The Death of the Thatcherite Rebirth

National Review Online, October 21, 2022

Last week, Britain’s newly minted (and now newly departing) prime minister, Liz Truss, replaced Kwasi Kwarteng as chancellor of the Exchequer (finance minister) with Jeremy Hunt, a figure from the soggy Tory Party’s soggy center who was widely seen as “a safe pair of hands.” Hunt’s allies claimed that he would be CEO to Truss’s chairman, and that is how it turned out.

Kwarteng had already abandoned one of the tax cuts — a reduction in the top rate of income tax from 45 to 40 percent — contained in a mini-budget now caricatured as an example of wild-eyed libertarianism. Another of its provisions, the cancelation of an increase in corporation tax (from 19 percent to 25 percent) next April, was itself canceled shortly after Kwarteng left, a move that will hurt businesses at a difficult time. Hunt also scrapped a planned cut in the basic rate of income tax from 20 to 19 percent (something the Labour Party’s wild-eyed libertarians had said they would not reverse), as well as some other measures included in the mini-budget. Hunt bragged that he had “shown Conservatives can raise taxes.” No comment.

Stripped of authority, her initial attempt (the ideas were hers as well as Kwarteng’s) at a supply-side solution to Britain’s sluggish growth in ruins, and her party mutinous, Truss had little option other than to stand down. She becomes Britain’s shortest-serving prime minister, managing far less time in office than George Canning (1770–1827), whose not-unreasonable excuse was that he died in office after only 119 days.

Although the policies set out in the mini-budget were, in principle, a step in the right direction, the way in which they were prepared, packaged, and presented was, as I wrote here, appalling. Above all, Kwarteng, who has some background in the financial markets, had failed to take account of the fact that, awakened from their long slumber largely by inflation and the belated fight against it, bond vigilantes are again beginning to prowl. If he’d bothered to ask the Bank of England for its thoughts on possible market reactions, that might have helped.

According to the authors of the mini-budget, “the UK has the second lowest gross debt as a proportion of GDP in the G7” (around 95 percent in 2021), but, they acknowledged, “As a result of a series of significant crises” that number is “high by historical standards.” Indeed, it’s high by any reasonable standards. As I wrote last Friday:

Kwarteng should have taken the trouble to check out market sentiment more than he did, especially in light of the recent decision by the Truss government to spend billions on shielding households and business from the worst of what the energy market might now have in store. That decision may not have directly contributed to the sell-off, but to follow that spending with tax cuts undoubtedly did.

That some of these “uncosted” tax costs rendered the British tax system marginally less progressive infuriated many commentators (driven, I suspect, as much by ideology as by any attachment to fiscal rectitude), including quite a few likely to be heard or read by those who move the financial markets.

Market concerns about Kwarteng’s seeming insouciance about Britain’s finances were compounded by the high-handed way in which he launched his budget without waiting to hear what the Office of Budget Responsibility, an independent public body established to, among other functions, assess the cost of tax and spending plans, had to say about his proposals — despite warnings that not doing so risked unsettling markets. Kwarteng’s firing of the British Treasury’s most senior civil servant, for reasons that remain unclear, only added to the unease.

Put all these factors together, add inflation (British inflation was running at 9.9 percent in September and has since reached double figures), throw in the presence of a new team at the helm, and it’s not hard to see why the mini-budget triggered a crisis in the British government-bond markets. This was made much, much worse when one of the mines planted during the era of ultra-low interest rates — the use of derivatives-based liability-driven investment (LDI) to boost pension-fund returns — exploded.

In their (partial) defense, it is far from obvious that Kwarteng and Truss should have known about this danger. After all, as Greg Ip wrote in the Wall Street Journal:

In 2018, the Bank of England investigated whether a big rise in interest rates would trigger a cascade of forced selling by bond investors, destabilizing the financial system. The answer was no, even if long-term rates rose a full percentage point in a week, which had never happened in records going back to 1990.

