Why Kwasi Kwarteng's mini-budget caused an economic crisis in the UK : Planet Money Liz Truss, the new Prime Minister of the UK, was determined to change the British economy. Instead, her government's mini-budget helped kick off a mini-financial crisis.

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Economic anarchy in the UK

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Ben Poole runs a high-end tea shop in the U.K.

BEN POOLE: I don't think there'll be a better-smelling work environment, personally.

HOROWITZ-GHAZI: Not only is the place rich with the aroma of exotic teas, it is also rich with history.

POOLE: The building was built in 1177.

HOROWITZ-GHAZI: Sir, did you say 1177?

POOLE: 1177, yes. By the Normans when they conquered England, yes.


Ben's business specializes in fancy, far-flung varietals that he buys in bulk from countries like China and India any time from early spring to midfall, depending on what type of leaf is being harvested. And for months now, he has been biding his time to make a big purchase from Taiwan of a very particular kind of tea.

POOLE: It's called Honey Hon Cha. It's a tea that smells like a perfume.

HOROWITZ-GHAZI: To buy that Honey Hon Cha, Ben will have to use British pounds, which, if you haven't been following international currency fluctuations, have been on something of a downward spiral the last few months. So he's been holding off on sealing the deal, hoping the pound would regain enough value to make that fancy tea just a little bit less expensive before it withers on the vine this fall.

CHILDS: But then, a couple of weeks ago, things got even worse for Ben and the pound in the form of a speech given to Parliament by the new Conservative chancellor of the Exchequer, or finance minister, Kwasi Kwarteng.


KWASI KWARTENG: And our plan, Mr. Speaker, is to expand the supply side of the economy through tax incentives and reform.

CHILDS: What he proposed in that speech, which included a series of massive tax cuts, caught the financial world off guard and ended up rippling across the British economy and beyond.


KWARTENG: Now, none of this is going to happen overnight.


KWARTENG: But today, we are publishing our growth plan. Today, we are publishing our growth plan that sets out a new approach for this new era.

HOROWITZ-GHAZI: Those opposition party members you can hear booing in the background, they were not the only ones shouting about what a bad idea this was. Releasing a wave of tax cut-fueled spending into an economy that was already battling 9% inflation, the markets also hated it. And within 24 hours, the pound had tanked. Earlier this year, the pound had been worth as much as $1.35. But now, Ben from the tea shop was watching it get dangerously close to one U.S. dollar.

POOLE: The markets really savaged it, you know? Everybody was talking about it - parity with the dollar, so $1, one pound. And that had never been heard before. And it went to its lowest point ever. And it's, I think, those moments where you realize that there are forces at work in the world of money that, you know, you have no control over.


HOROWITZ-GHAZI: Hello, and welcome to PLANET MONEY. I'm Alexi Horowitz-Ghazi.

CHILDS: And I'm Mary Childs. The week that followed Kwasi Kwarteng's budget announcement was one of the most unsettling the British economy had seen in years when that threatened to send the country into a kind of financial doom loop.

HOROWITZ-GHAZI: Today on the show, a war between faith in the perfection of supply-side economics and the market's beliefs about what counts as responsible economic policy.

CHILDS: Ben Poole, as you might've guessed, did not close his fancy tea deal amidst all of this though he did partake in plenty himself.

POOLE: It's a magical brew. I think that it's a place we go to for a bit of comfort. And in England, if there's a crisis, we make a cup of tea. (Laughter) It's just what we do.


HOROWITZ-GHAZI: OK. A lot of stuff has been going down politically in the U.K. over the past month or so. They are still, of course, dealing with the aftermath of Brexit. Boris Johnson finally stepped down as prime minister after months of scandal and controversy. Then, on top of that, the queen died. To learn how this all culminated in economic crisis, we called up Tony Travers.

TONY TRAVERS: I'm a professor at the London School of Economics and associate dean in the LSE School of Public Policy.

CHILDS: Tony explains that the story of the U.K.'s current economic crisis begins about a month ago. That is when the long succession fight over who would become the next prime minister came to an end, when an internal Conservative Party election elevated Liz Truss to the head of the government. And Truss has some very specific views about how an economy should work.


PRIME MINISTER LIZ TRUSS: I know that our beliefs resonate with the British people - our beliefs in freedom, in the ability to control your own life, in low taxes, in personal responsibility.

HOROWITZ-GHAZI: Truss, Tony explains, represents a kind of radical, free market wing of the Conservative Party, one with a vision for the U.K.'s economic future that she and four other members of the party codified about a decade ago in a book called "Britannia Unchained."

