businesses have gained from their tax cuts will be eaten up by rising mortgage costs and credit card bills.

In his defence, Truss hasn’t done all wrong since arriving at 10 Downing Street. She is clearly not going to give up on Britain’s support for Ukraine and, contrary to some of the noises she has made as Foreign Secretary, she seems to be following a more conciliatory course with the European Union, quietly abandoning plans to introduce new legislation to tear up Britain’s Brexit deal. However, she has made life unnecessarily difficult for herself – and may have let a genius out of the market that many outside Britain will soon regret.

Daniel K. Denny