Trussonomics One Year On

The ‘Kamikaze Mini-Budget’: In Memoriam

Tomorrow (23 September) we shall celebrate the first anniversary of the Truss-Kwarteng “mini-budget” which, according to Labour luminaries like Rachel Reeves, Angela Rayner and Emily Thornbury, “crashed” the British economy. That “fiscal event” was billed by Chancellor Kwarteng as “a new approach for a new era”.

Or rather, we shan’t celebrate it – since almost every vestige of that radical programme was undone within weeks. As were the Chancellor and then the Prime Minister. When she resigned on 25 October, Ms Truss had lasted 49 days.

The adults in the room who took the helm have since pursued the Treasury’s policy of economic orthodoxy – otherwise known as managed decline. Taxes have remained high, as has spending. The national debt continues to grow. Economic growth continues to be anodyne and productivity growth has stalled. NHS waiting lists get longer; unemployment is rising. As interest rates have risen to clobber inflation, so does the corporate default rate. There are still five million or so people of working age who cannot or will not work. Local authorities such as Birmingham are declaring bankruptcy.

So, let’s cast our minds back one year and consider what actually happened.

Liz Truss was elected by the Tory party membership on a platform of restoring the UK growth rate to the 2.5 percent mark which had been (approximately) the average between 1945 and the financial crisis. The thrust of the mini-budget – which was not a formal budget and therefore was not pre-evaluated by the OBR – was to cut taxes so as to stimulate the economy. These tax cuts would be unfunded, meaning that without corresponding spending cuts borrowing would have to rise. Kwasi Kwarteng believed, apparently, that if the markets were prepared to lend the UK government around £400 billion to close the economy down during the pandemic lockdowns, then they would be happy to stump up a similar sum to pep up the economy. Once growth kicked in then tax revenues would rise and – hey presto – the tax cuts would become self-financing.

Mr Kwarteng announced that the higher 45 percent rate of income tax would be scrapped; that the basic rate of income tax would be cut to 19 percent; and that the proposed rises in National Insurance Contributions (NICs) would be cancelled, as would the proposed rise in corporation tax from 19 to 25 percent. For good measure he reduced stamp duty. Be it noted that the top rate of income tax throughout the Blair years was 40 percent.

Contrary to popular belief, this package of tax cuts would have cost a relatively affordable £25 billion a year in revenue foregone out of the forecast tax revenues of £1.1 trillion for 2026-27. But the abolition of the cap on bankers’ bonuses, combined with the abolition of the higher income tax rate for people earning over £150,000, reinforced the notion that this was a budget for millionaires. That was politically inept.

What really spooked the markets was not the tax cuts per se but that they were introduced alongside a massive, open-ended programme to subsidise domestic fuel bills, given huge hikes in gas and electricity bills in the aftermath of Russia’s invasion of Ukraine. Figures published by the Treasury estimated that the Energy Price Guarantee (EPG) would cost £60 billion in its first six months (depending of course on how much higher energy costs rose). When the OBR finally came up with a figure in October it put the cost of the EPG at £55 billion.

By comparison, Mr Sunak’s furlough scheme, rolled out over 2020-21 to pay people to stay at home, had cost around £69 billion. The EPG might have cost less if it had been means-tested; but energy prices were capped for people who heat their swimming pools as well as for people struggling to heat mouldy tenements. In the event, the cost of the EPG was ultimately less than forecast at around £30 billion – but the markets weren’t to know that at the time.

All this transpired against a backdrop of already rising interest rates and a deteriorating economic outlook. The Bank of England had raised the Base Rate by 50 points the day before the mini-budget – and indeed the Fed had raised rates by 75 basis points on the Wednesday. As I wrote here at the time, inflation was already messing up the national finances. Government borrowing costs and mortgage rates were rising across the developed world. But in the 10 days after the mini-budget, gilt yields in the UK shot up by as much as 150 basis points. This was because of a specific factor relating to the UK gilts market which Ms Truss and Mr Kwarteng (and many more besides, including the Treasury mandarins) had not foreseen.

It turned out that the major pension managers which provide defined benefit pensions across the UK – Aviva, L&G, Prudential and the rest – held around £500 billion of UK gilts in structured vehicles called liability-driven investments or LDIs. These entities were required by accounting rules to balance their current assets against future pension liabilities, the latter being calculated on a net present value basis using prevailing market yields as the discount rate. As those discount rates rose, so LDIs were forced to sell gilts in the open market, depressing gilt prices further and thus driving gilt yields up further. This drove a “potentially self-reinforcing spiral…threatening severe disruption of core funding markets and consequent widespread financial instability”ⁱ.

This “doom loop” in the gilts market was only avoided by a major intervention by the Bank of England on 28 September which launched a £60 billion gilts buying programme, especially long-dated gilts. The intervention had the desired effect and gilt yields eased; however, the impression that the mini-budget had precipitated an albeit brief financial crisis, amplified by a temporary collapse in sterling which hit a 37-year low against the dollar the week after the mini-budget, would be indelible. Hence the tendency by both Labour, the Sunak-Hunt loyalists and even the Bank of England to blame our current woes on Truss.

