On October 20, 2022, London, UK, British Prime Minister Leeds Tras announced his resignation to the media at 10 Downing Street, London, UK. Visual China Picture
On the evening of October 20, Beijing time, Elizabeth Truss announced that he would resign as British Prime Minister, and a new round of elections will be held next week.
Tras announced his resignation after serving for 45 days, making him the "shortest-lived" prime minister in British history. Also "not succeeded" are a series of financial measures announced by Tras last month. It was these measures that once caused the British financial market to fluctuate violently, which led to the "fall of the Trass government."
Unproper tax cuts
The crisis of the Trass government began with an inappropriate tax cut. Trass' mechanical imitation of neoliberal policies ended up ruining his prime ministerial career.
On Friday, September 23, local time, the Trass government announced the country's most radical tax cuts in nearly 50 years, including the removal of the highest income tax rate for high-income people only and reduce income tax and home purchase stamp duty. At the same time, previous plans to increase corporate income tax will also be put on hold.
Specifically, the maximum tax rate for people with annual income of more than £150,000 will be adjusted to 40%, and the current tax rate is 45%. From 2023, the basic income tax rate has been reduced by 1 percentage point to 19%, one year ahead of the plan. The policy was originally scheduled to be implemented in 2023. At the same time, the British government has also announced a series of measures, including regulating weight loss, freezing alcohol taxes, and establishing new low-tax investment zones.
"The economic concept of the Trass tax cut policy comes from 'trickle economics'," Bai Xue, an analyst at the Research and Development Department of Oriental Jincheng, told Pengpai News that this concept advocates tax cuts for enterprises and the rich in order to encourage investment and promote economic development, so as to gradually expand the beneficiaries and benefit ordinary people.
However, the UK is currently facing a serious inflation dilemma, and Tras's introduction of stimulating fiscal policies at this time is tantamount to cooking oil for fire. At the same time, aggressive tax cuts have also increased market concerns about the UK Treasury market.
Wang Jinbin, executive deputy secretary of the Party Committee and vice president of the School of Economics of Renmin University of China, told The Paper that the tax cut policy was originally intended to reduce the burden on the British people under the pressure of high inflation, but the actual tax cut measures are aimed at the rich, which has also led to unfairness in British society and made the contradiction more prominent.
Affected by aggressive tax cut policies, the UK financial market experienced strong fluctuations: on the day of the policy release, the 10-year Treasury bond interest rate rose by 34 basis points in a single day, and the pound fell below 1.1 against the US dollar, depreciating by 3.2%. On September 26 (the first trading day afterward), the pound continued to decline against the US dollar, falling to 1.0224 at one point, with the maximum drop of more than 5%, hitting a new low since 1985. In the stock market, the FTSE 100 index plummeted by 141 points on September 23, a drop of nearly 2%. At the same time, UK Treasury bonds plummeted, with yields of 2-year, 5-year and 10-year Treasury bonds rising by 43, 51 and 33 basis points respectively from the previous day.
On October 14th local time, Finance Minister Kwasi Kwarteng was forced to resign due to public grievances, with a term of only 38 days, becoming the shortest-term secretary of the Exchequer since 1970, and was soon replaced by the new British Finance Minister Hunter (Jeremy Hunt).
htmlOn October 17, the new British Chancellor of the Exchequer Jeremy Hunt announced that he would cancel almost all previously proposed government tax cuts to stabilize the financial market and the Trass government."The tax cut policy was only less than two weeks after the market's violent reaction, and under pressure from the party, Tras announced the suspension one by one, completely giving up his core commitment to the election; then, Tras was "emptied" by his newly accepted Finance Minister Henry, the economic and fiscal power as the prime minister, and his economic reform plan was almost completely abolished, and even directly reversed the direction of fiscal policy, which also led to the government's "reversal of the energy subsidy" shortly after the introduction of the subsidy policy of "energy price guarantee", and announced that energy subsidies would end in April next year."Bai Xue said that the repetition and uncertainty of this policy greatly damaged the credibility of the British government and caused huge fluctuations in the market. It also reflected that Tras, as the prime minister, lacked governance experience and ability to control the cabinet, and lacked policy determination.
Professor Hu Jie from Shanghai Senior School of Finance at Shanghai Jiaotong University told The Paper that Tras is a "fan girl" of Mrs. Thatcher in economic policy, but she is not so experienced and not lucky enough.
