The British are Falling

Prime Minister Liz Truss and Chancellor of the Exchequer Kwasi Kwarteng are depicted on the cover of The Economist in a sinking ship labeled Great Britain.

Last weekend the British Pound suffered a severe decline after the government introduced a new policy that gave significant tax cuts to the wealthiest citizens along with a costly plan to counter painful energy costs. During that weekend, the Pound fell 8%, causing chaos to all involved in the British economy. That had citizens and investors alike questioning the leadership of their government for making such an ignorant policy change.

Just like most of the world, inflation has been hitting the United Kingdom hard, with August CPI showing 9.9%. In times like this, the last thing you want your government to do is to reduce its tax revenue and increase government printing to aid energy costs. With negligence on clear display, investors have begun to lose trust in the system, which is the first domino that falls when currencies collapse. That is why holders of the Pound debt began exiting their positions, sending the currency down to unheard-of levels. The currency that was once worth more than double the dollar, fell to near parity.

When faith is lost in a currency, investors jump ship to other currencies to avoid sticking around as governments, like that of Zimbabwe, inflate their currency to worthless levels. Although the US dollar has flaws, it’s still the world’s strongest currency and a favorite safe haven. That is because countries around the world use the dollar system and a collapse of the Dollar is the collapse of the global economy. Additionally, treasury yields are highly favorable in the US, with 6-moth treasuries paying almost 4%! So instead of remaining in British treasuries mismanaged by newly appointed Prime Minister Liz Truss and Chancellor of the Exchequer Kwasi Kwarteng, you can earn what is considered to be a risk-free yield on US-based debt.

Having investors flee the British Debt market caused some devasting damage because the primary holders of this British debt are institutions. Of these institutions, several of them are UK pension funds. Many of them were said to be at risk of getting margin called, leaving the Bank of England to fall back on the only “get out of jail free” card they know. They announced that they would begin quantitative easing again and start to purchase their bonds to keep the pension funds afloat. With no concern for the already high inflation, they have decided that just like the pandemic, they will print their way out of this, completely ignoring the reality of its impacts.

As a result of turning the printer back on, the Bank of England plans to raise interest rates by approximately 150 bps. That is three times their 50 bps hike last month, which was already the most significant rate hike since 1995. A rate raise of that size in such a short time is likely to crush most people who hold variable rate loans. It seems as if the United Kingdom, the fifth largest economy in the world, is on track for an inevitable recession. Unfortunately, the consequences aren’t confined to the UK. We are likely to see the earnings of multinational corporations suffer because they are receiving payments in these foreign currencies that are quickly losing value to the US Dollar. We are witnessing another complete disregard for monetary policy by government officials, and the question is how many more of these events can the global economy sustain.

“The government solution to a problem is usually as bad as the problem” — Milton Friedman