Is the British Economy in a Doom Loop?

When the government of British Prime Minister Liz Truss unveiled the details of her first budget one week ago—with a major tax cut for the country’s highest earners at its center—panic ensued: Britain’s currency fell in value to historic lows, the interest rate on government debt increased, and the Bank of England was forced into emergency action to purchase government bonds. British financial markets have lost a total of $500 billion in just the first three weeks since Truss took office, and observers around the world have wondered whether this could be the start of an international crisis.

Should Truss have seen this coming? Do Britain’s economic policymakers have any good choices left? And is this not just a crisis, but the start of a new era in international economics?

Those are some of the questions that came up in my conversation this week with Foreign Policy columnist Adam Tooze on the podcast we co-host, Ones and Tooze. What follows is a transcript of the interview, edited for clarity and length. For the entire conversation, subscribe to Ones and Tooze on your preferred podcast app.

When the government of British Prime Minister Liz Truss unveiled the details of her first budget one week ago—with a major tax cut for the country’s highest earners at its center—panic ensued: Britain’s currency fell in value to historic lows, the interest rate on government debt increased, and the Bank of England was forced into emergency action to purchase government bonds. British financial markets have lost a total of $500 billion in just the first three weeks since Truss took office, and observers around the world have wondered whether this could be the start of an international crisis.

Should Truss have seen this coming? Do Britain’s economic policymakers have any good choices left? And is this not just a crisis, but the start of a new era in international economics?

Those are some of the questions that came up in my conversation this week with Foreign Policy columnist Adam Tooze on the podcast we co-host, Ones and Tooze. What follows is a transcript of the interview, edited for clarity and length. For the entire conversation, subscribe to Ones and Tooze on your preferred podcast app.

Cameron Abadi: Is it fair to refer to Liz Truss and her finance minister, Kwasi Kwarteng, as economic ideologues? I know that Kwarteng has academic training as an economic historian—how would you characterize his historical work, and how does that square with the economic program that they’ve unveiled here?

Adam Tooze: Yeah, I think Truss and Kwarteng belong to the wing of the [Conservative] Party that does believe in the need to revive the party’s ideological muscles, if you like, to adopt a less pragmatic, more ideas-driven, visionary kind of approach to politics—essentially to revive the Thatcherite agenda of the 1980s. I think that’s the core idea, to be less compromising. Truss is on record as saying that she doesn’t care whether she’s popular or not. To really drive what they see as a transformational vision of Britain.

And yeah, Kwarteng was at Cambridge as a student when I was there. I’ve kind of been racking my brains as to whether or not I may have taught him. Kwarteng isn’t, I think, a technical economic historian—he’s more a historian of ideas. Probably more revealing about his politics of money is the book that he wrote called War and Gold. He might be the closest thing that Britain has to a gold bug in politics in the sense that he believes that gold-backed currencies constrain politics in the way that fiat money doesn’t, because gold-backed currencies constrain the amount of money-printing you can do, to put it crudely. And so, you know, periods of peace go hand in hand with periods of stable money, and periods of war are associated with instability. In all of these ways, he’s a man of ideas—so, yes, I think there’s a program here, I think it’s fair to say. I mean, otherwise you think they might have flinched at this point, but they seem pretty committed to their vision.

CA: Well, you’re leaving yourself vulnerable to take the blame if you’re saying you might have taught him, here.

AT: Oh, God.

CA: Probably better if you did not have him in class. But in addition to this being an acute crisis for Britain, I’m curious if this week’s events represent kind of a broader paradigm shift that’s underway in how international financial markets work. Not so long ago it seemed there was an unlimited appetite for Western financial assets of all kinds; we were just in the pandemic, and governments had no problem issuing loads of debt throughout that period. And if there is a paradigm shift underway, I mean, what exactly is responsible for it?

AT: Yes. I mean, you could say the bases were loaded in this case, you know, to use the kind of baseball idea, of the game being poised in a position such that very dramatic things could happen quite suddenly. Immediately after taking office, Truss had announced the program of price limitation to cap the energy bills of ordinary British consumers, which was wasn’t properly costed. And that’s one of the things that outraged people about this mini budget. But that was estimated to cost 150 billion pounds, about 5 percent of GDP. So, three times more than this tax giveaway. There’s something I think about this, the mini budget and the tax giveaway, that really incensed people.

