Trussonomics

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The Bank has been put in the invidious position of having to add unsterilised stimulus during an inflationary storm; or in cruder terms, it is having to print up to £5bn a day to bail out the fiscal misadventure of a careless, ideological government. All evidence is that the Prime Minister and her inner circle think they can pocket this stay of execution and persist as if nothing has changed. Such a course puts this country in serious jeopardy... 

But the inescapable fact is that the markets have said no, and the ensuing financial havoc overwhelms any plausible growth gain from fiscal stimulus. Citigroup is forecasting a 15pc house price crash. It is obvious what needs to be done. The Chancellor must take all cuts in income tax off the table until the public finances have recovered. He must stop talking about further cuts. He must return to the core message of supply-side reform. A modest retreat would have been enough on Monday. It may no longer be enough now. You have to get ahead of the markets in a fast-moving crisis of this kind. It is not tenable to extend a comprehensive energy subsidy for the affluent lasting two years at an unknown cost... 

You cannot buck the IMF, the bond markets, the currency markets, the Asian sovereign wealth funds, and the entire weight of global financial opinion at the same time. “You may believe in markets but that does not mean that markets believe in you,” said Torsten Bell from the Resolution Foundation.

The clock is ticking. The Bank will stop its emergency bond purchases on October 14. If the Prime Minister digs in and refuses to make any substantive change over the next twelve days, we can assume that global investors will again decline to finance her fiscal expansion. The Bank of England will then face a choice: It can either resume bond purchases, lose all authority, and go the way of the Turkish central bank; or it can raise rates to 5pc or 6pc to try to stem a combined run on the pound and the gilts market, causing a housing crash and a bloodbath of business bankruptcies. Nor is there any guarantee that the latter course would stabilise the financial system. One hates to say it in a Tory newspaper, but the Government seems embarked on a course of sheer madness.

Liz Truss is embarked on a course of sheer madness, taking the Bank of England with her

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Benefits payments are set to fall in real terms under government plans to reassure the City that it will control spending. Efforts to calm the markets in the wake of the mini-Budget came as a new poll showed Labour had a 33-point lead over the Conservatives – believed to be the biggest for any party since the late 1990s. On Thursday, Liz Truss and Kwasi Kwarteng used interviews to insist they would not ditch any element of their tax-slashing announcements, made last Friday, after a week in which the pound fell to record lows and interest rates soared.  

Instead, they made it clear that a squeeze on government departments was coming, with public spending remaining at levels agreed last year despite inflation eating into those budgets. Ministers were warned that spending cuts not seen since George Osborne’s austerity drive in the wake of the 2008-09 financial crisis would be needed to balance the books.

Mr Kwarteng, the Chancellor, refused to promise that benefits would rise in line with inflation – which could exceed 10 per cent – saying such a decision would be “premature”. There was speculation on Thursday night that a rise in line with average earnings, 5.4 per cent, was more likely. More than four million people receive Universal Credit. The Resolution Foundation think tank said some working families could be £1,000 a year worse off if benefits do not rise with average prices.

Benefits hit as Liz Truss tries to stem the mini-Budget bleeding

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Britain is unusual in relying on overseas buyers to finance almost half of government debt (Germany and Japan sell it all domestically) so it matters a lot what the rest of the world sees. And they saw the suspension of the Office for Budget Responsibility, the firing of the Treasury permanent secretary and a fight with the Bank of England. The new Prime Minister was seemingly at war with every institution set up to create confidence in the UK economic policy...

The three “Trusketeer” economists who backed her plans during the campaign are not slow to point to flaws now. “Communications failure,” says Patrick Minford. It all risks a “doom loop of rising interest costs and more borrowing,” says Julian Jessop: why not wait for a November Budget? Fiscal policy clearly needs to be credible, says Gerard Lyons – you can’t just borrow money without saying how you’d control spending.

Liz Truss has shocked her own allies and is dangerously close to the edge

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Liz Truss and Kwasi Kwarteng will refuse to release forecasts from the Office for Budget Responsibility (OBR) until more than six weeks after receiving them, despite calls for them to be published as soon as possible. The prime minister and chancellor said they would only publish the independent forecasts on 23 November alongside a fiscal statement, despite them being ready on 7 October.

