Truss, undone by historical ignorance, faces the chop

This is Iain Martin’s weekly newsletter, exclusively for Reaction subscribers.

When the Bank of England was founded in July 1694 it was designed to deal with a lack of cash during a pressing national crisis. The government, operating under a relatively new constitutional settlement, needed to rebuild its navy and be ready to combat threats to security. They lacked funds. A privately owned national bank, backed by the Crown, was established to facilitate the borrowing required. The certificates had gilded edges, as if to emphasise the robustness of the guarantee. Investors knew British gilts, government bonds, were generally safe and reliable places to lodge their money. In return they got a return, that is yield.

In this way the national debt was born, and with it the modern state. Ministers could borrow to finance armaments, warfare, public spending and, in time, welfare. The system underpinned the development of capitalism, the industrial revolution and eventually the expansion of the state, particularly in wartime. It was widely replicated.

England wasn’t the first country to launch a national bank to achieve this. Sweden’s Riksbank was created in the 1660s after a financial emergency. The English and the Scots also learnt lessons from the innovative, smart Dutch. The monarchy had been subject to a Dutch takeover in 1690.

A lot has changed since the 1690s. The Bank of England was nationalised post-second World War and is now operationally independent. There is a Debt Management Office, a Treasury agency handling debt. Much of the flummery, the top hats and gentleman’s club atmosphere, is gone from the gilts market.

The essential principle remains the same. The government must “get away” its debt and needs investors to have sufficient faith to buy gilts at a price that suits the government. In times of trouble, during a war or a pandemic, or a downturn, the government needs to do much more of it to fund a large deficit, the gap between spending and borrowing. Investors are generally prepared to take a long, sanguine view of the British position, because of the history of the Bank of England, the country’s status as a robust democracy, and the City’s reputation as a global financial centre and mover and maker of money.

It cannot be taken for granted. Want to borrow as much money as Britain and other countries are borrowing, especially when the era of ultra-cheap money is over? Well, you had better pay attention to the views, the sentiments, of those who are doing the lending enabling you to borrow. Take care.

Forgetting, or not knowing, that this is how the world works is what has destroyed Liz Truss.

Of course this year’s trends, falling bond prices and rising interest rates, are global and other countries are feeling the squeeze. The market moves had started long before the 45p tax cut appeared, but that was the straw that broke the camel’s back. At a perilous moment Britain’s new Prime Minister made the UK an outlier, a test case. In the memorable phrase of Christopher Hope of the Daily Telegraph, during a global storm when others are sheltering, Britain’s government ran out into the torrential rain, took all its clothes off and was promptly struck by lightning.

In the wake of the disaster the new Chancellor will have to over do it on the fiscal conservatism front, in the hope it will reassure the markets a grown up is in charge. I wouldn’t be surprised to see more taxes go quite a bit higher, to ensure there is no talk of a “black hole”. Don’t be shocked if the basic rate of income tax goes up, and VAT by a couple of points. I doubt the government can get away with anything meaningful on public service spending restraint, such is the furious mood of the public with a government that has little authority left. Hunt is holding it together, and thank goodness he has been appointed.

Any Tory MP or commentator opposing this would do what next instead? Go back into a fight with the global bond markets?

The bewildered stragglers, the space cadets, the few remaining Truss supporters on social media and in think tank land, grumble that this is all unfair. It was the (poorly-designed) energy bailout that was to blame, or something. The markets are at fault for not grasping the brilliance of the borrowing splurge to allow tax cuts to kickstart growth, and so on.

Back on planet earth, too many investors concluded the British government had gone off its head, behaving irresponsibly during a live European war and global economic emergency. Personally, I think investors have over-done the doom but that matters not a jot. What they conclude is what they conclude. 

The Truss fiasco is a disaster for those who believe in lower taxes, a limited state and private enterprise. Yet this is what Trussism has produced: the precise opposite of what she intended. The markets seek reassurance, taxes will go up and Hunt has a few days to prepare a full budget and get numbers from the Office for Budget Responsibility.

A few weeks ago, a day after the maxi-Budget unveiled by the then Chancellor Kwasi Kwarteng, I compared the strategy to the government attempting Reaganism without the dollar. As President, Ronald Reagan could blow the deficit and broadly do as he liked, rocketing borrowing, because the US has the world’s reserve currency, the dollar. It has been a long time since the British were in anything like that dominant position. During the First World War financial leadership was transferred to the US and the UK went from creditor to debtor nation.

Since then there have been all manner of scares and crises. The UK’s debt to GDP ratio went to almost 250% as a result of the Second World War. It is greatly to Britain’s credit that it steps up when it matters, in the early 1940s, in the Cold War, and again now in Ukraine, and is prepared to sometimes be poorer. It’s fashionable to laugh at Britain now, laid low by its government. The Brits are always there on European defence and security.

The focus now is on the latest failure of British economic policy. There was the post-Second World War impoverishment and devaluation, the 1976 run to the IMF and then the Black Wednesday experience with the currency markets, not the bond markets, in 1992. The 1990s crisis turned out to be an accidental boon, facilitating a strong recovery for which the Tories got no credit. There is no such national economic upside this time after a humiliation at the hands of the global bond markets.

