Commentary
The decline of the British pound has far-reaching implications for the global economy.
The near-crash of the British pound last month is just one of many such stories of declining currencies and central bank intervention taking place around the globe. It serves as a frightening harbinger of a major economic crisis to come.
The dollar has hit a 20-year high. Nearly all other currencies are depreciating, and the steps governments are taking to defend their currencies are inflationary. Countries are spending down their dollar reserves and purchasing their own currencies, but commodities, oil, and energy are all priced in dollars. Foreign debt also has to be paid in dollars. Therefore, depleting dollar reserves will make these international payments more expensive.
To rescue the pound, the Bank of England intervened and bought up $73 billion worth of pounds. As a result, the foreign currency reserves decreased by a record $54 billion. The UK foreign currency reserves have been in steady decline for the past 12 months, hitting only $171 billion in September.
But it isn’t just the UK taking similar steps. Japan’s government spent nearly $20 billion in September to prop up the yen. India spent $75 billion supporting the rupee. And Beijing warned state banks to prepare to go on a buying spree to save a beleaguered yuan. To fight inflation, which already stands at 18 percent, Belarus President Alexander Lukashenko has banned price increases. Since a ban on price rises has no impact on costs, suppliers will refuse to sell at the lower price, and the country will be faced with shortages.
The European Central Bank is planning $388 billion in support spending to counter rising energy prices in the European Union. This will increase inflation while increasing debt.
The recent pound crisis came on Sept. 26 when the British pound lost nearly 5 percent of its value overnight, hitting a 37-year low. The pound, usually worth quite a bit more than the dollar, came almost to parity at $1.035 to the greenback. After months of losses, the pound is worth 21 percent less than it was in January. The plunge came after the UK’s Chancellor of the Exchequer Kwasi Kwarteng unveiled the new minibudget—which was meant to boost the economy—in the face of inflation by implementing the largest tax cuts in 50 years. The government also announced a tax reduction for real estate sales and a cap on energy prices. At the same time, Britain plans to increase defense spending.
UK Chancellor of the Exchequer Kwasi Kwarteng attends an In Conversation with the Institute of Economics Affairs and TaxPayers’ Alliance on the third day of the Conservative Party conference at Birmingham ICC, in Birmingham, England, on Oct. 4, 2022. Ian Forsyth/Getty Images
Over the next six months, the tax cuts are expected to cost the government $48.17 billion, while the energy support is expected to cost $64.12 billion. The difference between the actual cost of energy and the government cap will be paid to the energy-producing companies by the government. And these payments will be funded with increased government debt. Consequently, the government has been forced to raise its debt ceiling, allowing it to borrow more.
Meanwhile, the British government’s borrowing costs have dramatically increased due to interest rate increases and skepticism caused by Britain’s commitment to increased spending and driving up the government debt, which already stands in excess of 85 percent of gross domestic product.
Cutting taxes while increasing government spending and public debt are all expansionary policies that add to inflation. In September, consumer price inflation expectations rose to 9.5 percent. High inflation should reduce unemployment, but the UK’s youth unemployment rate is more than 9 percent. Additionally, 39.8 percent of young people are considered inactive, meaning they no longer seek work. The total number of 18- to 24-year-olds who are “not in education, employment, or training” (NEET) is 12.5 percent. High inflation coupled with unemployment matches the definition of stagflation.
Investors are voting with their feet. Over the past 16 months, money has been steadily flowing out of the British stock market. In September alone, as a result of the announcement of the minibudget, investors pulled $2.7 billion out of UK equity funds. Investment flowing out of a country will cause the currency to depreciate. Much of the investment leaving other countries is flowing into the United States, which is driving up the dollar.
Countries worldwide, particularly Britain, are caught in a vicious cycle of inflation, low currency value, difficulty making foreign payments, high borrowing costs, rising debt, U.S. Federal Reserve interest rate hikes, a rising dollar, and the fear of citizens freezing to death this winter.
Views expressed in this article are opinions of the author and do not necessarily reflect the views of The Epoch Times.
