Some of us forget just how dominant Great Britain was just one century ago. Just before 1920, roughly 20% of the world’s population was under British rule, and the monarchy controlled a disproportionate amount of the world’s wealth. So, while the dollar has become the global reserve currency in recent years, the Pound has also been a bellwether. That is why when the Pound took a massive beating this week, the world took notice. Although it has recovered somewhat, the Pound was worth only 1.07 USD on 27 September. One year ago, it was 1.36.
The Pound is not the only current to struggle against the exceptionally strong dollar as of late. The dollar has strengthened mightily, which is causing pain throughout the globe. But those struggles are in large part due to large global forces, such as the war in Ukraine, energy prices, inflation, etc. Britain is struggling with all of those, plus some self-inflicted wounds. The first is Brexit, which is the gift that keeps on giving. Experts said the currency would fall following Brexit, and that the country would simply become poorer and lose significant purchasing power. That long-term decision from almost a decade ago is still taking its toll on the Pound, but more recent policy decisions have also had their part.
Laissez-faire, for some
Financial markets are typically pretty hands-off when it comes to wealthy nations like Britain and the United States. They can usually make their decisions to run significant budget deficits without causing too many major issues for their currency. That is because investors have faith in these nations, that they will eventually get their houses in order before anything too drastic happens, that they will pay their debts at some point. Importantly, there is a widespread belief that the Federal Reserve in the US or the Bank of England will do what needs to be done to keep inflation and deficit spending in check.
But last week, something happened that set off a currency run. Liz Truss, the new Prime Minister of the UK, announced that they would be drastically increasing spending in the short term while cutting taxes – especially the taxes on the highest earners. Besides being politically unpopular, the financial world took notice. The “fiscal event”, as Truss’s team put it, was considered by experts to be perhaps one of the most foolish decisions possible. The Pound got pounded, and for good reason. But what might be humbling for Britain is that such a decision by the UK or the US would not normally have caused a bank run, but now there is so little faith in the UK leadership that the financial world is treating the once-great empire as an emerging economy. From an economic standpoint, the fiscal event was such a boneheaded decision that the financial markets decided that the nation was clearly being run by idiots, and for banks to put up with that, a nation has to pay a premium.
While Truss has since walked back the tax cuts, the issue remains: there is very little faith in UK leadership.