TRAVERS: Which was really a sort of manifesto for getting workers to work more and harder, deregulate, cut the size of the state and reduce taxes.

CHILDS: Tony says that all fits because Liz Truss has been fashioning herself in the political mold of the free-market-loving former Prime Minister Margaret Thatcher. Here is Truss a few years back.


TRUSS: We all know that liberty and opportunity go hand in hand.

CHILDS: People on Twitter started circulating this photoshoot where it almost looks like she's, like, cosplaying as Thatcher.

HOROWITZ-GHAZI: But Liz Truss wasn't working with the same political runway that Thatcher had had when she was elected in 1979 because Truss was stepping into the job more than halfway through the usual five-year term for a prime minister. So if she was going to get stuff done, it was going to have to happen quickly.

TRAVERS: Liz Truss sees herself as a radical. She sees herself as doing things that other governments wouldn't dare to do. And even though there's only this two-year window really between today and the next British general election, she thought, yeah, I'm just going to do it. I've got to show a difference. I've got to show we're a disruptive government. We're going to change.

CHILDS: Which brings us to Finance Minister Kwasi Kwarteng's presentation before Parliament of a disruptive new set of tax cuts aimed at stimulating economic growth.


KWARTENG: Mr. Speaker, we are at the beginning of a new era. And as we contemplate...

UNIDENTIFIED PEOPLE: (Shouting, inaudible).

KWARTENG: And as we contemplate...

UNIDENTIFIED PEOPLE: (Shouting, inaudible).

KWARTENG: That's right. That's right - a new era, a new era, a new era.

HOROWITZ-GHAZI: On top of the little tax cut for everybody, Kwarteng proposed to scrap a plan to increase corporate tax rates. He also proposed lifting a cap on bonuses for bankers and abolishing the 45% tax rate on the highest earners.

TRAVERS: If you add it all together, it meant that the better off you were, the more you gained, that they were less worried about how the cake, the U.K. cake, was cut up providing the cake grew - so less interested in redistribution and more interested in growth.

CHILDS: A lot of folks, even within the Conservative Party, were immediately up in arms about how much this plan favored the wealthy. But on the surface at least, this was classic Thatcherite supply-side trickle-down Reaganomics.

HOROWITZ-GHAZI: The idea is that in the long term, freeing up money through tax cuts will lead to more investment on the part of business owners and high earners, which will lead to higher productivity and economic growth - so much growth that tax revenues will eventually go up, and the tax cuts will pay for themselves.

CHILDS: But fiscally responsible orthodoxy would demand matching those tax cuts with cuts in spending. And Liz Truss' government didn't do that. They proposed no spending cuts. And on top of that, they'd already committed to a massive new program to subsidize high energy bills for households and businesses, which was really popular but is more government spending.

HOROWITZ-GHAZI: And Truss was making these moves amidst some of the worst inflation in decades as the Bank of England, like central banks around the world, was raising interest rates, making borrowing more and more expensive in hopes of getting people to spend less.

TRAVERS: We've now got different part of the government putting its foot on the accelerator and part on the brake. That's at its simplest. And, you know, car drivers will realize this is not necessarily a helpful long-term policy.

CHILDS: And this is the moment when investors around the world look at this seemingly contradictory set of policies playing out in the U.K. and think this is a terrible way to drive the car that is the British economy. Maybe we're going to get out, like, now. Just, do you mind pulling over?

HOROWITZ-GHAZI: The way they did this was by selling whatever British assets they were holding, starting a chain reaction that threatened to bring the whole economy tumbling down. That's after the break.

So the chancellor of the exchequer, Kwasi Kwarteng, gave his big speech on Friday, September 23. In the hours that followed, the pound, British stocks and British government bonds all started to drop. And one of the people watching this car crash that fateful Friday was Toby Nangle, a former fund manager and current financial commentator.

TOBY NANGLE: You saw the currency fall. You saw bond prices fall. And then you get to the weekend, and that's a nice, natural break. So everyone's looking to the chancellor. What's he going to do?

CHILDS: Like, maybe they can just reverse course. And we can all have a nice Monday, put back together all the things we broke in our panic and re-stiffen our upper lip, return to calm and carry back on. It just depends on Kwasi Kwarteng saying something even remotely reassuring.

NANGLE: And he doubles down. He says, right, I'm going to do some more unfunded tax cuts coming through. You know, just wait till you see me get going.

