The one thing I know about British politics is that if I ever get depressed about the state of U.S. politics, I can always pick up a British news story and feel much better. There is a long history here. They created a separate church so the heir-obsessed King Henry VIII could annul his marriages and behead his wives without spiritual condemnation. Is it any wonder we beat them twice, and then little more than a hundred years after the second beating had to save them from the Germans, only to have to save them again some 25 years later from, yes, the Germans again.
There are many lessons to be learned in the shortest run ever as a Prime Minister of Great Britain, and I’m sure there will be books written that will take longer to read than Ms. Truss’ tenure. We are going to focus on two immediate lessons that deal with economics and how markets work.
What got Truss into trouble was her reportedly aggressive tax-cutting schemes. Lesson number one is an economic policy lesson: tax reform is about reducing the government’s influence on the economy, not just cutting people’s taxes. Since the days of Reagan and Thatcher, every conservative politician in the world has preached tax cuts: “Vote for me and you will keep more of your money.” It is often said that what voters want is lots of government programs and no taxes; that doesn’t work so well in real life, but most politicians hope to be out of office before the bill comes.
Tax policy success is like everything else: the devil is in the details. We seldom get details these days; we just get a declaration that the Truss government was going to cut taxes, usually with some added modifier like “ill-advised,” which makes the article more propaganda than actual news. I don’t know the details of the Truss policy proposals, but I do know a fair amount about what Reagan actually did in office. Reagan was far more of a tax reformer than an actual tax cutter. During his administration, Congress lowered income tax rates and reduced the number of brackets, but they also eliminated many tax shelters.
The biggest economic issue with tax policy is not usually the rate, but the impact of tax incentives on the economy. The big-picture goal is to reduce the influence of government on the economy, not necessarily to reduce one’s tax bill. In the real world, high tax rates are always accompanied by tax loopholes for the politically favored. In this way the government influences the economy, and usually that turns out to be a bad idea. Reform is not about reducing tax receipts; it is about reducing these incentives. My guess is that Truss, like many conservative politicians, oversimplified the lesson and just wanted to cut, then cut some more.
When the markets took a look at the Truss economic agenda, they saw deficits exploding in an already precarious fiscal situation. They reacted by doing what markets do best in the short term: panic. The value of the pound plummeted and rates on British debt rose rapidly.
This brings us to lesson number two: markets anticipate. An important factor here that has not been reported, at least certainly not enough, is that Truss never actually did anything as Prime Minister. None of these recommended policies were voted on, and even things that did not need parliament’s approval had no chance to take effect. But markets don’t wait for the real-world impacts; markets anticipate, and by the time reality finally hits, they are anticipating the next thing.
This is probably the most important lesson to be learned here. The Biden administration’s first official act was to shut down the Keystone Pipeline and put a moratorium on oil and gas leasing activities in the Artic National Wildlife Refuge. Energy prices started to rise. A logical person could point out that the pipeline wasn’t finished, so it really didn’t change the status quo. One may point out the numerous existing oil leases that are not being drilled for various reasons. The same person could point out that “Trussenomcics” was all theoretical. None of that logic matters to markets.
Market anticipation isn’t always right, and that is what creates opportunities. The stock market this year has been anticipating a severe recession brought on by higher interest rates, yet in reality, in June and again this month, corporations are reporting results that indicate this isn’t happening. We should enjoy the rally while it lasts and hope the market has learned a lesson. We need to stay diligent, however, because today’s reality is not as important to the market as the market’s belief in tomorrow’s reality. Markets anticipate.
Chuck Osborne, CFA