Former British Prime Minister Harold Wilson is often quoted as having said that a week is a long time in politics. No doubt the current occupant of the office, Liz Truss, would understand Wilson’s point. Prime Minister Truss, who bowed before Queen Elizabeth II and took the country’s reins less than a month ago, has endured a roller-coaster ride with few parallels in modern British history.
Her premiership was supposed to provide stability after a summer of political scandal and turmoil. Now, three weeks and three days after she took office, her plans to deal with an economic tempest have triggered problems far worse than those she was meant to solve. And Truss and her team are being blamed for a crisis that is threatening the British economy, the British currency, and her political career as well.
Such is the panic that even the International Monetary Fund, the financial backstop for the world’s economic basket cases, was moved to issue a striking rebuke, effectively telling Truss to rethink her policies. In the U.S., Treasury officials are reported to be alarmed by what is happening across the pond. And in Britain, there are fears of a crisis on the level of the Lehman Brothers collapse in 2008 that brought the global economy to its knees. One senior London-based banker, speaking anonymously to the Financial Times, said things were so bad at one point this week that “I was worried this was the beginning of the end. It was not quite a Lehman moment. But it got close.”
So how exactly did Britain — and Truss — get here?
The economic pressures were already piling up when Truss replaced the scandal-riven Boris Johnson in early September. Thanks in part to Russia’s invasion of Ukraine, Britain was facing a steep rise in energy costs and high inflation across the board. One estimate, cited by King’s College London professor Anand Menon in a conversation with Grid, suggested that more than 60 percent of Britons were on track to be in what economists call “fuel poverty” by January. In other words, they would be spending a tenth of their incomes on just their fuel bills.
Dealing with this crisis was job number one for Truss, and just two days into her tenure she announced a package of measures to keep prices down for consumers. Soon after, her finance minister (known in Britain as the Chancellor of the Exchequer), Kwasi Kwarteng, issued what was billed as a plan to boost economic growth. Announced last week, its primary pillar was a huge package of tax cuts, priced at around $50 billion, which would offer the most benefit to some of the country’s wealthiest people.
“For too long in this country, we have indulged in a fight over redistribution,” Kwarteng said as he issued what he called “The Growth Plan 2022.” “Now, we need to focus on growth, not just how we tax and spend. We won’t apologize for managing the economy in a way that increases prosperity and living standards.”
The measures were unexpected — and unprecedented in recent history. According to the Institute for Fiscal Studies, a widely respected independent London-based economic think tank, the Truss and Kwarteng plan amounted to the biggest set of tax cuts since 1972.
The problem: Few economists thought the Truss plan was the right answer — particularly at a moment when the country was reeling from a cost of living crisis. And, as Grid has reported, the British pound was, with other international currencies, already under pressure because of interest-rate rises in the U.S.
The financial markets didn’t like the “Growth Plan 2022,″ either. Their skepticism was compounded by a critical omission: The Truss government offered no convincing explanation of how it intended to pay for the tax cuts. Kwarteng failed to take the customary step of sharing independent forecasts as to what his plans would mean for growth and the government’s borrowing levels. Such forecasts are compiled by an independent economic watchdog, and typically published in tandem with budget presentations. Their absence only added to the market’s doubts.
The immediate consequence was a historic sell-off of the British pound, and even a brief seizing up of the market for British government bonds. Governments sell bonds to raise money to finance day-to-day businesses; keeping bond markets functioning is essential for economic stability.
Ultimately, Britain’s central bank, the Bank of England, had to step in, pumping billions into the markets to reassure investors that the U.K. was still a safe financial bet. The bank effectively provided a backstop to the selling, as a way of ensuring that the panic didn’t spread to other parts of the financial system.
“Were dysfunction in this market to continue or worsen, there would be a material risk to UK financial stability,” the central bank said in a statement. “This would lead to an unwarranted tightening of financing conditions and a reduction of the flow of credit to the real economy.”
Translation: There could be a repeat of the crisis of 2007-08, when problems in the financial system meant that everyday lending for individuals and small businesses was hit, triggering waves of economic pain, including job losses.
Pain for the people
In fact, the pain has already begun to touch ordinary Britons.
In one eye-catching development, several British mortgage lenders temporarily suspended business, as they rushed to reprice their mortgage deals to reflect the latest market turmoil. In some cases, mortgage rates for new loans faced sharp upward revisions — hitting both potential buyers and existing homeowners.
Meanwhile, the drop in the pound drives up the cost of imports. For Britain, this could complicate efforts to fight inflation; in 2020, the country imported around 46 percent of the food it consumed.
Higher prices would, in turn, likely lead to even higher interest rates, as the central bank in London tries to keep a lid on inflation. The result would be lower growth, as higher borrowing costs exert pressure on economic activity.
The economic tumult matters not only for Britain but the world at large, particularly as businesses and individuals deal with the global impact of the Ukraine War. The conflict has driven up prices for food and energy in Britain and beyond, adding to the fallout from the covid pandemic. The last thing the world needs now is the equivalent of a raging dumpster fire at the heart of one of its biggest economies.
“A basic tenet of economics is more uncertainty leads to less engagement by consumers and businesses,” Raphael Bostic, a top U.S. Federal Reserve official, said this week. “The key question will be, what does this mean for ultimately weakening the European economy, which is an important consideration for how the U.S. economy is going to perform.”
The biggest fear is what economists and financial traders call “contagion.” Put simply, the spreading of the pain — much like the spreading of a contagious disease — from Britain to other other economies because of a number of factors, including the crisscrossing connections among financial markets. The fears are particularly acute at this moment because of the other pressures faced by the global economy as a whole. As one financial investor told the Reuters news agency: “It is like having a sand castle where bits and pieces start falling of all together. I think the UK is one of those pieces … it is just adding to the pain, adding to the stress.”
Are Truss’ days numbered?
Meanwhile, back in the U.K., questions abound about Truss’ own future.
For now, her government is refusing to change course. In a series of media interviews Thursday, Truss insisted that her plans were sound. “We are cutting taxes across the board because we were facing the highest tax burden on Britain in 70 years, and that was causing a lack of economic growth,” she asserted to the BBC.
But just as the financial markets haven’t bought her arguments, the public hasn’t, either. New polling shows that the fallout is coming fast — and beginning to affect her party’s political standing.
New opinion polling shows that Truss’ economic plans have resulted in a 33-point lead for the opposition Labour Party — the biggest for the party in any survey published since the late 1990s.
For Truss, it marks — at least for now — the lowest point in a premiership that is less than four weeks old. And the low point in what had looked like a promising career. When she came to power, Britain’s Economist newspaper put her on the cover of its local edition, with the headline: “Can Liz Truss Fix Britain?” Less than a month on, she’s back on the same cover, this time in a sinking dinghy with Kwarteng. The headline this time around: “How Not To Run A Country.”
Thanks to Dave Tepps for copy editing this article.