Thread by @andyverity

If either Boris Johnson or Rishi Sunak replaces Liz Truss, she and Kwasi Kwarteng could be forgiven for dwelling on an irony so twisted it’s almost insane.

They’re supposed to have been booted out of Downing Street for three deadly sins: 1) making huge ‘unfunded’ tax and spending announcements, 2) plunging millions into financial problems and 3) performing screeching u-turns.

But let me ask you a trivia question. Who are the only prime minister and chancellor in British peacetime history to announce larger ‘unfunded’ tax and spending measures than Truss and Kwarteng? And I mean – much larger?

Yes, you’ve guessed it. If 1) is a deadly sin (and I’m not sure it is) than it is undeniable that they’ve committed it. They’ve also got quite a record on 2) and 3).

‘I guarantee,’ said a signed statement from Johnson in the 2019 manifesto, ‘We will not raise the rate of income tax, VAT or National Insurance.’

He also promised his government would ‘not borrow to fund day-to-day spending.’ ‘Au contraire’, said the pandemic. ‘You will borrow so much to fund day-to-day spending it will set a new peacetime record.’

In his first Budget on 11 March 2020, Rishi Sunak announced his determination to stick ‘within the fiscal rules in our manifesto, but with room to spare’, announcing a spending and tax cuts of £30bn, limiting direct help for stricken households and businesses to £7bn.

Nine days later, on 20 March, after Johnson had been forced into a u-turn on his initial resistance to lockdown, Sunak also did a huge u-turn. To hell with the fiscal rules: this was an emergency.

He announced an intervention unprecedented in British history where the state would pay 80% of the wages of private companies forced by lockdown to shut up shop, the Coronavirus Job Retention Scheme (furlough).

The following week he also announced generous help for the self-employed – if they fitted neatly into the schemes’ flowcharts. However, an estimated 3-4 million people were excluded from support for technical reasons...

...because, for example, they’d just started work or set up as limited companies rather than sole traders. The computer said no.

Sunak resolutely ignored their increasingly desperate calls to extend the schemes, avoiding deadly sin 3 – the u-turn. But people who’d been excluded were plunged into debt.

To them, Johnson and Sunak had caused their dire straits (deadly sin 2), cutting off their income by forcing them to shut, but refusing to compensate them like everyone else.

In the next 12 months, Sunak spent £1,112 billion of public money paying for furlough, the transport system, higher benefit payments, VAT and business rate relief etc – more than any Chancellor had ever spent before.

It was £318 billion more than his income from taxes – the biggest budget deficit in peacetime history.

All those extra spending measures and tax cuts were ‘unfunded’ - if by that we mean making spending commitments with no tax rises or spending cuts to offset them. It far exceeded the £100bn+ of spending pledges and tax cuts Kwarteng announced in his mini budget.

Oh and by the way, to accompany this record-breaking, ‘unfunded’ spending commitment, there was no OBR forecast.

Few at the time were rude enough to remind Sunak he’d breached his own fiscal rules. Bond prices didn’t plummet and gilt yields – the interest rates effectively demanded by the government’s creditors that set a floor for fixed rate mortgages – didn’t jump.

But as Kwarteng would have been reminded by the Bank of England deputy governor for financial stability Sir Jon Cunliffe, had he chosen to consult him, there was one crucial reason for that: a key difference that made Sunak’s record ‘unfunded’ spending possible...

That is that whenever he needed to borrow by selling UK government bonds (aka gilts), there was always a powerful buyer in the market: the Bank of England. It ended up buying more than 90 per cent of the bonds the government issued during the pandemic.

So the government ended up owing almost all the pandemic-related debt to another government entity – the BoE - whose assets and debts sit on the Treasury’s balance sheet.

In other words, not only was the huge additional spending that Sunak approved ‘unfunded’. The government ‘borrowed’ most of the hundreds of billions for that spending – from itself.

That was possible because on 19 March 2020, the day before Sunak’s big u-turn, the BoE pledged to buy an £200 billion of government bonds, propping up the prices (and therefore driving the yields – effective interest rates over 2 years, 5 years, 10 years, 30 years – down).

