UK crisis: The markets strike back

Liz Truss almost turned the UK into a distrusted emerging economy

For the past few years, governments — especially in the West — have been able to intimidate the markets into silence. Markets have accepted vast expansions of central bank balance sheets, gargantuan borrowing programmes, and fiscal and monetary policy that defied all convention. Anyone would be forgiven for thinking this is the new normal: Unless a country was as close to the brink as, say, Sri Lanka, the markets would quietly accept whatever policymakers handed out.

This belief has come crashing down to earth, and in the single most unlikely country. The United Kingdom was the country that initially invented the giant government borrowing programme, and indeed developed modern central banking to finance it. For centuries, investors have been willing to lend British governments money that those investors’ grandchildren or great-grandchildren would see repaid. Three hundred-plus years of institutional history bought the British a certain degree of trust.

The short-lived government of Liz Truss pushed that trust too far. The markets revolted, driving up interest rates, home loan rates, and the cost of government borrowing. First Ms Truss’ chancellor, Kwasi Kwarteng, and then Ms Truss herself were forced to depart, casualties of the markets’ fury. Ms Truss’ time in office lasted barely more than six weeks — and, indeed, could have been three weeks shorter if not for the fact that Queen Elizabeth’s passing delayed the announcement of her new economic direction.

 “Trussonomics” was, in its essence, not so different from many growth prescriptions that right-wing ideologues have gotten away with in power before. Ms Truss promised that a round of tax cuts would revive British growth momentum, when combined with far-reaching deregulation. When the mourning period for the Queen was over, Mr Kwarteng presented the government’s plan: £45 billion or so of tax cuts, including on Britain’s highest earners, with practically no explanation as to why these were necessary or how they would be financed. These were, Ms Truss and Mr Kwarteng believed, the essence of why they had been chosen to run the Conservative Party by its membership, and a tribute to the one Tory prime minister whose shadow still defines right-wing parties in Britain and beyond: Margaret Thatcher. Ms Truss had promised Thatcherite tax cuts when campaigning to succeed Boris Johnson — to the visible frustration of her rival, Mr Johnson’s former chancellor of the exchequer Rishi Sunak — and she presumably felt that she must deliver.

Illustration: Ajay Mohanty

When Mr Kwarteng announced the largest tax cuts in 50 years, the fallout might have been less severe if the British government had not seemed so determined to ignore the basic rules under which most governments operate. Normally, in Britain, budgets are analysed for their fiscal implications by an independent body known as the Office of Budget Responsibility (an institution that India dearly needs to mimic if it is to survive the next few high-debt years unscathed). Mr Kwarteng dispensed with this formality. Ms Truss also sacked the finance ministry’s top bureaucrat, which the markets saw as one more signal that regular economic orthodoxy would not hold back her fiscal policy.

But, as it was, confidence in Britain and its government plummeted. The pound headed, incredibly, towards parity with the US dollar. Yields on UK government bonds soared to over 5 per cent, levels not exactly associated with a mature economy like Britain. Yields rose by more in a single day, according to the Bank of England, than they had in “all but four of the last 27 years”.

Various outsiders weighed in using tones more usually seen when discussing Argentina or Southern Europe. Larry Summers warned of contagion from the British experiment. The International Monetary Fund issued a rare and strongly-worded reproof. The unprecedented consensus in the commentariat and international organisations convinced the markets they were right to assume this was an unusual event; both reactions fed on each other and confidence in Britain spiralled downwards.

In order to recover some control over the narrative, Ms Truss jettisoned her partner in crime,

Mr Kwarteng. The chancellor, who was clearly implementing a joint vision, deserved better than that. Yet it looked that Ms Truss’ ruthlessness and her decision to bring in, as Mr Kwarteng’s successor, the very orthodox Jeremy Hunt, might steady the ship of British state — and, incidentally, preserve Ms Truss’ job.

But here the second part of her programme bit back. The Tory party faithful might have been willing to overlook the chaos unleashed in the sacred name of tax cuts. But deregulation would have to be on their terms, and not Ms Truss’. Thatcher’s deregulation, decades ago, probably turned out to hurt mainly Labour voters; Ms Truss’ plans were less carefully crafted to fit in with the social divisions that power British electoral politics. Rural Tory backbenchers were appalled that part of Ms Truss’ plans to increase energy security included increasing the government’s ability to permit fracking — a form of oil extraction — in their constituencies. The spectre of industrialisation is meant to inhabit the dark satanic mills of Labour country, not green and pleasant Tory-land. In an absurd sequence of events that rivals and perhaps surpasses any crucial vote in our own Parliament, Britain’s House of Commons voted to back Ms Truss’ plans amid scenes of ruling party MPs being allegedly physically forced to vote one way rather than the other. This was a step too far for the party, and Ms Truss lost all authority and had to resign.

 This sequence of events is darkly instructive. And the right lessons need to be learned from it. First, borrowing too much is not a step too far for the markets: What really will cause them to revolt is if you appear to be unmoored from economic orthodoxy and do not have a clear and transparent plan for the future.

Second, ideologically-driven parties cannot be trusted to rein in economically extremist plans from their leaders; they will not revolt over borrowing or fiscal plans, but only if their core social interests or their constituencies are threatened.

This may be why Ms Truss’ departure is upsetting some of those on the left as much as those on the right. The left does not believe markets should dictate the limits of government policy. The right does not think markets should bet against the growth-enhancing potential of tax cuts. Only the diminished centre — which would argue for gradualist deregulation and careful fiscal mathematics — seems to welcome the notion that the new normal is very much like the old: Don’t fight the markets and expect to win, even if you’re Number 10.

The writer is head of the Economy and Growth Programme at the Observer Research Foundation, New Delhi