HOROWITZ-GHAZI: Here's Kwarteng on the BBC that Sunday.


KWARTENG: I want to see over the next year, people retain more of their income because I believe that it's...

LAURA KUENSSBERG: Well, that's...

KWARTENG: ...The British people that are going to drive this economy. And I want...

NANGLE: That was exactly the opposite to what pretty much everyone in financial markets would have wanted or expected.

CHILDS: So all the action that started on Friday after the mini-budget announcement now intensifies. The pound keeps falling, and so do prices for U.K. government bonds. At this point, upper lips across the country lose all composure.

NANGLE: So Monday morning opens. And my goodness, you know, I thought - you know, Friday was, like, a once-in, you know, 30-year event. And then, on Monday, you had a bigger event come through. It was astonishing. And that's when it started really hitting systemic proportions.

CHILDS: It's a scene in one of those movies about Wall Street. Everyone's slamming down their phones, and they're yelling, and they're holding their head in their hands. They look like they might cry.

NANGLE: The market reacted by selling U.K. government bonds heavily, more heavily than they had done on Friday. You put those two days together, you haven't had anything like that happen, you know, in 50 years.

HOROWITZ-GHAZI: Because by now, investors have kind of lost faith in the British economy. They're looking at the British government's plans and thinking, these are a disaster - no reduction in spending, but lots of tax cuts aimed at getting businesses and people to spend more money? Isn't that just going to pour fuel on this historic inflation fire we're in the middle of fighting?

CHILDS: And because bond prices have been going down, interest rates in the market have been going up. And interest rates have all these secondary effects in different parts of the economy. Anybody who has a mortgage, for example, with a floating rate, which, in the U.K., is actually a lot of people - millions of people, higher rates are bad for them. And in the market, higher interest rates mean companies will have to pay more to borrow money, which they need to grow or do anything, really. And the same goes for the government.

HOROWITZ-GHAZI: OK, so all of that is obviously concerning. But there is something potentially even more concerning because, as we know from prior market freakouts, there's always one sleepy corner of finance that suddenly becomes a total disaster, that somehow threatens to take down the entire system.

CHILDS: And as with all sleepy corners of finance, not a lot of people have been paying attention to this one except our guy, Toby. In fact, he wrote a post in the Financial Times in July saying, hey, this little corner could be one of those disasters-in-waiting.

NANGLE: What I've been really - found myself focused in on, it's got to do with pension funds.

HOROWITZ-GHAZI: Pension funds invest money today in order to pay out more money to workers as they retire. These funds oversee literally trillions of dollars. And in the U.K. in recent years, they've been piling into this one strategy, which includes betting on whether interest rates are going to go up or down using contracts called derivatives.

CHILDS: So the pension fund makes a bet with a bank on where interest rates will be. And as part of the deal, the pension has to give the bank collateral usually in the form of government bonds.

NANGLE: Because if you're not good for it, then your counterparty has got to make sure they've got something that they can then seize at the end of the day.

HOROWITZ-GHAZI: And furthermore, the bank says if interest rates go up above a certain threshold or the collateral's price goes down below a certain threshold, then the pension fund has to provide even more collateral.

CHILDS: And this has worked fine for pension funds for years because interest rates weren't moving that much. But when the new government's budget plan sent rates shooting up fast, way faster than anyone anticipated, past that certain level, pension funds were suddenly in a bind. Banks were demanding they hand over all this additional collateral.

NANGLE: And pension funds weren't really set up to deal with that situation, a lot of them.

CHILDS: Because no one saw this coming.

NANGLE: Yeah, no one saw, like, the thousand-year flood.

HOROWITZ-GHAZI: Except Toby a little bit in July. He basically warned that if rates went bonkers in the way that they were now going bonkers, things could spiral out of control.

CHILDS: And the spiral goes like this. If the pension funds run out of collateral to hand over, it's just like a homeowner who can't pay the mortgage. The bank says, OK, you're done. That's over. It can seize that collateral - your house, your government bonds - and sell it.

NANGLE: All that collateral that you've been posted, your counterparty will potentially just liquidate - sell, dump in the market, and close down your position.

HOROWITZ-GHAZI: And a bunch of bonds getting dumped into the market, that makes their prices go down even more, maybe breaking through another one of those thresholds that triggers a request for even more collateral.

NANGLE: And this would push the yield higher and knock out the next one and then the next one and the next one.

HOROWITZ-GHAZI: This is what Toby called a doom loop - very metal - for U.K. government debt, one that could spread the contagion from the pension funds to the banks to who knows what else in the financial system.

