British Prime Minister Truss turned an economic crisis into a dumpster fire

Former British Prime Minister Harold Wilson is often quoted as saying that a week is a long time in politics. No doubt the current occupant of the office, Liz Truss, would understand Wilson’s point of view. Prime Minister Truss, who bowed to Queen Elizabeth II and took over the country less than a month ago, has endured a roller-coaster ride with few parallels in modern British history.

His premiership was meant to provide stability after a summer of political scandals and unrest. Now, three weeks and three days after taking office, her plans to weather an economic storm have sparked far worse problems than she was supposed to solve. And Truss and his team are blamed for a crisis that threatens the UK economy, the UK currency and his political career as well.

Such is the panic that even the International Monetary Fund, the financial backer for global economic basket cases, was pressured into issuing a stark rebuke, effectively telling Truss to rethink its policy. In the United States, Treasury officials would be alarmed by what is happening on the other side of the Atlantic. And in Britain, there are fears of a crisis on the level of the Lehman Brothers bankruptcy in 2008 that brought the global economy to its knees. A London-based senior banker, speaking anonymously to the Financial Times, said things were so bad at one point this week that “I was afraid this was the beginning of the end. It wasn’t quite a Lehman moment. But it got closer.

What happened?

So how exactly did Britain – and Truss – get here?

Economic pressures were already building when Truss replaced scandal-torn Boris Johnson in early September. Thanks in part to Russia’s invasion of Ukraine, Britain faced soaring energy costs and high inflation across the board. One estimate, quoted by Anand Menon, a professor at King’s College London, in a conversation with Grid, suggested that more than 60% of Britons were on track to be in what economists call ‘energy poverty’. here January. In other words, they would spend a tenth of their income just on their fuel bills.

Dealing with this crisis was Truss’ number one task, and just two days into her tenure she announced a package of measures to keep prices low for consumers. Soon after, his finance minister (known in Britain as the Chancellor of the Exchequer), Kwasi Kwarteng, released what was touted as a plan to boost economic growth. Announced last week, its main pillar was a massive tax cut package, priced at around $50 billion, that would deliver the most benefits to some of the country’s wealthiest people.

“For too long in this country, we have fought for redistribution,” Kwarteng said as he released what he called “The 2022 Growth Plan.” “Now we need to focus on growth, not just how we tax and spend. We will make no apologies for managing the economy in a way that increases prosperity and the standard of living.

The measures were unexpected – and unprecedented in recent history. According to the Institute for Fiscal Studies, a highly respected London-based independent economic think tank, the Truss and Kwarteng plan represented the largest package of tax cuts since 1972.

The problem: Few economists thought the Truss plan was the right answer, especially at a time when the country was reeling from a cost-of-living crisis. And, as Grid reported, the pound was, along with other international currencies, already under pressure due to rising interest rates in the United States.

The financial markets also did not appreciate the “2022 Growth Plan”. Their skepticism was compounded by a critical omission: the Truss government offered no convincing explanation of how it intended to pay for the tax cuts. Kwarteng did not take the usual step of sharing independent forecasts of what his plans would mean for growth and government borrowing levels. These forecasts are compiled by an independent economic watchdog and generally released at the same time as the budget presentations. Their absence only added to market doubts.

The immediate consequence was a historic sell off in sterling, and even a brief seizure in the UK government bond market. Governments sell bonds to raise funds to fund day-to-day operations; keeping bond markets functioning is essential for economic stability.

In the end, Britain’s central bank, the Bank of England, had to step in, pumping billions into the markets to reassure investors that the UK was still a financially safe bet. The bank effectively provided a safety net for the sale, to ensure that the panic did not spread to other parts of the financial system.

“If the dysfunction of this market continues or worsens, there would be a significant risk to the financial stability of the United Kingdom,” the central bank said in a statement. “This would lead to an unwarranted tightening of financing conditions and a reduction in the flow of credit to the real economy.”

Translation: There could be a repeat of the crisis of 2007-08, when problems in the financial system meant that daily loans for individuals and small businesses were affected, triggering waves of economic difficulties, including job losses.

pain for the people

In fact, the pain has already started to affect ordinary Britons.

In an eye-catching development, several UK mortgage lenders have temporarily suspended operations, as they rush to reprice their mortgage offers to reflect the latest market turmoil. In some cases, mortgage rates for new loans have undergone sharp upward revisions, affecting both potential buyers and existing owners.

Meanwhile, the falling pound is driving up the cost of imports. For Britain, this could complicate efforts to fight inflation; in 2020, the country imported around 46% of the food it consumed.

Higher prices, in turn, would likely lead to even higher interest rates as London’s central bank tries to contain inflation. This would result in weaker growth, as rising borrowing costs put pressure on economic activity.

The economic turmoil is significant not just for Britain, but for the world as a whole, especially as businesses and individuals deal with the global impact of war in Ukraine. The dispute has driven up food and energy prices in Britain and beyond, adding to the fallout from the covid pandemic. The last thing the world needs right now is the equivalent of a trash fire raging in the heart of one of its biggest economies.

“A fundamental principle of economics is that more uncertainty leads to less consumer and business engagement,” Raphael Bostic, a senior U.S. Federal Reserve official, said this week. “The key question will be what it means to ultimately weaken the European economy, which is an important consideration for the performance of the US economy.”

The biggest fear is what economists and financial traders call “contagion”. Simply put, the spread of pain – much like the spread of a contagious disease – from Britain to other economies due to a number of factors, including the criss-crossing links between financial markets. Fears are particularly acute right now because of other pressures facing the global economy as a whole. As one financial investor told Reuters news agency: “It’s like having a sandcastle where pieces start falling all together. I think the UK is one of those plays…it just adds to the pain, the stress.

Are Truss’ days numbered?

Meanwhile, back in the UK, questions abound about Truss’ future.

For now, his government refuses to change course. In a series of media interviews Thursday, Truss insisted his plans were solid. “We are cutting taxes across the board because we were facing the highest tax burden in Britain for 70 years, and it was causing a lack of economic growth,” she told the BBC.

But just as the financial markets did not buy his arguments, neither did the public. A new poll shows the fallout is coming fast – and starting to affect his party’s political standing.

A new opinion poll shows Truss’ economic plans have given the opposition Labor Party a 33-point lead – the largest for the party in any poll published since the late 1990s.

For Truss, this marks – at least for now – the lowest point of a premiership that is less than four weeks old. And the low point of what had seemed like a promising career. When she came to power, the British newspaper The Economist put her on the cover of its local edition, with the headline: “Liz Truss Fix Britain? Less than a month later, she’s back on the same cover, this time in a sinking canoe with Kwarteng. The title this time: “How not to lead a country”.

Thanks to Dave Tepps for writing this article.

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