The UK has contended with a carousel of prime ministers in the second half of 2022. But the reasons for Boris Johnson’s resignation—rumblings of a cost-of-living crisis and his government’s bad behaviour during 2020’s Christmas lockdown—pale in comparison to the havoc wreaked during successor Liz Truss’s historically short tenure. It’s easy to blame the person at the top. But were these PMs really responsible for ruining the economy?
Fittingly enough for November, the true marriage of politics and economics can largely trace its origin to that most storied of human conflicts: World War II. Infecting most of the northern hemisphere, five years of fighting left the wider world battered, both emotionally and economically. With war still raging overseas, representatives from the foremost Allied nations travelled to Bretton Woods, New Hampshire, where they spent most of July 1944 atop Mount Washington, carving out an agreement that would establish tighter controls over monetary systems, which generally consist of a country’s Treasury, mint (the branch that actually prints money) and central bank (which decides things like interest rates). They also sought to allow international trade to be conducted more freely, and perhaps most critically, solidified the need for governmental intervention in times of market turmoil—a guiding principle of Keynesian economics.
Born from the belief that the Second World War was largely a result of economies being devastated by the First and the failure of countries to address that devastation, the Bretton Woods Conference set out to ensure the avoidance of another economic disaster such as America’s recent Great Depression. The agreement was somewhat idealistic: attendee Cordell Hull, then US Secretary of State, expressed his desire for countries to have similar prosperity so as to eliminate jealousy and ensure long-term peace. But the deal was an overall success; it stood until 1971, when the US opted to unpeg the US dollar from gold bullion, ushering in the free-floating currency exchange rates we know today.
The conference had lasting, important legacies. The 22-day meeting made symbiotic relationships between governments and central banks a given. It established objective third-party organisations the International Monetary Fund (IMF)—a branch of the United Nations that promotes practices to ensure economic expansion and high employment the world over—and the World Bank, which lends money to low-income countries for projects that could make them more prosperous. Furthermore, it greatly reduced the possibility of debilitating currency devaluations, the fear of which had stunted international trade and thereby hampered economies before the war.
The idea was that in times of great trouble—wars, depressions, recessions—central banks and their associated governments could work in partnership to intervene and regulate financial markets.
Recent events raise an important question: is it working? Have we seen less economic turmoil since the Bretton Woods Agreement, or are government initiatives breaking the economy?
Wall Street got drunk, and the world got a hangover
In the summer of 2008, US president George W Bush explained the ongoing credit crunch (now commonly referred to as the Great Financial Crisis, or GFC) to a group of politicians by joking that “Wall Street got drunk, and now it’s got a hangover”. More akin to alcohol poisoning, the market contagion spread far beyond the US housing market and led to a global recession stateside and abroad. The Federal Reserve (Fed) and then-Chair Ben Bernanke became household names, and a small-town local newspaper’s coverage differed little from the front page of the Financial Times. The late noughties represented a time when the central bank was largely operating as a branch of government—perhaps a fitting development, as some economists believe a lack of regulation by the US government was what led to the sub-prime crisis, in which banks lent money for mortgages to people demonstrably unable to pay them off.
The global economy crashed as some US banks collapsed and others were propped up by government funds (or ‘bailouts’). Unemployment hit 10% in the US and topped 8% in Britain. The Fed slashed interest rates aggressively as the government handed out stimulus cheques. Many central banks began buying the government bonds of their own countries (a practice known as ‘quantitative easing’) as a way to inject money back into the economy, which would in turn, it was hoped, help get the public back on its feet, as there would be more money for things like hiring and shopping.
The takeaway: Yes, in this case, it’s likely the lack of regulation from the US government fostered an environment in the banking industry that allowed the GFC to occur. In 1999, President Bill Clinton repealed parts of the Glass-Steagall Act, which had previously dictated that commercial and investment banking be kept separate, on the belief that too much regulation over the banks left them unable to mitigate risk to their investors’ and depositors’ money on their own.