CHILDS: And this was probably, definitely not what Liz Truss and Kwasi Kwarteng had in mind when they announced their budget. They were just trying to unleash supply-side prosperity, not ruin the financial system. But short of taking back their plan, they don't have much ability to do anything about this unfolding disaster. On their own, they don't have the power to directly intervene in the bond market.

HOROWITZ-GHAZI: But there is one institution that does. So far, we have talked about two of the big actors in the British financial system - the government and the bond market. But as every PLANET MONEY listener knows, there is also the central bank - in this case, the Bank of England, which is kind of part of the government but, very importantly, independent.

CHILDS: Up to this point, the Bank of England had been diligently working to fight inflation - gently hiking interest rates, trying to tighten monetary policy. The central bank wants interest rates to go up, but not like this, not with rates rising so quickly they threaten to take out all the pension funds, which, in the worst-case scenario, could destabilize and maybe even topple the entire banking system.

NANGLE: If you make all the banks bust, that will cure inflation, but that's not necessarily a good outcome.

HOROWITZ-GHAZI: It's not a good outcome. Like, sure, part of the mandate of central banks is to manage inflation. But part of the mandate of a central bank is also to help avoid all of the banks going bust.

CHILDS: So despite having devoted all its energies to tightening monetary policy - raising interest rates carefully and gently and dampening demand - last Wednesday, the Bank of England went in the opposite direction. It announced it would go on a U.K.-government-bond shopping spree.

NANGLE: They came in and broke the doom loop and said, you know, we're going to be here, and we're going to intervene.

CHILDS: And straightaway, rates started going down again. The pension funds would live to pay out their obligations another day. And then, on Monday, Kwasi Kwarteng said, OK, we hear you. Never mind. We're going to keep that top tax bracket where it is, at 45%. We will still tax the rich. And the government hinted at possible spending cuts. It wasn't a full concession, but it was a walking-back.

HOROWITZ-GHAZI: To Toby Nangle, who kind of saw all this coming, this was a very demoralizing week as a Brit, but a terribly productive week for his financial commentating. And the way it all played out, he says, does show that one of the main actors in the British financial system is working as it's supposed to.

NANGLE: I think that the Bank of England, intervening as it did was, like, a really amazing surgical strike. It went in and corrected a market dislocation. Maybe it came in, like, half a day late, but it came in with professionalism, and it completely seemed to address the problem that it was looking at.

CHILDS: The government - maybe there are a few more lessons in this for the government. Like, maybe don't try to do all your policies in two days or surprise everyone with massive, new, unfunded tax cuts.

HOROWITZ-GHAZI: And Liz Truss' says government has become hugely unpopular during all of this. They are way down in opinion polls. It isn't necessarily clear she'll hold onto her job for the next year or two.

CHILDS: So Toby says maybe one broader lesson of all this: no matter what pretty theories of economic growth you have in your head...

NANGLE: That you have to bear the markets in mind. You have to take them into consideration. The idea of having complete control is a lovely idea, but it's a bit of a fantasy even if you're the government. You know, you're just one actor in this play, right?

HOROWITZ-GHAZI: As for Ben Poole, our high-end tea importer who'd been waiting months for a more favorable exchange rate before buying his beloved Taiwanese tea, he says that despite the fact that the pound's value is back to where it was before this latest crisis, it hasn't risen enough to make him want to close the deal. In the meantime, he says...

POOLE: We have a saying here, myself and my brothers. It's, have a nice cup of tea and pretend everything's all right.


POOLE: So it's a bit like keep calm and carry on. But it - yeah, just be in denial. It's fine. Have a cup of tea, and pretend everything's all right. And I mean, with enough time, it will be.

CHILDS: I mean, hopefully.


HOROWITZ-GHAZI: Are you hankering for some PLANET MONEY swag? If so, we've got squirrel mugs. We got stickers. We got micro-face socks. Head on over to shopnpr.org/planet-money to get your fix.

CHILDS: We are always on the lookout for great story ideas. Email us at planetmoney@npr.org. We are also on all socials media - @planetmoney.

HOROWITZ-GHAZI: Today's episode was produced by Dave Blanchard with help from James Sneed. It was engineered by Debbie Daughtry and edited by Keith Romer. Our acting executive producer is Jess Jiang. I'm Alexi Horowitz-Ghazi.

CHILDS: And I'm Mary Childs. This is NPR. Thanks for listening.

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