- Truss blames financial institutions for her short-lived premiership
- Kwarteng faced harsh criticism in Washington for UK’s tax cuts
- Market backlash doomed Truss’s and Kwarteng’s economic plans
In October 2022, the then-Chancellor Kwasi Kwarteng arrived at the temporary residence of Britain’s Ambassador to Washington, Dame Karen Pierce, on a wet and windy night in Washington, D.C. He appeared to be a man without a care in the world.
As the English sparkling wine poured, his extrovert hostess, who was colorfully attired, appeared equally at ease.
In reality, storm clouds were gathering in Westminster as politicians dreadfully observed the chaos in the global financial markets, soaring interest rates, and plummeting pound.
Kwarteng had endured a tumultuous day despite his outward appearance of unwavering tranquility.
America’s highly respected Treasury Secretary Janet Yellen, a former chairman of the US Central Bank and the Federal Reserve, had read the riot act to him regarding the potential capsize of the entire Western economic system by Britain’s cavalier tax cut program. Additionally, Kristalina Georgieva, the formidable managing director of the International Monetary Fund (IMF), had issued him a public reprimand.
Liz Truss, the prime minister of Kwarteng, was even betraying him.
He had traveled to Washington against her advice in the belief that failing to attend the G7 and IMF gatherings, as panic seized the world’s stock exchanges, would be interpreted as weakness.
Denis Healey’s unfortunate reaction to the news that the pound was plunging on international markets in 1976 is a lesson that no British Chancellor should overlook when assuming office.
It was a disastrous misjudgment for the Labour Chancellor to leave his gin and tonic in the VIP lounge at Heathrow and return to the Treasury rather than traveling to the Philippines capital of Manila for an IMF meeting.
The Wall Street Journal, the most prestigious financial daily in the United States, published the headline “Goodbye, Great Britain” several days later.
However, by the time the typically gregarious and cheerful Kwarteng arrived at the Ambassador’s drinks party last October, he had realized that a political tsunami had erupted in his absence, escalating from a meltdown on the money markets that threatened to remove his intellectual soulmate, Truss, from office.
He announced to the boisterous press corps that he would be rescheduling his journey in order to meet with his colleagues at home.
He was unaware that his former acquaintance, Ms. Truss, had arranged for Jeremy Hunt, who had returned from a business meeting in Brussels, to assume the position of HM Treasury by the time his red-eye flight landed in London.
In her latest publication, Ten Years To Save The West, the brief-lived Prime Minister recounts her experiences during this frenetic period.
The mini-budget’s detour
The most remarkable aspect of Truss’s account of the Growth Plan, or’ mini-Budget’ as it was dubbed, is the manner in which it reveals the pair’s utter naivety. The plan led to the defenestration of Kwarteng and, a few days later, Truss herself.
In an effort to disseminate the responsibility for the catastrophic 49-day premiership that was hers, she targets our foremost financial institutions.
Truss devotes page after page to denigrating the Bank of England, the Treasury, and the Office of Budget Responsibility, and, to a certain extent, I can sympathize with her.
‘Group mentality’ has indeed infected these diligent protectors of the United Kingdom’s economic and financial stability. However, the financial markets have been the ultimate arbiters of a government’s economic decision-making throughout the history of modern finance.
Winston Churchill, who was then the Chancellor of the United Kingdom under Stanley Baldwin, was compelled by currency dealers to remove sterling from the gold standard in 1931, six years after he had made the fatal error of re-entering at the pre-World War I rate. This action resulted in a 10% increase in the cost of British goods exported to the United States.
In 1976, the ‘gnomes of Zurich,’ a powerful group of Swiss financiers, ultimately sent Denis Healey to the IMF with a cap in hand to request a bailout.
Eighteen years later, the foreign exchange markets were responsible for the downfall of John Major’s government. The UK was compelled to withdraw from the European Exchange Rate Mechanism (ERM) on “Black Wednesday” after the pound’s value failed to exceed the lower limit required for ERM participation despite repeated panic-stricken interest rate increases.
The credit crisis was precipitated in 2008 by hedge funds’ brutal attack on the share prices of British banks. This compelled Gordon Brown to bail out the Royal Bank of Scotland (which owned NatWest) and the other major banks.
In March 2020, the Bank of England responded to the financial system’s implosion on both sides of the Atlantic by reducing interest rates to the bone (0.1%) and providing billions of pounds of assistance to the banking sector during the onset of COVID-19.
James Carville, President Clinton’s electoral strategist, used the phrase “It’s the economy, stupid” to concentrate the minds of his campaign workers.
‘It’s the markets, fool’ is an adage that any contemporary politician should memorize.