Truss and Kwarteng to hold back OBR forecasts for six weeks | Economic policy | The Guardian

• Would they do that if these forecasts were positive for their tax plans? Of course not..
  

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Without the Bank’s decisive action, it is no exaggeration to say that the UK faced a pensions meltdown in which as many as ten million people with gold-plated ‘final salary’ schemes would have been affected. One investor told the Financial Times that 90pc of UK pension funds would have been “wiped out”. The problem stems from a massive new bubble that has been allowed to develop in something called Liability Driven Investments. An estimated £2.5 trillion sits in UK private-sector pension funds and the assumption is that most of that money is safely tucked away in assets such as government bonds and shares. That is true, but only up to a point. Pension schemes typically invest more than half of their assets in gilts, in order to meet future long-term liabilities. But ultra-low interest rates have left yields on a steady downward trajectory for the last 25 years. This pushes up the accounting value of pension fund liabilities, so increasingly fund managers have sought to hedge their UK government bond positions through LDI trades.

Pension schemes use LDIs to offset the swings in their liabilities stemming from bond market volatility by investing in other more high-growth assets such as corporate debt and mortgages. But there’s a further layer of complexity because investment managers then hedge the risks further through derivatives, often using existing bond assets as collateral against the contracts. Anyone with a private pension may be shocked to learn that the amount of liabilities held by UK pension funds hedged using LDI strategies has roughly tripled in size to £1.5 trillion between 2010 and 2020, the equivalent of roughly 40pc of the UK institutional asset management industry. What is more surprising is that the £1 trillion tied up in Government bonds proved to be the weak link in the chain. As gilt yields rose sharply on the back of an almighty sell-off, bonds were suddenly worth less than the loans made against them. Spooked creditors demanded extra collateral to cover their positions.

The Bank of England’s emergency £65bn bond-buying programme saved the day. It quickly brought yields back down, helping to calm the market. Without it, there would have been fire sale of assets, including perversely more of the same bonds, as pension funds scrambled to raise cash to meet margin calls. Former Governor Sir Mark Carney said that if the Bank had failed to act, the knock-on effects “would more than ripple” they “would cascade through financial markets.” Still, it is patently absurd that all it took was little more than a 1 percentage point spike in bond yields to threaten to bring the entire house tumbling down.

There is a ticking time bomb under the financial system

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High street bank HSBC has warned that “mass forced sales” are a growing risk as mortgage repayments will rise by up to £5,000 a year. Mortgage rates had already surged above 4pc before last week’s mini-Budget and a rise to 5.5pc is now an “imminent possibility”, the bank said. Households coming to the end of a fixed-term deal will soon face increases of around £5,000 a year. Before Chancellor Kwasi Kwarteng’s statement last Friday analysts were expecting repayments to rise by £3,500.

HSBC warns of ‘mass forced sales’ as mortgage costs jump by £5,000 a year

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A little summary

• No handouts U-turn but energy price cap benefits the rich
  
• No windfall tax, despite existing windfall
  
• Cut the top rate of income tax from 45% to 40%
  
• Abolish the planned increase in corporation tax
  
• Reversing the planned national insurance rise
  
• Abolish stamp duty
  
• Abolish the cap on bankers bonuses
  
• In total £45B of tax cuts
  
• No disguise like Cameron’s “big society”, Johnson’s “levelling up”, just straight up libertarianism
  
• No scrutiny either of the Office for Budget Responsibility (which he has refused) and then delayed by 6 weeks
  
• Nor the help of an experienced permanent secretary in the Treasury sacking of its permanent secretary, Tom Scholar (whom he has sacked)
  
• Huge fiscal expansion in the face of high inflation and rising interest rates risks the BoE having to raise rates even more
  
• Unfavorable market reaction
  
• The market reacts as if Britain is Argentina with both bonds and currency falling 
  
• Timing might be fortuitous as economies are tipping into a recession and monetary policy is tightening [4]
  
• No evidence tax cuts actually work on the supply side (Trump 2017 tax cut research, decades of tax cut research)
  
• BoE had to come to the rescue and buy Treasuries as pension funds were about to blow themselves up with LDIs Libability Driven Investments, setting a vicious cycle in motion.
  
