There’s a new Prime Minister in the United Kingdom (again), and with the new Prime Minister is a new Chancellor of the Exchequer. The new top team has announced an economic plan full of tax rises and public spending cuts, and markets in Europe and around the world have finally begun to calm down because of it. Now we’ve got some breathing space, it seems like a good time to reflect on what went wrong, why it went wrong, and who was responsible for it.
The United Kingdom has always been seen as a bastion of stability, so when it makes economic moves so sudden, so unexpected, and so poorly received that the exchange rate of the pound against the dollar drops to a rate of almost 1:1, something has clearly gone badly wrong. Here’s the at-a-glance version of how it happened.
The brief rise and immediate fall of Liz Truss
For a brief period of history that now feels like a fever dream but included the death of Queen Elizabeth II and the subsequent period of mourning, the UK Prime Minister was Liz Truss. She lasted forty-four days in the post and, in her closing days, was haunted by the spectre of a lettuce. The Daily Star newspaper, smelling blood in the water towards the end of her Premiership, put a wig on a lettuce and opined that Truss would be forced from office before the lettuce perished. They were right; the lettuce won.
Truss’s time as Prime Minister was brief, but not as brief as the tenure of her Chancellor, Kwasi Kwarteng. Truss and Kwarteng have been friends for decades and co-authored economic policy books. Everything they intended to do to the British economy had been outlined long before, so the people who voted for Truss in the Conservative Party leadership election can’t say they weren’t warned. Truss was forced to fire Kwarteng after thirty-eight days because of his catastrophic “mini-budget,” after which she only survived a further six days. We’re getting too far ahead of ourselves, though – let’s look at why they both lost their jobs.
When Kwasi Kwarteng delivered a “mini-budget” in September, he described it as “the biggest package of tax cuts in a generation.” Both Truss and Kwarteng said that the package was aimed at delivering rapid growth, but it contained some hugely controversial measures. The most eye-catching of them was that the top rate of tax – forty-five per cent – levied against those who earn more than £150,000 would be completely scrapped. Anyone with an income of over £50,000 would pay tax at forty per cent, and that would be the blanket rate. Income tax would also be cut by one per cent in April 2023, and a planned rise in national insurance was scrapped.
The general feeling among analysts was that these changes would benefit the already-wealthy far more than they’d benefit at the bottom of the ladder. This feeling was amplified when Kwarteng announced that the cap on the amount of bonus money that bankers could be paid would be scrapped, supposedly to promote the idea that the UK is a world-leading financial centre. The cuts went on. A planned rise in corporation tax was scrapped. The threshold on stamp duty increased to £250,000. The entire Office of Tax Simplification was scrapped. Increased in duty on alcohol were cancelled. The list went on and on.
Analysts, financial experts and even members of the Conservative Party started to get cold feet about this apparent tax giveaway when Kwarteng refused to publish a forecast from the Office for Budget Responsibility alongside his budget, which prompted questions about how these tax cuts would be paid for. All he could say was that he’d provide more information at the end of October. That was more than a month away when he delivered his budget.
The British tabloid press loves few things more than a pun, and it’s unfortunate that Kwasi Kwarteng’s name lends itself so well to the word “Kamikaze.” As people tried – and failed – to make his sums add up, Kwarteng’s budget was nicknamed “the Kami-Kwasi budget.” The name stuck, but more importantly, the government’s borrowing costs began to skyrocket, and the value of the pound tanked. Markets hated the budget.
Why did markets hate the budget?
To put it simply, the sums didn’t add up. Kwarteng had stripped away billions of pounds of income for the government and replaced it with nothing. There was now an enormous hole in the UK economy and the government’s finances, and Kwarteng wouldn’t – or couldn’t – explain how it was going to be filled. The markets lost confidence that the UK could service its debts, and the resulting market chaos forced the Bank of England to pump £65bn into buying UK bonds to prevent several pension funds from becoming insolvent overnight. The shockwaves were felt in every stock exchange in the world. The budget was catastrophic and politically unsurvivable.
To give the scale of this error, imagine the UK government as a casino. You’re considering spending money there because you believe you might make a return on it, but before you do so, you check SisterSite.com to compare casinos and find out the odds of making a return on your spending. The website tells you that the casino can’t be trusted because its outgoings don’t match its income, so you can’t be sure your bets will be honoured. That’s how investors make decisions, too. They know there’s always a risk in investing, but if the asset they’re considering investing in is giving off major “your money isn’t safe here” signs, they’ll stay away just as surely as we would stay away from that metaphorical casino.
Is it safe now?
Sort of. The response to the budget was so bad that Liz Truss had to summon Kwarteng home from a conference in the United States of America – a conference where he was trying to sell the benefits of his budget – and tell him that he was fired. It was an attempt to save her own skin, but it was too late. Jeremy Hunt, Kwarteng’s replacement in the role, immediately undid every aspect of Kwarteng’s budget. The plan had belonged to Truss just as much as it had belonged to Kwarteng. She was still in power, but she was mortally wounded, and her authority was gone. It took less than a week for the party to force her out of the role.
Rishi Sunak, who served under Boris Johnson as Chancellor, is now the Prime Minister of the UK. He’s seen as competent, but his party’s reputation is so badly damaged that it trails the Labour Party by twenty points. He’s likely to lose the next election no matter what happens between now and then. The UK has settled a little for now, but more change may be coming.