📈God Save the Pound

The Queen of England passed away and seemingly took sane fiscal policy with her. Confused by what’s going on with all the headlines about the British Pound? Ian’s here to clear it up. Also, Alex and the Culture Desk are out this week visiting family in Wisconsin. And by family, we mean gallons of Spotted Cow.

Did someone forward this blog post to you? Thank them for their wisdom and discernment. Do us a favor and subscribe for more!

---

Earlier this month, the Queen of England, Queen Elizabeth passed away after ruling for over 70 years. This is a shockingly long time for us Yanks who elect a new president every 4-8 years and also it is surprising because citizens actually liked her. Not something us Americans often do with our politicians (we are coming for your insider trading Pelosi).

Luckily, Queen Elizabeth left us in the extremely capable encased hands of her son King Charles (get it? Look at those sausage fingers).

This transition of power was mostly meaningless, but it did help me write that joke. However, this year, there was an actual change of Prime Minister in England from Boris Johnson to Liz Truss following his resignation.

While all of this was taking place, the UK government, much like the US government, has been grappling with inflation. On top of that, they are dealing with energy policy fallout from the Russian invasion and an economy likely already in recession.

So Prime Minister Truss and her Finance Minister Kwasi Kwarteng took a page out of America’s book:

And in truly American fashion they went BIG, with the largest tax cuts in 50 years.

This is likely a good point for you to ask, why you, the reader, would care about any of this. I mean, we all like taking shots at the old motherland but Whoopty doo Basil, what does it all mean?

Well, it matters because even though they are ruled by a sausage-fingered old man, Britain is still a significant economy ranking 6th in GDP, and being one of the top reserve currencies for Central Banks. 

These tax cuts were so drastic and not accompanied by any plan to pay for them that markets took notice and became uhh… just a little bit concerned. Below is a chart of the British Pound Sterling vs the US dollar. See if you can spot when they announced these tax cuts.

(Hint: it’s that massive drop)

The tax cuts precipitated one of the largest drops in the history of the pound. This means that the US dollar now buys more than it ever has, partially due to a lack of faith in the current government spending policies. This article has lots of charts to help highlight this but here is one if you are too lazy to click a link.

This budget move caused a drop on par with Coronavirus and some of the largest financial panics of all time - which is shocking. Especially since the pound has been on a slow and steady decline for a long time. 

Again, in simple terms, this means there is less demand for the British pound, and this matters because not only will it make it more expensive for Brits to import items but it also affects their borrowing costs (if only there was an economic consortium of countries they could join to collectively negotiate imports and exports to maintain relative price stability for their citizens. Ah, well).

If there is hesitancy to buy British pounds and British government loans then everything suddenly becomes more expensive. Just look at how the government's borrowing costs exploded following this news:

Meanwhile, the Bank of England (England’s version of the Fed) has been raising short-end rates in an attempt to slow inflation. And although they wanted to raise borrowing costs, they did not want it to happen quickly and disorderly. Their job is to make sure the world economy and its citizens maintain faith in their financial institutions and these moves we have highlighted did anything but that.

So they had to step in and announce they would begin doing something called Quantitative Easing which you may remember from the past when the Fed did this. Essentially they said we are going to continue hiking short-term rates while buying bonds to make sure longer-term rates don’t get too high.

Yes, this is confusing so let's use an analogy of a young married couple.

Let’s say the wife represents the Prime Minister, and the husband will represent the Bank of England. 

Now, this couple is spending beyond their means and having trouble making rent, so the wife (Prime Minister) suggests they cut back on their savings and 401k to maintain their lifestyle instead of cutting other non-essentials. 

The husband (Bank of England) agrees to go along with this until they run out of money in their checking and savings accounts. At this point, they turn to their bank for a loan and the bank says no, so the husband says that's fine, let's just put this on the credit card to keep the party going. 

And that is essentially what England is doing, injecting money they can’t afford into the economy short term while financing this spending with reckless long-term borrowing. The only thing they haven’t suggested is having a baby to save the marriage.

What’s the Upside?

This week was another in a long line of crazy weeks for the markets since we started this blog, and it was just nice that for once it wasn’t centered around American politics or finance so we could make light of it. 

However, this UK debacle is somewhat of an exercise in how not to handle fiscal and monetary policy so let's just hope the big brains in Washington took note.