Perhaps this is like the 1976-79 period in reverse, with Jeremy Hunt as patriot Denis Healey. Then, a Labour Chancellor and Prime Minister made themselves unpopular with their own party by beginning the process of attempting public spending control, preparing the way, unintentionally, for Margaret Thatcher. The Callaghan government was destroyed by the resulting winter of discontent. This time, a Tory Chancellor at the end of a long period of Conservative government will begin the move towards much higher taxes, because the public loves public spending and infrastructure investment. Big government surged under Boris and Covid, now it’s about to get even bigger under the Tories, and then Labour.

In opposition, what is left of the centre-right will have to rethink and remake the case for enterprise and economic freedom, knowing this dying government has given good ideas a bad name for a generation and more. 

Premiership now Sunak’s to lose

If there are Tory MPs out there who think the Prime Minister can survive this, I haven’t heard from any of them. Things are moving fast, although much will depend in terms of timing on what happens with the markets.

Who will replace Truss if she opts to resign in the next few weeks or is forced to stand aside? I won’t waste your time here with a long list of potential successors strutting about. Boris Johnson is a joke that is no longer funny. Home Secretary Suella Braverman as PM would hasten the annihilation of the Conservative party even faster than Liz Truss.

The country is not in the mood for another ridiculous Tory leadership contest lasting months, with hustings and stupid TV events, as though it’s all the most tremendous wheeze.

The best of the cabinet (not a long list), senior MPs and wise owls from the Lords and voluntary party will have to arrive at a person by acclamation. Perhaps as George Osborne has suggested a quick parliamentary contest could be arranged, whittling it down to one, a winner, within a week, although even this delay sounds self-indulgent.

So, cut to it. Realistically, it comes down to a choice between two senior figures. That is the former Chancellor Rishi Sunak and the Defence Secretary Ben Wallace. Sunak got a lot wrong in office, but he came second in the summer contest and has been vindicated in his warning about the bond markets. Wallace (I declare an interest, old friendship, having known him since the early days of the Scottish parliament) is very sound on the war in Ukraine and on geopolitical risk in a way that finance guy Sunak is not. Wallace is popular with Tory members.

The pair do not get on. This has not been a barrier to cabinet members working together in the past, in a war cabinet setting. Again, there is a war on, an economic crisis and a tough winter to come on energy. After that, calls for a general election may become impossible to resist.

Grown-ups work together in national emergencies. The pair’s differing experiences are complementary. The two sides to this crisis are war and the financial markets.

There is some speculation Wallace will emerge as the unity, compromise PM. Having not run in the summer because he didn’t want it and feared the impact on his family, I doubt the Defence Secretary will change his mind.

Sunak wanting to be Prime Minister will need the support of Wallace, when the war, escalation fears and rearmament will be dominant themes of the winter. Sunak will need to build bridges, starting with Wallace.

I can hear the howls coming from those who hate the thought of Sunak in Number 10. Fine. After the last month, what or who have you got instead?

SNP proposes Trussism times ten

The inspiration for the establishment of the Bank of England came from a Scot, William Paterson. In 1691 his proposal was not adopted, although the idea was sound and taken up by Charles Montagu, 1st Earl of Halifax, who became Chancellor of the Exchequer in 1694. Well done, William Paterson. We are all in your national debt.

Unfortunately, Paterson’s next idea was less sound. His Darien scheme, a plan to create a colony, New Caledonia, in central America, was sanctioned in Edinburgh as a great patriotic endeavour. It was a disaster, all but bankrupting Scotland and helping to create the conditions for the Act of Union that followed in 1707.

I mention this because Nicola Sturgeon, the First Minister of Scotland, keeps popping up on TV talking about the economic chaos caused by the “Torees”. Fine, Sturgeon is a skilled communicator and the “Torees” have made a mess.

There is an oddity, though. Sturgeon is unveiling a new plan on the proposed economics of Scottish independence. What is envisaged by the SNP is Truss-like, a faith-based project, ten times riskier than Trussism and much more complex than Brexit. Scotland would leave the UK single market, Scotland’s biggest market, and a hard border would be put in place. The SNP envisages Scotland using the pound and not having its own central bank, or not at first. Its financial system would have no lender of last resort, no Bank of England lifeline. On this flimsy basis it would set sail on the global financial markets to borrow, hoping bond traders would be kind. Then Scotland would try to join the EU, and perhaps the Euro, though there would surely have to be an intermediate Scottish currency first.

This madcap project reminds me not of the establishment of the Bank of England in 1694. It is more reminiscent of William Paterson’s less successful idea, the Darien Scheme that bankrupted Scotland. 

What I’m reading

Back in the land of the Covid positive test this weekend, and in between coughing, sleeping, and WhatsApping, I flipped between two books set in the Puritan New World of the mid-17th century. The new Robert Harris novel, Act of Oblivion, is the evocative tale of the hunt for two regicides, Cromwellian soldiers who fled to New England. How does he do it? Every Harris novel is the ideal blend of historical research, compelling characters, and perfect pacing. I’m also almost at the end of Malcom Gaskill’s The Ruin of All Witches: Life and Death in the New World, out now in paperback. Set in New England during a Puritan panic – before Salem there was Springfield – this is an extraordinary work of non-fiction, an instant classic that reads like a thriller.

Have a good week.

Iain Martin,
CEO and Publisher,
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