The London Bridge is falling down economically! Is high inflation and a tumbling stock market in the US getting you down? Because as bad as things may seem here, they could always be so much worse like in Great Britain that seems to be dealing with even higher inflation than we have here and their economy is turning into shepherd’s pie due to September 2022 events.
So could the economic train wreck that’s happening in the United Kingdom be the black swan that no one is expecting?
A black swan refers to Nassim Nicholas Taleb’s term of an unpredictable event that has severe consequences beyond what is expected in a given situation.
This September has been quite dramatic for the United Kingdom as Queen Elizabeth passed away after shaking hands with the new Prime Minister Liz Truss. Now Truss is shaking up markets and the British economy with an earthquake of tax cuts and fiscal spending to try to stimulate growth.
So far, the markets and media have had a negative reaction to “Trussonomics,” which wants to implement trickle down economic policies like Margaret Thatcher and Ronald Reagan did. “Trickle down” economics has been heavily criticized.
Truss’ Chancellor of the Exchequer, aka British Finance Minister, aka Treasury Chief Kwasi Kwarteng announced these fiscal measures known as the “mini-budget” on Friday, September 23.
Then on Monday, September 26, the British pound sterling crashed to almost reach parity with the US dollar where it fell to its lowest exchange rate of 1 pound buying $1.03. Over the last few decades the pound usually averaged $1.50 but I remember visiting England and Scotland when one pound bought almost $2! Now that the tables have turned, we can eat our shepherd’s pie or fish & chips on the cheap as American tourist dollars go a long way in the UK these days.
In case you’re wondering like I was, Kwarteng’s role is like that of Janet Yellen, who is considered the CFO of the US federal government and has the title of the Secretary of the Treasury.
As the UK’s CFO, Kwarteng must have made a pretty serious mistake because he’s earned the ire of the International Monetary Fund (IMF) that issued a stinging rebuke of UK’s current economic policy.
With UK inflation reaching 9.9% in August, after being 10.1% in July, the IMF believes the UK’s fiscal policy to stimulate growth (spending money with the unfunded 45 billion pounds of tax cuts) is working against its monetary policy to fight inflation (tightening / hiking interest rates).
While the pound recovered to buying $1.11 by September 30, the damage seems to have been done since “a nation’s currency falls because investors question its economic policy,” according to UK asset manager Toby Nagle.
Throughout Liz Truss’ short tenure since September 6, the pound has been mostly declining relative to the dollar.
As Hurricane Ian was making landfall in Florida as a Category 4 storm on Wednesday, September 28, the Bank of England (BOE) had to step in to stabilize the storm in their bond market by buying 65 billion pounds of long-dated British government bonds known as “gilts.” They effectively restarted the money printer instead of turning it off like they were planning to by starting to sell off bonds, but now this plan had to be delayed.
Until the BOE had intervened, the British gilt yields were spiking because traders had been selling the bonds because of their lack of faith in what’s going to happen to the British economy. Markets have decided there is limited upside to the new Prime Minister’s economic policies. Most likely we’ll see higher interest rates (BOE had raised them to 2.25% in September), which will likely slow down the economy more than allow for growth to happen.
While a weaker pound makes British exports cheaper to the rest of the world, it makes imports more expensive for British consumers like food, energy, and housing. This could have downstream implications for not just Britain, but eventually the rest of the world.
The uncertainty surrounding the British economy could amount to black swan type of events with ripple effects in other economies. Per Larry Summers there could be global repercussions and some suggest this uncertainty could contribute to a global recession.
The mini-budget is not so mini because it’s going to cost the equivalent of 1.5% of British GDP, and the British government’s big gamble is to try to increase growth by 2.5% to offset the fiscal costs. Only time will tell if Truss and Kwarteng will be right on their aggressive stimulus, or if it will backfire and end up being a huge embarrassment for the British government.
It kind of feels like the calm before the storm because the volatility we’re seeing in the British currency and bond markets could be a precursor of what could be coming. Maybe we just need to hunker down, grab some hot meat pies, and chillax for whatever economic storm could be headed our way.
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