Liz Truss and Kwasi Kwarteng, who are two of the foremost advocates of free market capitalism, should have been acutely aware of their influence.
It remains one of the great mysteries of the universe that they permitted themselves to believe that their faith in the ability of lower taxes to re-ignite growth and propel Britain toward the sunlit uplands, even if it required increased borrowing, did not need to be shared by the bond traders, currency dealers, and stockbrokers who would ultimately regulate their fate.
They did not appear to consider the possibility of a ferocious market backlash. This kind of situation had destroyed previous Labour and Tory administrations as they plotted their economic coup with child-like enthusiasm in secret sessions held at Chevening, the Grade I-listed official country residence in Kent of the foreign secretary James Cleverly.
However, Truss is so naive that, as her book demonstrates, she is unwilling to acknowledge that the markets were the driving force behind her removal from office.
Rather, she seeks solace in a conspiracy theory that attributes her failure to her ambitions and her departure from Downing Street to the gaffe-prone governor of the Bank of England, Andrew Bailey, and the leaders of other obscure national financial institutions.
It is undeniable that the Bank committed grave errors in its anti-inflationary efforts, particularly in its failure to regulate the UK’s pension funds and its persistence in injecting liquidity into the economy through quantitative easing after it had become counterproductive (more on this later).
The Office of Budget Responsibility (OBR) must also be held accountable for its perpetually inaccurate forecasting. The Truss-Kwarteng cause was also harmed by the Treasury’s fixation on balanced budgets.
The markets undermined Trshould have been supporteds vision.
Nevertheless, Truss’s vast vision was ultimately defeated by the markets. When London’s foreign exchange market trades $2.9 trillion daily, in addition to the £2 trillion-plus in bonds and gilts, no central bank or Treasury can withstand market sentiment.
Traders who take aggressive positions will always win any power conflict with the Treasury, at least in the short term.
The Wild West of unfettered markets undid Truss, as it did so many of her predecessors. However, she refuses to perceive the situation in this manner. Bailey’s Mini Budget received a nightmarish reception as a result of her misjudgments in the world of the looking glass.
She maintains that the decline in the value of the pound on foreign exchange markets, which was a contributing factor to her demise, had commenced prior to the budget’s presentation.
Bailey failed to raise interest rates as anticipated, and the currency merchants were taken aback by his decision to sell £40 billion of the Bank’s gilts, which are government bonds.
In Truss’s opinion, the bank made a mistake by reducing the market price of government bonds while simultaneously increasing gilt yields, the interest rate they pay.
We, the media, were also accountable for neglecting to recognize that the genuine narrative was a robust dollar, as demonstrated by the decline in the Japanese yen. The pound’s catastrophic decline was a component of a more extensive trend in which the G7 currencies experienced a decline in response to the powerful dollar.
Truss’s animosity toward Bailey was further exacerbated by his refusal to allow Kwarteng’s preferred candidate, who remains unidentified in her memoir, to assume the position of permanent secretary at the Treasury after the Chancellor dismissed Tom Scholar on his first day of employment.
This episode is perplexing. The governor’s objection was predicated on his apprehensions regarding an adverse market reaction to the removal of a man who had been a pillar of the Treasury for approximately three decades.
However, what is the rationale behind the ‘independent’ governor of the Bank of England’s decision to determine the individual responsible for managing HM Treasury? Furthermore, why is her preferred candidate for the Treasury position kept from what is purported to be a comprehensive and candid account of the events?
Truss also launched a comprehensive attack on the governor’s management of the pension fund crisis in the wake of her Mini Budget, which caused gilt prices to plummet.
Banks, insurers, and pension funds were encouraged to increase their holdings of gilts in the aftermath of the great financial crisis of 2008, as UK government bonds have long been considered risk-free assets. (Banks mandated insurers, and pension funds were encouraged.)
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The hypothesis was that stability would be restored if they could transition away from more volatile investments, such as financial products known as derivatives that are founded on questionable assets like subprime mortgages.
However, Britain’s £ 1.5 trillion pension funds industry had grown impatient with the low returns generated by gilts during an era when interest rates were being maintained at historically low levels, unbeknownst to Truss, Kwarteng, and a significant portion of the financial world.
The investment professionals of pension funds devised a novel asset class known as a Liability-Driven Investment (LDI) in order to enhance their returns.
The pension funds utilized their bond portfolios as collateral to borrow funds to pay for these.
Truss laments that she needed to be informed of the potential time bomb at the heart of the financial system, which could detonate at any moment if the interest rate on gilts deviated from an anticipated range.
No one truly anticipated the extent of the threat that LDIs would prove to be. City watchdogs had largely disregarded an early warning of their potential peril, which was concealed within the Bank of England’s financial stability report.
