The Fall of Liz Truss
Elizabeth Truss’s resignation on Thursday made her tenure the shortest of any Prime Minister in British history. At 44 days, it was less than half the length of the tenure of George Canning, who lasted 119 days – and he had the excuse of dying while in office. Her tale is one of hubris and tragedy. But it is also one about the power of the markets, the precariousness of the debt-based economic system Western governments have embraced, and the fate which threatens to befall anyone who challenges a status quo which is unsustainable in the long-run.
Truss entered office with high hopes, especially among free-market conservatives and advocates of the trans-Atlantic relationship, but found herself isolated a mere six weeks later. She had the lowest approval ratings in history, witnessed her party descend into physical infighting during a parliamentary vote, and faced the indignity of being lectured about economic policy by Joe Biden.
While Joe Biden might be taking a victory lap for calling her tax cuts a mistake, the weaknesses of the U.K. economy are merely much more advanced versions of the same imbalances which afflict most major Western countries, including the United States. What happened to Truss when she tried to confront them should stand as a warning to American policymakers who think they can indefinitely avoid hard choices over debt, or believe that the markets will allow them the freedom to choose anything other than rigid austerity.
There were legitimate reasons behind Truss’s decision to gamble on an aggressive pro-growth economic policy, just as there were reasons for the market reaction. The United Kingdom had not only underperformed its fellow G7 economies over the past decade, but when inflation was taken into account, wages and incomes had been almost entirely stagnant. Behind this lay almost non-existent productivity growth. British education was failing to train workers to use technology, while companies were declining to invest in the sort of infrastructure which would promote growth. Workers, buried under high tax rates and secure in a strong, if decaying welfare state, had little incentive to challenge the status quo beyond complaining about what everyone knew. At some point, someone had to do something.
Truss attempted to do something with a mixture of corporate and individual tax cuts, elimination of regulatory red tape, the removal of caps on banker bonuses, and support for fracking. The markets reacted negatively, with the Pound Sterling losing almost 8 percent of its value. The reason was ostensibly concern over “unfunded” tax cuts, but this was simplified into concern about tax cuts in general. In actuality, markets were likely concerned about the U.K.’s level of debts, and doubted politically whether the government would be able to cut spending. In the view of international investors, the issue was not the “cost” of the tax cuts in financial terms but in political ones. They feared that it would be politically hard if not impossible to justify spending cuts, especially to pensions, if the government “had enough money to give tax cuts to the rich.”
This was a legitimate concern. It is easy to understand why investment banks and hedge funds would advise shorting the Pound and the entire U.K. economy on the basis of a lack of faith in the U.K. political system and politicians to seriously engage with the problems. This rationale would have led one to short it for most of the last decade, and Liz Truss and her former-Chancellor Kwasi Kwarteng merely announcing the shift in direction would not have changed this calculus because investors would have remained convinced they would be forced to change theirs.
The reason for the market assault was not that markets feared the Truss/Kwarteng supply-side program, but that they believed it would be reversed. They feared, with even more justification, that if Truss was forced to reverse her program under public pressure, or even forced out over it, there was no way she or her successors would be able to resist demands from unions for greater funding, the defense lobby for higher spending, or individual MPs opposed to fracking or development projects. Nor would any interest group refrain from escalating their demands in response to a policy of appeasement.
Following the market meltdown, Truss, whether willingly or not, followed the path of least resistance. She fired her Chancellor, Kwasi Kwarteng, a friend of over a decade, for implementing her policy. She replaced him with Jeremy Hunt, a former rival from the “left” of the party who had nevertheless run a highly opportunistic campaign for the leadership this summer, selecting a far-right MP as his ticket-mate and promising tax cuts that dwarfed the ones Truss had proposed. This “elder statesman” promptly reversed Truss’s policies, reinstating tax increases, announcing across the board budget cuts, and even scaling back her energy support package, limiting the guarantee to six months rather than the two years previously announced.
Officially, this was an effort to reassure the markets, which responded with alacrity. The pound recovered from $1.09 to $1.14. But this policy was also aimed at another figure within the Conservative Party, the former Chancellor, Rishi Sunak, who Truss had defeated this summer by a margin of 57 percent to 43 percent. Sunak, a former Goldman Sachs banker, had been putting himself forward in recent weeks as a vindicated visionary, and pushing a media message that only his coronation as Prime Minister, without a contest (which he would likely lose), could reassure markets. Hunt’s actions, in addition to soothing financial panic, were a chess move within the world of Tory party blood sport, intended to cut Sunak off at the pass.
Nevertheless, the announcements did little to help Truss, especially once Truss’s new appointees fell out among each other, a process that took mere days. Just days before she resigned, Truss sacked her Home Secretary, Suella Braverman, one of only two remaining right-wingers in the cabinet, for reasons that appear opaque even to Braverman.
By then, Truss’s policies had alienated almost everyone. Supporters of tax cuts had received higher tax rates. At the same time, the supporters of a working-class, “leveling up” agenda now faced far deeper budget cuts than would have been necessary to sell the pro-growth agenda to the markets. The final straw was a vote, initiated by the opposition Labour Party, to block the government’s plans to expand fracking. What should have been a straightforward defense of a pro-growth policy fell victim to the Byzantine machinations of the party. Fracking was associated with Jacob Rees-Mogg, the Business Secretary, who was a rival of Braverman’s for control of the right of the party.