Today, gilt yields and mortgage rates are higher than they were at the nadir of the Truss government. The “muppet premium” is back, even though we have two very sober head boys in charge of the economy. (Sunak was head boy of Winchester and Hunt of Charterhouse). The 2-year gilt yield is at 4.83 percent as I write; and you will struggle to fix a 5-year mortgage below 6 percent. The UK has to pay more to borrow money than the olive belt bad boys Italy and Greece.

Of course, Liz Truss did not make any progress on the spending side of the government finances equation: but then, she did not have time. Her ideas about how to reform the NHS did not even see the light of day.

“From Singapore-on-Thames To Argentina-on-Sea”

Speaking at the Global Progress Action Summit in Montreal last weekend, a summit of trendy lefties and eco-warriors, former Bank of England Governor Mark Carney made a joke aimed at the Truss government and those who defend it, comparing Britain to Argentina.

In point of fact, that is ahistorical. Argentina has defaulted on its debt nine times since independence from Spain in 2016. It is perennially subject to rampant inflation. Britain has not defaulted on its debt since King Edward III became impecunious and halted repayments to his Florentine financiers (principally the Bardi and Peruzzi families) in 1343. Britain has experienced severe bouts of inflation in recent times – in the 1970s, the late ‘80s and now – but nothing compared to Argentina’s protracted monetary debauchery. Currently, we have inflation of 6.7 percent (as we learnt on Wednesday), while our Argentine friends are battling inflation of something like 125 percent.

But Mr Carney’s facile witticism was rapturously received. The international elite believes – in Dr Doom, Nouriel Roubini’s, words – that Britain has shot itself in the foot with Brexit. Any attempt to fashion the UK as a pro-market, entrepreneurial economy distinct from the EU will be snuffed out by the adverse reactions of the financial markets.

The global good and the great believe – with some justification – that the disruption of the Brexit vote, and then the five years of vicious political infighting which followed, have weakened the British body politic as much as the British economy. The evidence for that is that there have been five prime ministers and (embarrassing, this) seven Chancellors of the Exchequer in the seven years since the Brexit vote of June 2016. First there was Project Fear; now there is Project Bregret.

On Tuesday (19 September) the OECD regurgitated the Argentina motif. A report estimated that Britain will be one of the worst performing advanced economies next year, with only Argentina performing worse. The agency thinks that the UK economy will grow by just 0.8 percent in 2024, although Argentina’s economy will contract by 1.2 percent.

Edward III’s default had negative effects for England. Borrowing costs rose and trade with Europe declined. The humbling of Liz Truss has had a similar effect. Yet the lady is unbowed.

In a speech to the Institute for Government on Monday (18 September), Ms Truss intimated that it is people like Mr Carney who have pursued the “25-year economic consensus” which has led to Britain’s economic malaise. She re-animated her trope, first aired at her address as prime minister and party leader to the Conservative Party Conference on 05 October last year, that there is an “anti-growth coalition” consisting of “the economic and political elite, corporatists, parts of the media and even a section of the Conservative parliamentary party”.

Pro-market operators will buy that. But not all. In a survey of 230 or so global investors conducted by Bloomberg last week, two thirds said a Labour government would be best for UK stocks and the pound, with either an outright win for Labour or a Labour-led coalition seen as the “most market-friendly outcome”. 80 percent of the respondents said that confidence in British assets had not yet fully recovered since the gilt market wobble.

Sir Keir Starmer’s new strategy of taking Britain closer to the EU – though the details of just what he proposes are still murky – will no doubt reinforce the sentiment amongst foreign investors that Labour is a lower risk option than the chaotic Tories.

It is of note that in her speech to the Institute for Government on Monday, Ms Truss called for a relaxation of the UK’s net zero agenda. On Wednesday (20 September) that is exactly what prime minister Sunak announced.

Trussonomics 2.0

If, as seems likely, the Conservatives lose the general election that will most probably be held in the fourth quarter of next year and are displaced by Labour or by a Labour-led coalition, it is unlikely that Mr Sunak would wish to endure a full parliament as Leader of the Opposition. He will no doubt be inundated with job offers – not least from across the pond – with telephone number salaries attached. That suggests that the Tory leadership will once more be contested early in the next parliament. And if Ms Truss is not a contender it is probable that a Trussite will make the case for a tax-cutting, leaner government agenda.

That means that the history of what happened in the kamikaze mini-budget will be re-examined anew – only this time the Tories will have more time to reflect on what they believe in, what they really want and how to realise their ideals. There is already a caucus of Tory MPs who want to abolish our monstrously unjust regime of Inheritance Tax (IHT) – or at least to massively raise the threshold in the first instance, as Donald Trump did in the USA. Sir Jacob Rees-Mogg aspires to a flat tax of 20 percent across income, capital gains and IHT. The Conservative Growth Group (CGG) of 50 or so Conservative MPs, led by Simon Clarke and Ranil Jayawardena, claims not to want to challenge Mr Sunak’s government, but agitates for tax reform.