That pushed down eg 5-year fixed rate mortgages to record low rates of as little as 2%. (With fixed mortgage rates now at 6%-plus, those who took their loans out then face a huge payment shock when their five-year deal comes to an end).

The BoE’s £200bn pledge followed over a week of panic among investors in the bond markets – the ones that lend money to governments – who’d taken fright in the preceding week as it dawned on them that the cost of supporting economies through lockdowns would be vast.

In a ‘dash for cash’, they sold bonds so heavily, it pushed up yields by then-record amounts and de-stabilised pension funds. Sound familiar? Yes – it happened again – this time in the UK only - after the mini budget - on an even bigger scale.

Pension funds had effectively borrowed to invest in bonds – a means of boosting the returns from their assets. Much like a homeowner who buys a £100,000 house with a £10,000 deposit and a £90,000 loan, they might double their deposit money if prices rose by 10%.

But when bond prices plummeted in the dash for cash, they hit negative equity. The banks who’d lent them money were demanding more ‘deposit money’ immediately (‘margin calls’).

They could only get the cash by selling assets - threatening to set off a doom loop of selling, more margin calls and more selling. That all happened first under Johnson and Sunak.

What stopped the downward spiral in March 2020 was the announcement by the BoE (and other central banks worldwide) that they would step in and start buying bonds in huge quantities - supporting bond prices and therefore holding down interest rates.

However – and this is key - at the mini budget on 23 September 2022, Kwarteng had no such powerful buyer promising to snap up every bond the Treasury wanted to issue to raise funds.

Kept in ignorance of the extent of his forthcoming tax cuts, the BoE had announced, just one day before, that it would start ‘quantitative tightening’ – meaning it would sell, rather than buy, huge amounts of bonds...

to try to push interest rates up and fight the inflationary inferno. The BoE was not briefed on the extent to which the mini budget would fan its flames.

That announcement removed the buying support for bonds, setting the scene for the bond market meltdown that ensued the following week.

In the lyrics to her classic song, Alanis Morrisette’s concept of irony isn’t quite there. ‘Rain on your wedding day’ isn’t ironic. It’s just a bummer.
But in Kwasi Kwarteng’s case, he may rue the good advice that he just didn’t take. Sir Jon Cunliffe could have warned him.

Sunak completed more than a dozen ‘fiscal events’ announcing big tax or spending measures in 2020 and 2021 – most of them without an OBR forecast. He repeatedly opposed himself in public to extending the furlough scheme and was repeatedly forced to u-turn.

It’s also worth noting that public sector net borrowing halved in 2021/22, after emergency support was withdrawn. No austerity – as in slashing departmental spending or benefits – was required.

Borrowing fell faster than expected because tax receipts grew rapidly as the economy emerged from lockdown, closing the gap between the government’s rising tax income and its spending.

In that respect, Kwarteng made a good point about growth: As we saw from 2009 to 2020, without growth, spending cuts – even brutal, damaging ones – don’t bring your debts down very fast.

It’s growing your tax income that enables you to shrink your borrowing and start paying down debt. But in any case, the public finances are there to support the wider economy: not the other way round.

In August 2021, Johnson announced national insurance was going up by one and a quarter percent for both employers and employees to tackle a chronic long-term problem of underfunded social care. This time, everyone noticed the u-turn.

But the implementation of the tax rise – April 2022 – unfortunately coincided with the energy price shock and the war in Ukraine.

As with Truss’s spectacular u-turn, appointing Jeremy Hunt to reverse her flagship tax cuts, Sunak’s u-turns were often greeted by markets with relief. It was when he didn’t u-turn so that millions excluded from support were subjected to huge financial stress.

Perhaps you’re thinking it’s not fair to compare Johnson and Sunak’s unfunded spending commitments with Kwarteng’s: ‘But that was different! The pandemic was an international emergency!’

Well, yes. But then – what is war in Europe, rampant inflation, the biggest drop in living standards in decades and an impending global recession – if it’s not also an emergency?

You can argue, à la Truss, that where Sunak and Johnson did u-turns, then at least they listened – eventually. But if either Sunak or Johnson try to don the mantle of ‘fiscal discipline’, they may need reminding...