Billed as a confidence vote, one in which the government would punish MPs who failed to support the government, the spokesman the government sent to introduce the vote suddenly announced, ostensibly by accident (but widely suspected to have been deliberate sabotage by rivals) that it was no longer a confidence vote and MPS could vote as they liked. Mogg was furious, and Truss confronted the whips, who resigned. In an effort to persuade them to reverse their resignations, Truss herself missed the vote, while her Deputy Prime Minister was witnessed on video physically dragging reluctant Tory MPs into the correct voting lobby, some in tears. For Truss it was the end. She gave up the following day.
Her withdrawal is unlikely to resolve the chaos quickly. Policy-wise, the party has fallen into opportunism as illustrated by the fracking vote. Truss, who ran on a pro-growth agenda of cutting taxes and addressing the cost of living, is now preaching high taxes and lower spending. Rishi Sunak, who campaigned as a “responsible technocrat,” is now attacking the government for excessive spending cuts, while opposing fracking. Boris Johnson has indicated interest in running again.
In the meantime, no one is even discussing the underlying issues Truss’s initial program was intended to address. Market concerns about the debt were real, but the time when debt could be addressed solely through austerity is over. For the last decade and a half, the U.K., much like the U.S., has borrowed astronomical sums, not to fund growth, but rather the illusion of it.
In the 1990s, middle class affluence came to be defined in terms not of income or earnings, but rather “wealth,” the amount of assets one owns. Rather than savings, individuals were encouraged to trust in retirement funds which invested in an ever-rising stock market, while house prices rose year after year. This defied economic logic. If productivity was not growing, and the workforce, due to declining birthrates, risked shrinking, with immigration replacing more skilled with less skilled workers, then where was the money coming from to push real estate and stocks ever higher? The answer was debt.
Much as the U.S. college loan program, by offering infinite loans to anyone to attend any school they wished, allowed for rapid inflation of tuition costs, governments undertook a broader program of money printing. Termed “quantitative easing,” banks were lent vast sums of new money to invest in markets, driving them upward. This created the illusion of growth for the economy as a whole and served to negate the ambitions of a generation of workers who watched their investments balloon. In much the same way high marginal tax rates discourage work, so too did asset inflation.
But stocks were not the only assets being inflated. Governments around the world kept interest rates at nearly zero for more than a decade after 2008. The result was that, much as with the federal student loan program, millions were able to take out enormous mortgages to buy houses. This produced a cyclical effect. It meant housing prices remained high, as there was a subsidized supply of potential buyers, which meant homeowners perceived a large increase in wealth. It furthermore encouraged individuals to take out large mortgages for houses they might not even want, at prices well above what the actual utility of the property was, in the belief it was an investment which could only go up.
The problem then was not the printing of money. It was that, rather than using the printed money to cover lower taxes, less regulation, and pro-growth policies (as Truss attempted to do), it was invested merely in inflating asset prices. By the time Truss tried to pivot, there was no more money left.
That is the truly terrifying element, and one which Joe Biden should pay more attention to than he did Larry Summers’s warnings about inflation in early 2021. The danger of high inflation was not that inflation was fatal in and of itself. There are arguments that in a crisis, such as COVID-19, some borrowing could be worth it, or for investments, as Truss later attempted. The problem was that the normal mechanism for curing high inflation, central banks raising interest rates, would not merely limit growth but potentially crash the economy.
In a normal economy, prices for goods and assets go up and down based on supply and demand. That applies to stocks, which should reflect the actual increased earnings of a company, and houses, which should reflect who wants to actually live in them. Instead, trillions of borrowed and printed dollars were invested in stocks on the assumption they would increase above the rate of inflation, all while individuals took out mortgages far larger than their annual earnings. If they suddenly had to pay thousands more a year, they would be forced to sell their homes and assets, causing a market fall which in turn would force others to do so as well, even if their property was now worth less than the mortgages.
While some have fixed-rate mortgages, not everyone does, and even the decrease in demand could cause the prices to fall from their inflated levels. Some degree of correction was inevitable. This could not continue. The simple laws of physics were against it. But something Liz Truss and her advisers grasped was that the collapse could be mitigated if the economy, the real economy, could be grown as much as possible to close the gap between it and prices. Having failed, the U.K. public faces a cost-of-living abyss next year as the housing market seems on the verge of collapsing.
Joe Biden too must realize the dangers the U.S. faces. All of the same arguments he and his allies made for why the student loan system was unsustainable, and that the loans could never be paid back, could also apply to trillions in mortgages. They apply to productivity. Yet Democrats seem determined to reduce productivity, whether through labor rules, environmental policies, or support for woke ESG initiatives. The irony is that many of the arguments Bernie Sanders made about the student loan industry were true. If we continue to subsidize infinite loans for infinite annual tuition rates for an infinite variety of nonsense degrees, taxpayers will end up having to cover the bill. But Democrats refuse to engage the issue.
The Republican Party, like many of Truss’s advisers, understands the vague need for pro-growth policies. They grasp the damage ESG investing has done and the need for domestic energy. However, they make the same error too many of those around Truss made. They fail to grasp that the hour is already too late for Reaganite confidence that the fundamental state of the American economy is sound. They believe that rather than exacerbating the crisis, which they are, Democratic policies are the sole cause, and that if they are removed, somehow the debt will vanish, the stock market will resume climbing, that they can support development to make housing affordable, yet still ensure retirees and the middle class see their house values rise. They believe they can raise interest rates to fight inflation without any negative effects.
The hour is late. Choices will have to be made. It is not yet midnight, however. If clearly acknowledged, these risks will be overlooked by markets which, after all, will go down with the ship of the U.S. economy. Republicans have to be serious about reform. That means showing determination Truss did not, while also recognizing that the task ahead is far more difficult than she seemed to realize.
Originally on AMAC. https://amac.us/liz-trusss-failure-in-u-k-is-a-warning-about-the-future-of-the-u-s-economy/