Bite a bat, break the economy
Ushering in the 2020s was an economic crisis no government could claim to have predicted or caused: the coronavirus pandemic. While the urban-legend origin story is probably highly inaccurate (a worldwide vow of vegetarianism won’t save us from the next one), the disease did come from another species, entirely ignorant of human fiscal and monetary practices. We know the virus took root in China, where authorities quickly instituted lockdowns as a way to curtail its spread. Other countries were not so quick off the mark, and the illness spread to virtually every corner of the globe; economies were doomed to be shut down, either by quarantine commands or workforces bedridden by the bug.
With interest rates still low from the previous decade’s major economic crash, the government took the reins on trying to fix this one. Fiscal policies (government spending, as opposed to monetary policy, determined by a country’s central bank), such as the UK’s furlough scheme, were introduced to protect jobs and allow the public to afford bills and necessities. The US government distributed three rounds of stimulus cheques as unemployment surpassed the levels seen during the GFC. As vaccines appeared at the start of 2021, the stock market boomed. A promising event on paper, but one that came with problems of its own . . .
The takeaway: Neither central bankers nor politicians can truly be blamed for this one. Though there is an argument to be made that quicker, stricter lockdowns could have saved lives and ended quarantine earlier (thereby allowing people to go back to work), a global pandemic cares not for business. A slowdown was largely unavoidable.
Did Liz Truss trample UK markets?
As the world emerged from lockdown and stock markets soared, so too did inflation. In the US, additional funds from stimulus cheques meant many households could afford higher-priced items. Supply-chain pressures caused by Covid (slowdowns in production, not enough staff) meant for many pockets of the manufacturing industry, demand was much greater than what they were able to supply, which in turn allowed them to raise prices. In February 2022, Russia launched an attack on Ukraine. The ensuing war and resultant sanctions on the former sent commodity prices skyward as the world worried about the availability of exports like oil and wheat come winter.
In early September, Liz Truss was appointed to succeed Boris Johnson as prime minister. Along with her chosen chancellor Kwasi Kwarteng, she announced subsidies and tax cuts that would put further pressure on the national debt. Government officials seemingly thought financial markets would take it in their stride: but they were startlingly wrong. The stock market plummeted, sterling tanked, and UK government bonds, considered a low-risk investment, saw their prices fall. The IMF denounced the “large and untargeted fiscal package” in an uncharacteristic public statement.
As was intended at that 1944 meeting on Mount Washington, the Bank of England intervened: to protect a number of endangered UK pension funds, it cancelled plans to sell back the financial assets it had purchased to prop up the economy during Covid. Truss was predictably asked to resign, and markets were soothed as Rishi Sunak took her place.
The takeaway: While time will tell how it all plays out, it seems Liz Truss’s short-lived and sensational government took a bad situation and made it worse. In this case, the safety-net function of the central bank stemmed the outflow of funds, but the situation served as an uneasy reminder that a politician’s fiscal plans affect more than just election results.
The answer to our question is that most dissatisfying reply: it depends. Government policies undeniably influence a country’s financial fortunes, and they are the ones that are going to impact the public’s daily lives. These are the developments that become news outside the financial sector in the event that they go alarmingly wrong.
In spite of this, there will always be some catalysts impossible for individual governments to predict and remedy—Covid-19, for example, or drought. Still, it is worth keeping an eye on those in leadership. The motivations of politicians can echo around economies and industries (Donald Trump’s trade war comes to mind) and trickle down to your pocket or portfolio.
This is what’s known as ‘political risk’, and it’s existed for as long as people have grasped for power. As such, experienced investors have developed some tried-and-true ways to lessen its impact. For one, make sure your investments are geographically diverse—don’t put all your eggs in one (country’s) basket. Different asset classes (like government bonds, infrastructure or stocks in businesses from developing regions) have different protective attributes. Currency hedging is another useful way to do this. Investing in a number of different currencies (say, both the pound and the euro) helps to even out the effects of depreciation in a certain area.
Financial markets have long been accustomed to the ebb and flow of politics. Invest for the long-term and stay diversified. And next time a political scandal rears its head, stay the course and, if you can stomach it, enjoy the show.