"She has a distinct governance philosophy: tax cuts to release the economic vitality of the UK. However, she lacks understanding of the complexity of economic laws, especially the internal linkage relationship of the financial system, and fails to properly resolve the risks brought by her tax cut policies and smoothly overcome the painful period of economic paradigm switching. So much so that the tax reduction policy has not been successful and hastily given up. This ruined her career as a prime minister. "Hu Jie said. The "pension crisis" triggered by
British Treasury bonds plummeted, which also led to the investment losses of British pension funds and the crisis of insufficient collateral. This has become one of the largest financial system risks derived from the UK fiscal chaos.
In order to ensure the consistency between changes in the value of assets and liabilities, for many years, British pension funds have adopted liability drive investment (Liability Driven Investment) , LDI) strategy.
Guotai Junan Zhou Hao said that in this strategy, it is a common way to obtain returns through bonds and it also involves a variety of derivative instruments such as interest rate swaps. From the actual operation, the UK long-term Treasury bonds linked to inflation are the most suitable choice for this investment risk . The LDI investment strategy improves the overall rate of return by holding high-risk and high-yield assets, and also uses leverage to increase the risk exposure to long-term Treasury bonds.
According to a report by the Bank of England, pension funds regardless of size All sizes and sizes participate in LDI investments directly or indirectly. Large pension funds usually invest themselves in LDI, while small and medium-sized pension funds usually jointly invest in the same pooled LDI fund.
Wang Jinbin said that British pension institutions are important investors in the UK financial market. If they act in accordance with Trass' tax cut policy, once British Treasury bonds are sold, their yields will rise, and their valuations will fall sharply, which will lead to mismatch of the asset-liability side of the British pension institutions, causing pension funds investment losses.
"The trigger point of this risk is the sudden increase in the risk of breaking the capital chain of the pension industry. Tax cuts bring more fiscal deficits in the short term; therefore, the government needs to issue more government bonds to fill the gap, resulting in higher government bond interest rates. The price of issued treasury bonds has dropped, resulting in the need for additional collateral in transactions using them as collateral; and the pension industry happens to be the big dealers of such transactions. They are difficult to raise enough cash to cope with the demand for additional collateral in the short term and face a crisis of liquidation. "Hu Jie said.
On the other hand, derivative tools used in LDI investment strategies to push for the decline in interest rates to bring downward treasury bond yields will also suffer losses when interest rates suddenly rise sharply.
Bai Xue said that in the low interest rate environment in the past decade, British pension funds have purchased a large number of interest rate swaps that "pay floating interest rates and charge fixed interest rates" and allocate assets mainly bonds, which makes them extremely sensitive to interest rates. The surge in the UK Treasury bond interest rate interest rate derivatives held after the government announced a large-scale tax cut has caused a large amount of floating losses. The requirement of margin, pension funds were forced to sell large amounts of British Treasury bonds, and a large-scale liquidity run occurred. This further reduced the price of treasury bonds and pushed up yields, forcing pensions into a "death cycle" and increased its bankruptcy risk.
html At the end of September, when British bonds were sold in large quantities, British pensions had to fill the deficit caused by derivative instruments by selling their holdings (collateral). Many pension funds expressed their unwillingness to reduce the use of LDI strategies. At this time, the Bank of England could only take action. On September 28, the Bank of England announced the temporary delay of quantitative tightening and implemented a two-week and unlimited increase in long-term Treasury bonds."The tax cut policy was stopped in time, and the Bank of England took action to purchase Treasury bonds, which stopped the trend of Treasury bond depreciation and lifted the pension liquidation crisis. But the harm has been caused." Hu Jie said that this wave of turmoil has impacted the smooth operation of the economy and financial system; interfered with the central bank's rate hike strategy; it also damaged the credibility of the government's economic policies.
"It is obvious that the Bank of England is facing pressure from many aspects, because it not only needs to fight inflation, but also needs to take measures to stabilize the financial market. However, in order to control the stability of long-term UK Treasury yields, the Bank of England must inject liquidity. If the established target is not achieved, these liquidity is likely to slide to a new round of quantitative easing policies." Zhou Hao said.
"Brexit" aggravates the UK's economic problems?
pound is also one of the "victims" of the storm. As the pound has been falling rapidly over the past few weeks, the Bank of England has had to intervene at a critical moment. Zhou Hao said that the recent sharp fluctuations in the pound reminded people of the "Black Wednesday" on September 16, 1992, which forced the British government to withdraw from the European exchange rate mechanism (ERM).