To be fair, the bank tested the effect of interest rates’ rising by up to one percent in a week. What occurred in the wake of the mini-budget was more dramatic than that:

In the days surrounding the British government’s tax-cut announcement on Sept. 23, yields on British government bonds, called gilts, gyrated as much as 1.27 points in a single day as pension funds dumped bonds and closed out bond-linked derivatives positions to meet margin calls. The Bank of England was forced to step in and buy bonds to stem the selloff.

Nevertheless, it is worth noting that the Bank of England had identified LDI as an area of potential risk, before shrugging it off. Perhaps the bank’s own notion of extreme risk had itself been shaped by the era of ultra-low interest rates.

Meanwhile, it seems almost superfluous to mention that the pound also crashed after the unveiling of the mini-budget, bottoming a touch above $1.03 (an all-time low), down from around $1.13–1.14.

Investors have welcomed the arrival of Hunt, someone who appeared more conscious of fiscal discipline. The yield on the ten-year gilt (British government bond) was 3.91 percent at the close on Thursday, after peaking at 5.14 percent during the panic (it had been yielding 3.3–3.4 percent shortly before the mini-budget). The pound was trading at $1.12 at about the same time on Thursday, roughly its level before its slump.

Truss is an admirer and would-be emulator of Mrs. Thatcher. After a succession of dismal Conservative governments, that should have been an improvement. Sadly, she does not seem to have studied the Iron Lady’s tactics. In her earlier years, at least, Thatcher’s policy-making was marked by careful preparation and, where necessary, incrementalism. Neither played much role in the formation of the mini-budget.

Perhaps the calendar was to blame. Mrs. Thatcher began her efforts to turn Britain around after becoming prime minister in 1979. She had five years until the next general election, while Truss had not much more than two. Mrs. T. would probably have seen that as a reason for caution. Truss may have seen it as the opposite. Until the appointment of Hunt, for example, she had done little to reach out to less ideologically congenial colleagues, a dangerous strategy given that she was only the runner-up in the parliamentary contest for the Conservative leadership (behind Rishi Sunak, the former chancellor, who may yet end up as her successor). It was ordinary party members who voted her into the top job. On the other hand, this so-called free-market fundamentalist had been willing to spend billions on providing something of a shield for households and industry against soaring energy prices. Ironically, Hunt will be scaling back that relief in April, which will lead to significant economic and (for the Tories) electoral misery.

Whatever ideological turn the Conservatives take over the longer term, for now, their focus will be on salvaging something from the next election. That won’t be easy — one recent poll gave Labour a 36-point lead over the Conservatives. But, before too long, the Conservatives ought to move on from the ideology — if that’s the word to describe such an incoherent mess — that they have followed over the last twelve years or so. Lacking even the virtues of traditional Toryism, it bears some relationship to European Christian Democracy, with additional technocratic flourishes. The economic consequences have, predictably, been nothing to boast about.

From the mini-budget:

Economic growth in the UK in the two decades prior to the pandemic averaged 1.8%, almost a percentage point lower than over the previous two decades.

Productivity growth has also declined. The second of those two decades — a decade, admittedly, after the global financial crisis — was one in which Britain was run by Conservative or Conservative-led governments. Under the circumstances, the idea the party should return to the principles, if not necessarily the prescriptions (times change) that worked so well under Thatcher and, with hiccoughs, her successor, John Major, made sense. Looked at in 2022, that would include, on the economic side, yes, tax cuts, deregulation, a more skills-based approach to immigration, and an energy policy that will avoid hobbling the British economy. That last must eventually mean tackling the current commitment to net-zero greenhouse-gas emissions by 2050, an act of recklessness that will be as ineffective as it is destructive (central planning is what it is), introduced by the Conservatives in 2019 with support from across the political spectrum even though, like the mini-budget’s tax cuts, it was “uncosted.” Funny, that.

Unfortunately, the narrative that irresponsible “free-market fundamentalism” (rather than a series of blunders) plunged the U.K. into a crisis has been taken up with gusto by much of the media, the opposition, and a notable section of the parliamentary Conservative Party. Whoever emerges as their new prime minister, the likelihood is that the Tories will consign supply-side reform and, in due course, themselves to the recycling bin (if not the trash can) of history.