Christopher Marshall examines the so-called 'Truss Crash' being used as the justification for Labour tax increases, and finds the case wanting

Before the 2024 General Election it was opposition MPs who regularly insisted that Liz Truss had ‘crashed the economy’ but now it’s the turn of Conservatives, some of whom are citing the Mini Budget and Truss’s brief period in office as the reason why they lost the election. The anti-Truss narrative has become very well-established, but perhaps it’s time to ask how reliable that narrative really is.

It’s worth remembering that there was a considerable downturn in the financial markets during 2022 with many investors losing money in both Britain and the US. This was a consequence of two factors in particular: first, supply shocks caused by the end of lockdowns and the war in Ukraine and second, runaway inflation leading to higher interest rates.

So, 2022 was already a difficult year financially, but the main accusation against Truss is that she crashed our economy; did that really happen? The UK economy is measured by GDP (the total value of goods and services produced) and GDP actually remained reasonably steady during the Truss premiership. To see a genuinely crashing economy we need to look at what happened during lockdown, when GDP fell by almost 20%.

Strictly speaking, the UK economy didn’t crash in September and October 2022, but there was another complaint that the Mini Budget had ‘spooked the markets’. This accusation refers to the financial markets, but which ones? The FTSE100 was relatively stable during that period, so the stock market doesn’t appear to have been alarmed by Trussonomics. However, there was certainly one financial market causing concern and that was the bond market, although its problem wasn’t necessarily caused by the Mini Budget.

The bond market reacts to interest rate changes. There is a negative correlation, meaning if interest rates go up, the price of bonds goes down (and vice versa). Before the Mini Budget there had been seven interest rate rises and each one would have pushed down the price of bonds. Then, the day before the Mini Budget, the Bank of England announced it was going to sell a large quantity of bonds. This was a reversal of the Bank’s long-term, QE policy of buying bonds and the effect of the announcement was, predictably, to send bond prices down even more.

Lower bond prices mean higher yields and this affects the Treasury when it issues new gilts (government debt) because it has to offer higher rates of interest, pushing up the cost of government borrowing. Yields were rising similarly in both Britain and the US, but it was only in Britain that the rise was labelled a ‘moron premium’ and blamed on the Mini Budget.

Falling bond prices had a disastrous effect on another institution: pension funds. Most pension funds are DC, or defined contribution, these funds take money from savers and invest it. Over time, each fund may do well or badly. A less common type of fund is DB, or defined benefit. Intended for people on final-salary pensions, these funds are obliged to pay out a guaranteed amount on maturity. The problem for DB pension funds was that a proportion of their assets had to be held in bonds, because bonds are, supposedly, safe.

Unfortunately, bonds had been paying very low interest rates since 2009 and this was a difficulty for the DB pension funds. Some funds solved the problem by using their bonds as collateral to borrow money which they then invested in equities or derivatives to provide a better return. This technique, which initially appeared to be very successful, was called Liability Driven Investment (LDI).

The disaster came about because whenever bond prices fell, those bonds being held as collateral also lost value and then the pension funds were obliged to make up the difference. Some funds struggled to do this and some had to raise money by selling off their bonds at a discount, which only made the falling bond market even worse.

Because the falling market was putting some DB pension funds into difficulties the Bank of England was forced to reverse its original announcement and resume buying bonds. This steadied the market, so those people with final-salary pensions (including BoE staff apparently) wouldn’t lose out.

A falling bond market and the possible collapse of some DB pension funds was a serious problem but it wasn’t necessarily caused by Truss or her Chancellor, Kwasi Kwarteng. Instead, it could be argued that the responsibility lay with the Bank of England, the financial regulators and the previous Chancellor of the Exchequer, Rishi Sunak.

One obvious question (which no one seemed to ask) is, if the Bank of England was able to steady the market by announcing they would buy bonds, were they previously responsible for panicking the market when they announced they were going to sell bonds?

The final complaint against Truss is that because of her, the ‘economy’ lost £30bn, but that often-quoted figure has been rather hard to establish. It was possibly an estimated cost to the Treasury based on money the Government wouldn’t be receiving because of tax cuts, although almost all of the proposed tax reductions announced in the Mini Budget were later reversed.

The accusation that Truss had crashed the economy was regularly made by opposition MPs in Parliament and on panel discussions but it never seemed to be refuted by any Conservative MP. The reason for that is perhaps because any serious refutation would call into question the decision of Conservative MPs to remove Truss as Prime Minister and replace her with Sunak.

Although Liz Truss had been voted as Leader by the Conservative Party members, she wasn’t the choice of many MPs who would have preferred Sunak. When some volatility in the financial markets (which actually predated Truss’s leadership) was blamed on the Mini Budget’s proposed tax reductions, there was a noticeable lack of support for the Prime Minister from various Conservative MPs, some of whom appeared to be
openly briefing against her.

Now, with an enormous Labour majority in Parliament, the 2022 Mini Budget and all its supposed repercussions looks like becoming an official excuse within the Conservative Party to explain their unpopularity with the voters. But that narrative was always unreliable and it’s unfortunate that Conservatives MPs allowed, or even encouraged it to become so well established.