• 40%+ Mortgage of mortgage products were retracted as pricing became volatile
  
• Mortgages are rapidly getting more expensive adding to household financial stress on top of the energy crisis.
  
• The new government religiously believes in free markets but when these give their verdict they tell voters to ignore it.
  

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Liz Truss’s hopes of long-term survival as prime minister have been dealt a massive blow by a bombshell series of polls, giving Labour leads of up to 33 points and showing support for the Tories melting away after her “kamikaze” mini-Budget of tax giveaways for the rich. The prime minister emerged from five days of silence on Thursday to deliver a defiant defence of the £45bn package, which she insisted was “the right plan” even while admitting it handed “disproportionate” cash gains to the wealthiest in society. 

But independent experts described the package unveiled by chancellor Kwasi Kwarteng last Friday as the biggest “unforced error” of modern economic history, warning it will usher in a new age of austerity, with the government needing to find almost £50bn a year in cuts to public spending to meet its own targets.

Bombshell polls throw massive question mark over Liz Truss’s future as PM

In its first weeks the new government has shredded its own reputation, unleashed higher inflation, forced emergency action from the central bank, and made growth harder. Just imagine what it can do in a month or two.

How not to run a country

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Liz Truss’s government is considering ways to shrink the size of the welfare state, a key cabinet ally Simon Clarke has suggested. The levelling up secretary said ministers were looking at how to make sure “extremely large” state is aligned to a low-tax economy, as economists and unions warn of major austerity cuts ahead. Mr Clarke said Britons and others in western Europe were living in a “fools’ paradise” in which they enjoy a “very large welfare state” despite sluggish economic productivity. “I think it is important that we look at a state which is extremely large, and look at how we can make sure that it is in full alignment with a lower tax economy,” the cabinet minister told The Times.

Government wants to cut ‘very large welfare state’, says Truss cabinet ally

In July, Truss assured us she would not return to the austerity of the 2010-15 Tory-led coalition. “I’m very clear I’m not planning public spending reductions, what I am planning is public service reforms,” she said. In other words, Trussonomics is not Osbornomics. Yet another round of spending cuts is precisely what her government is now planning in a desperate attempt to scramble out of the hole of its own making and calm the financial markets.

Liz Truss is not doing what she promised in her leadership campaign | The Independent

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Concerns were also voiced by Tories on Saturday after Simon Clarke, a key Truss ally and the levelling up secretary, signalled that welfare would be cut as part of plans to bring public spending back under control. James Cartlidge, MP for South Suffolk, said: “To be clear, cutting tax for top earners while reducing benefits in a cost of living crisis is unacceptable.”

Voters abandon Tories as faith in economic competence dives | Liz Truss | The Guardian

Liz Truss has a matter of days to row back on controversial tax and welfare cuts or face a parliamentary rebellion which could see her removed from Downing Street by Christmas, Conservative MPs have warned. As the prime minister arrived in Birmingham for her first annual conference as leader, senior backbenchers told The Independent that MPs across the party are “livid” at suggestions she plans to renege on a promised benefit uprating to pay for tax cuts for the rich in chancellor Kwasi Kwarteng’s mini-Budget. One described the combination of austerity for the poor and giveaways for the wealthy as “electoral suicide” and confirmed Tory MPs were talking to Labour on parliamentary means of stopping it.

While organised plots have not yet formed, they expected them to get under way in earnest unless Ms Truss shows signs of backing down by the time the Commons returns from recess on 11 October. Former Tory chancellor Kenneth Clarke told The Independent that Ms Truss and Mr Kwarteng need to “learn important lessons quickly” after a “politically inept” mini-Budget including £45bn of unfunded tax cuts, which sent the markets into freefall and Labour surging to leads of as much as 33 points in the polls. Another veteran of Sir John Major’s Treasury team, Phillip Oppenheim, said Ms Truss was “quite possibly the last ever Tory prime minister”.

Liz Truss ‘could be gone by Christmas’ unless she backs down to ‘livid’ Tory MPs