Under Sir Keir Starmer’s Labour, the UK will find it difficult to resist the clamour to ramp up spending one crisis at a time. The Tories’ hands were forced by the financial crisis, the inflammable cladding crisis, then Covid and the furlough scheme, and then the energy crisis, to provide rescue finance on an unprecedented scale each time the sirens sounded. Under Labour, the aerated concrete crisis will only get worse as more public buildings are deemed unsafe. School classrooms, hospital wards and theatres are already closing across the country. Labour is very unlikely to make the moral case for a smaller state. The worse the national finances get under Labour, the more the Trussites will feel vindicated.

Liz Truss is still alive and kicking – and she is now making her case. She kept her silence for a time after her defenestration, but in February she wrote a 4,000-word account of her premiership for the Daily Telegraph. And in an interview for the Daily Mail at the end of August, she fingered those who she thinks are the real culprits, inciting some derision from the left: the deep Treasury, the OBR, Joe Biden (who famously dismissed her version of “trickle-down economics”), plus the “Greta Thunbergs of this world” and an “unimaginative” Tory Party. “I was pushing against a system and against an orthodoxy that was gradually moving to the left”, she told the Mail.

Trussites talk about “institutional resistance”. Ms Truss will publish a new book in April next year – Ten Years to Save the West. That will be required reading for those who wish to remodel the Tory party. (As is Danny Kruger’s new book, Covenant, about which I shall have something to say shortly).

During her premiership I found Ms Truss’s communications skills dismal. (Although I am assured by people who know her – and I live in her constituency – that on a one-to-one basis she is highly engaging). For that reason, I doubt that she will ever return as Tory leader, let alone PM. What is for sure, however, is that so long as UK growth remains feeble Trussonomics will not fade away.

To that extent at least, she deserves her ministerial car.

Afterword: Rishi Changes Tack

The prime minister’s re-framing of the UK’s approach to the net zero by 2050 announced on Wednesday afternoon (20 September) is welcome. Although, in my view, he did not make a good fist of explaining why this is necessary for the good of the economy and for social justice.

Firstly, the policy that people in rural areas without a connection to the gas grid whose oil boilers conk out in 2026 would have to install heat pumps at extraordinary cost was simply unviable, unjust and would have had zero effect on global warming. There are only two manufacturers of heat pumps in the UK: Kensa, in Cornwall, which only manufactures ground source heat pumps, and RED in Northern Ireland, recently acquired by Octopus Energy. Most heat pumps are currently imported, unlike gas boilers which are made here by companies like Worcester Bosch.

Ask a plumber and he will tell you that most older properties are entirely unsuitable for heat pumps – even if you rip out the existing radiator network and install underfloor heating at eye-watering cost. Further, there are simply not enough engineers who are capable of installing these contraptions. Heat pumps represent a still immature technology, though I am open to the idea that they will become more efficient and more affordable over time. The government should incentivise house builders to roll out communal ground source heat pump networks in new-build housing estates; but to compel cash-strapped families to install heat pumps against their will this decade would have been impracticable and unfair.

Second, to align our ban on the sale of new petrol and diesel-powered cars with the EU and California makes perfect sense. The fact is that the UK automotive sector will not be ready for a phase-out of the internal combustion engine in 2030. There will be an insufficient number of affordable EVs made in the UK to satisfy demand. There is thus the danger that the void will be filled by cheap Chinese products, further weakening the domestic automotive sector. The charging network will still not be complete by 2030.

With internal combustion engines becoming increasingly fuel efficient and less polluting, it is a great shame that a quota of petrol-powered cars will not be manufactured after 2035, even though demand for them will still exist in many parts of the world.

It is all very well for the CEO of Ford UK to wail about the lack of certainty in government policy – but Ford has not made a single car here since 2002 (though it has continued to manufacture engines in Bridgend and Dagenham, as well as transmissions in Halewood). Toyota, which does still build cars in the UK, welcomed the policy shift.

The political risk for Mr Sunak is that the absolutist net zero zealots will characterise this sensible adjustment of the transition to net zero as a “betrayal”, or even as climate change “denial”. There will be weeping and gnashing of teeth – as exemplified by the superannuated climate ultra, Lord Deben, who was once a Tory. The reaction from the climate purists across the political divide (Lord Goldsmith among them) has already been hysterical.

Regular readers will know I have been banging this drum for some time. I hope this doesn’t sound smug, but as a commentator it’s gratifying when one’s predictions become reality.

i^ According to the Bank of England’s Sir John Cunliffe in a letter to the House of Commons Treasury Select Committee, 05 October 2022.