I mean, it was not properly run: Britain has an independent auditor, the Office for Budget Responsibility, OBR. And it wasn’t even given a look in on the 45 billion[-pound] giveaway that was announced in the mini budget. I think that had a lot to do with triggering the market reaction, the sense that really there wasn’t anything that this administration wouldn’t stop at spending money on. In a matter of weeks, essentially, they’d decided to give away about 200 billion pounds.

In general, bond markets all over the world are under pressure right now. But in the British case, there’s an additional technical factor which has contributed to the avalanche-like sell-off, which is the pension funds in the U.K. of course hold lots of government bonds. These are private pension funds, and they had decided to hedge themselves against the possibility of interest rates falling. So rather than just being able to pocket the windfall of the interest rate increase, they actually found themselves needing to unwind a bunch of hedge deals which covered them against the opposite eventuality. And that is what was triggering the sales of assets.

CA: What exactly is the nature of the crisis when a currency falls in a developed economy like Britain? I mean, it seems like the scale of the panic we’ve been seeing is pretty separate from the kind of direct impact on the real economy experienced by most people.

AT: I mean, Britain is a very open economy. It’s not the United States. And so the falling exchange rate will hurt. It will hurt immediately in terms of the cost of practically everything in the supermarket. So there will be a quite direct effect there. But we’re talking about a relatively modest currency movement. We’re not talking about the 20, 30 percent fall over a matter of days. We’re talking about a 10, 15 percent fall, which is still very dramatic for a currency as significant as sterling, which is a reserve currency, a minor reserve currency.

But you’re right, the panic is out of proportion to that. The panic is huge because it affects the government bond market. And that is a big deal in any country, because that is the foundation of the flexibility of government finances. And it’s a very big market. It’s trillions of dollars’ worth even in the U.K., and in the U.S. it’s $24 trillion. This is a huge pool of assets in which practically anyone, one way or the other, principally by way of, say, the Social Security fund or by means of a pension, is invested. And so that’s the bit that’s spasming. And in the British case, and this is what’s really alarming, is that the currency movements appear to be closely associated with the spasms in the bond market, and that’s something you really don’t want to see. You would prefer those two things to be independent of each other. When they become coupled together, it begins to feel a little bit like an emerging market situation where investors are, in a sense, opting in or out of a country, and when they opt out of the government bonds, they exit altogether. And that’s a worrying sign when that happens. And it can become self-reinforcing, because as the currency falls, the bonds become less attractive to hold, and so on and so forth.

CA: I’ve seen a fair number of conservative commentators in Britain refer to the financial market reaction here as irrational. But then these are the same types, as far as I know, that otherwise refer to markets as the wisdom of the masses, you know, with financial prices representing some underlying truth. Is this a deeper blind spot in conservative free-market thinking? And which of these two opposing views is closer to the truth in your eyes now?

AT: Yeah. This is among the more remarkable aspects of the current moment, actually, the alienation between the Tory party, which you would think of as, you know, the bastion of business interest in British politics, and the economic experts of the city of London.

It points to this deep structural break that goes back to 2016 and to the Brexit referendum. It was a Conservative government that called the referendum under David Cameron expecting to win for Remain. So the Tory party, the mainstream of the Tory party was Remain, because it’s clearly better for British business to be in the EU. And around the prime minister, there was a mobilization of both global and national expert opinion in favor of staying within the EU. And, of course, it was the Brexiteers that won. And ever since, the Brexit wing of the Tory party have been in this sort of boisterous refusal of economic gravity.

The striking thing about Truss and Kwarteng is you wouldn’t necessarily think of them as simply populist, because they’re kind of elite conservatives. So it’s really strange. It’s not so much populism, I think—it’s kind of a kind of cosplay Thatcherism. And the city’s just calling their bluff and saying, “Look, we’re not kidding around. This is not a pantomime. If you do this, it will not actually add up. And we cannot at that level, you know, we can’t hold the pound, and we can’t hold the U.S. Treasury paper at the kind of interest rates you’re offering. Wake up, smell the coffee, get real.”