The tragedy of Liz Truss’s downfall

Liz Truss is out and Liberals are cheering everywhere. Why? Because Britain’s in-and-out prime minister challenged conventional wisdom on how to create a thriving economy. She threatened to undermine elites who advise defeatist policies that encourage slow growth and celebrate Big Government instead of competition, investment and entrepreneurship.

She also pledged to boost investment in North Sea oil and gas production and reverse the country’s ban on fracking, as UK energy bills soar by more than 50% compared to a year ago. Climate activists swooned in horror.

The swift downfall of the embattled Prime Minister is a sad day for England and for the developed world.

Liz Truss was elected to revitalize a sluggish country still suffering from Brexit, as well as misguided energy and tax policies. The Conservative Party – his party – had occupied Number 10 Downing Street for 12 years but had struggled to keep taxes low given the growing demands for social services, particularly during COVID-19.

When Truss took office just a few weeks ago, inflation was at 10%, growth was slowing and real GDP was still below the pre-COVID level of 2019. Government debt was approaching 100% of GDP and deficits were increasing. The month before he took office, the budget deficit was nearly double what had been forecast, the highest on record in August.

In short, she inherited a mess.

Many businesses, and in particular lucrative financial firms, fled London after Brexit, fearing that England’s withdrawal from the European Union would prove constraining for cross-border deals and hiring. It was a legitimate concern; the rules were not written, and in the fast lanes of international finance, transactions could not wait for the creation of the new order.

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Some 7,000 jobs left the city; it was not, for many companies, an easy decision.

Truss wanted to attract them again, in part by removing caps on bankers’ bonuses imposed in the wake of the financial crisis. More broadly, Truss pledged to cut taxes, believing that such measures would encourage a wave of new start-ups and growth. Kwasi Kwarteng, Truss’ Chancellor of the Exchequer, described the measures as key to his “unabashed growth plan” for the economy.

Kwarteng released a “mini budget” outlining its ambitions, including attracting overseas visitors with value-added tax (VAT)-free shopping, postponing a planned corporate tax increase and slightly lower rates overall. The budget projected increased unfunded spending and, in fact, larger short-term deficits.

The plan caused Kwarteng and Truss to be widely mocked and defamed; the mini budget was called reckless. Bond markets fueled criticism. English government bonds, known as gilts, fell in price as interest rates rose, causing wild volatility in normally choppy markets and near panic among traders.

Truss may have pushed a plan at the wrong time, when markets were particularly jittery; proposing measures that would increase short-term deficits was a mistake. But she is not entirely responsible for the rapid repudiation of her program and her leadership. Pension managers, global central banks that condoned “free” money, the Biden White House and Federal Reserve Chairman Jerome Powell are also guilty of this story.

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The market crisis was explained not only by the fact that lower tax rates would aggravate deficits, but also by the fact that pension plan managers had taken advantage of their bond holdings in order to meet their obligations to retirees.

Repo borrowed against their gilt holdings to finance riskier investments, creating a scenario similar to the one that emerged during the financial crisis, when companies went bankrupt for taking advantage of their normally safe mortgage holdings.

It’s also true that because Biden and congressional Democrats pushed through trillions in wasteful spending as the economy was already recovering from COVID lockdowns, the Federal Reserve raised interest rates, pushing the dollar to a record level against the pound sterling. That didn’t help calm market jitters.

The Bank of England, facing a market rout, stepped in to buy gilts that were wholesale undervalued as pension managers scrambled to meet collateral demands. This rare intervention convinced investors and critics that the policies proposed by Truss were reckless.

So, is Liz Truss really the bad guy in this room, or are the people who engineered an excessively easy money period and pushed investors to risk their holdings really to blame?

This is an important question because developed economies, including the United States, all need strong growth to fund the ever-increasing demands of welfare states. It is also important to appear to justify opposition to the low-tax, light-regulation approach adopted by US Presidents Reagan and Kennedy, British Prime Minister Margaret Thatcher and, more recently, President Trump.

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The so-called “supply-side” economy has notably stimulated the most prosperous periods in our history. Advice from those advocating lower taxes and smaller government may be key to getting the United States and Western Europe back on track after the heavy toll of COVID shutdowns and overspending and, now, galloping inflation. Policymakers in the United States and elsewhere must begin to reverse the disastrous tsunami of government spending as we try to right our economic ship; the fire of the Liz Truss program will argue against such a change in direction.

Unfortunately, Truss’ economic program was misrepresented by a rookie finance minister, who was quickly ousted, but the damage to his credibility made his leadership impossible.

The Truss affair will remain as a lesson in budgetary sobriety, but the reduction of expenditure will not be part of the lessons. It’s a tragedy.

Liz Peek is a former associate of the large Wall Street firm Wertheim & Company. Follow her on Twitter @lizpeek.

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