It’s official: British Prime Minister Liz Truss did not outlast the lettuce.
After six weeks in office (the shortest tenure for a British prime minister), Truss was forced to resign in the wake of economic turmoil caused by her disastrous “mini-budget”.
Why it matters: The collapse of her government shows the renewed power of so-called “bond market vigilantes” to dictate economic policy (and punish politicians who don’t take a hard line against inflation).
- Bond vigilantes (a catch-all term for institutional investors that buy lots of government bonds, or debt) sell bonds when inflation soars, which pushes bond prices down.
- This is bad news for governments with large deficits: As interest rates rise to tackle inflation, that debt becomes more expensive, which can lead to even larger deficits.
Bond vigilantes have been quiet since the financial crisis in 2008, thanks to near-zero inflation, but with prices rising again, they are back with a vengeance.
- Truss’ plan to add to the government deficit by lowering taxes was seen as a move that would push inflation (already at 10%) higher.
- The vigilantes started dumping bonds in response, causing yields on UK government bonds to rise sharply and throwing the economy into turmoil.
- Major pension funds in the UK were pushed to the brink of collapse, and the Bank of England was forced to intervene.
Zoom out: Truss’ government was the first to fall victim to the once-again powerful bond markets, but it may not be the last.
- The Bank of Japan announced an emergency bond-buying program yesterday in an attempt to halt falling bond prices as its currency continues to weaken.
- Even the mighty US economy could be vulnerable: Officials have reportedly gamed out whether a UK-style market meltdown could happen state-side, per The NYT.
Bottom line: Governments that try to stimulate the economy by racking up big deficits will likely find themselves in a vicious fight with bond vigilantes—one, as Truss’ downfall shows, they may not win.