Wang Jinbin said that Britain's insistence on Brexit had a "barrier" from the European market. As for the trade and investment in Europe, the UK has to pass the division between countries or regions, taxation, and cross-border capital movements will bring higher costs to the UK, resulting in an increase in costs in the UK at the trade and financial levels.
Bai Xue also said that the UK's low growth problem is also related to Brexit. Judging from the reasons of low investment rates, Brexit has led to a sudden divestment between the British industrial chain and mainland European countries, a large number of entities and financial investments fled the UK's mainland, and the activity of corporate investment has dropped sharply. In addition, the Northern Ireland Protocol has set up customs clearance inspections between Northern Ireland and the British Isles, further weakening the connection between the British industrial chain and Northern Ireland , resulting in the long-term situation of maintaining a very low corporate income tax rate, which is still unable to effectively boost investment confidence.
analyzes the deep-seated problems faced by the UK. Wang Jinbin said that it is a decline in its competitiveness, especially the decline in the competitiveness of the UK's real economy. It can be seen that the deficit of the UK's foreign business account has hit record highs for a row, indicating that the UK's international export competitiveness has declined sharply, which is closely related to the decline in the overall level of the UK's manufacturing industry for a long time in the past.
Bai Xue also said that the UK is highly dependent on energy imports, and after Brexit, immigration loss in the UK intensified, causing an imbalance in its labor supply. The source of the current high inflation in the UK, in addition to the fiscal and monetary stimulus during the epidemic, is also the energy crisis and the insufficient labor supply. This leads to the fact that the UK is more sensitive to inflation than other developed economies, , and its high inflation problem is the most serious among major European countries. This is also why it is difficult to solve the inflation problem in the UK simply by relying on government tax cuts and other regulatory relaxation measures.
"The British economy is currently mainly trapped by high inflation. In the long run, we hope to get rid of the trap of high tax + low growth and enter the track of low tax + high growth. At the same time, the Conservative Party of British politics does not recognize the high tax + low growth model of the European continent and always tries to find a new path, and Tras is its representative." Hu Jie said.
Challenge of the next prime minister
Tras announced when he resigned that the new prime minister election will be held next week.
"In the past month, the capricious fiscal and monetary policy has caused great damage to the credibility and financial reputation of the British government. Therefore, the first task of the new British Prime Minister will be to restore political and economic stability, formulate feasible and stable medium-term fiscal plans and long-term growth plans to cope with the current dilemma of stagflation under low growth and high inflation, and restore market confidence in policies." Bai Xue said.
In the short term, Hu Jie said that the UK will still face energy supply problems and related major inflation problems; at the same time, there are capital outflows caused by the depreciation of the pound; as well as the surge in government debt after the epidemic and the Russian-Ukrainian conflict.
In the long run, Hu Jie said that the UK will also face the problem of structural development driving force such as optimizing fiscal policies, releasing economic vitality, attracting foreign talents and labor, and solving human shortages.
Bai Xue said that in the dilemma of stagflation, the next British government will still face the same policy constraints, and the dilemma facing the British economy will be difficult to reverse in the short term.
Judging from the causes of British inflation, before the Russian-Ukrainian war silenced, the problem of high inflation in the UK may not be completely eliminated through policy forces; on the other hand, after denying the policy direction of tax cuts in just a few weeks, the UK's fiscal policy has shifted from extreme easing to complete tightening; at the same time, high inflation will also cause the Bank of England to continue to raise interest rates. This combination of fiscal and monetary policies will further exacerbate the risk of Britain falling into recession. In addition, the essential problems in the medium- and long-term growth of the UK economy, such as uneven income distribution, lack of structural reforms, Brexit and insufficient labor supply caused by the epidemic, will not be improved in the short term, which means that the stagflation state in the UK will be difficult to easily reverse in the short term.
Bai Xue also said that considering that the UK's bond interest rate has risen sharply in this crisis, which has pushed up the UK's debt interest cost, even if the current fiscal policy has shifted, the UK still needs to raise funds for the remaining tax cut plans and interest cost payments in a short period of time, which also has a certain constraint on the formulation of the new government's fiscal policy.
"How do you weigh the trade-off between economic recession and inflation? The worst result may be that the British economy enters recession in advance, but inflation remains high. This will have a significant negative impact on the UK and the global economy." Wang Jinbin said.
