By Alex Callinicos
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Pound collapses on Kwarteng’s watch

This article is over 1 years, 6 months old
The markets are betting against the plans of Liz Truss and Kwasi Kwarteng. This will mean trouble for the Tories
Issue 2824
Kwarteng Tories pound Tory Tories Truss

The pound has fallen, and its Tory Truss and Kwarteng’s fault (Picture: Flickr/Number 10)

In the deluge of criticism that has overwhelmed Liz Truss’ and Kwasi Kwarteng’s disastrous “fiscal event”, probably the most damning came from US ex-Treasury secretary Lawrence Summers. “I think the UK is behaving a bit like an emerging market turning itself into a submerging market,” he said.

Summers was referring to the collapse of the pound sterling. It fell on Monday to its lowest exchange rate ever with the US dollar. This is a massive vote of no confidence by the financial markets in the new Tory government. 

When this is described as an “emerging market” crisis, commentators are referring what has happened repeatedly to the bigger economies in the Global South—from Mexico in the early 1990s to Turkey today. 

Fuelled by heavy foreign borrowing, usually in the dollar, the economy booms for a while. But when the bust comes the country’s currency drops on the foreign exchanges, making it harder to repay foreign loans and worsening the crisis.

This kind of crisis is developing on a global scale thanks to the US Federal Reserve Board’s policy of sharply raising interest rates to reduce the rate of inflation. The dollar has therefore risen sharply, pushing other central banks to follow suit. As the Financial Times newspaper puts it, “a ‘reverse currency war’ is in full flow. This means monetary authorities across the world are now ditching their standard quarter-point increases in favour of 50, 75 and 100 basis point moves in order to stem dollar declines.

“Rate rises have become so aggressive the World Bank warned last week they risk sending the global economy into a devastating recession that would leave the world’s poorest countries at risk of collapse.”

Many commodities are priced in dollars, so the Fed’s policies are actually exporting inflation. And the burden of debt is rising as borrowers have to make higher interest payments in more expensive dollars.

Britain runs a huge balance of payments deficit with the rest of the world—£51.7 billion in early 2022, 8.3 percent of national income. To pay for its imports of food and manufactured goods it depends on what ex-Bank of England governor Mark Carney called “the kindness of strangers”. That is, a continuous inflow of capital from abroad.

Brexit already disrupted Britain’s relationship with its most important trading partner, the European Union. Its dependence on imported natural gas makes it particularly vulnerable to the energy crisis that dominates the inflationary surge in Europe.

Truss and Kwarteng are in trouble because they revealed on Friday last week their willingness to massively increase government borrowing, not just to protect households and firms from this crisis. 

They are gambling that £45 billion worth of tax cuts aimed at the rich will stimulate a rise in the growth rate to its pre‑financial crisis level of 2.5 percent a year. Although they invoke Margaret Thatcher, this is much more like the policies of her great ally Ronald Reagan in the US during the 1980s. 

But Britain doesn’t control the world’s main reserve currency. And the markets are betting against Truss and Kwarteng partly because the government will have to finance its extra borrowing with much higher interest payments.

The Tories are getting caught in the brutal global monetary squeeze. The Bank of England has already strongly hinted it will counteract any inflationary impact of government policy by increasing interest rates even more than it was planning to. But it hasn’t done this yet. Last week it confined itself to a 0.5 percent rise—below what has become the going rate of 0.75 percent.

Deutsche Bank, one of the big players in the City of London, is calling for an emergency meeting of the Bank’s Monetary Policy Committee to increase interest rates further, and (in the words of the Times newspaper’s economics editor) to send “a strong signal that it willing to do ‘whatever it takes’.

A Deutsche economist says, “The market is giving very strong signals that it is no longer willing to fund the UK’s external deficit position at the current configuration of UK real yields and exchange rate”.

Ironically, it may be the very market worshipped by Truss and Kwarteng that breaks their government.

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