When Government Fails…

• 06-Oct-22
• admin

Image by Edd Allen from Pixabay 

 

When shit hits the fan, it’s a god-awful, bloody mess.

 

The financial crisis in the UK, worsening by the day over the past week, is just that – shit hitting the fan. On the day Kwasi Kwarteng announced his “mini-budget”, it almost brought down the entire pension fund industry in the country.

 

Only quick action by a stoic Bank of England saved the day. But that solution is likely to be temporary and has a heavy cost. An immediate collapse of possibly the whole financial industry was put off, but that may cause inflation to worsen and possibly start a death spiral of the cost-of-living crisis feeding into a depression. The only way this economic crisis can be salvaged is a hollowing out of the Conservative Party or a return to power of the Labour Party, which in itself would not be without economic repercussions.  One simple error in execution would sink the Tories; and continuing, idiotic obstinacy in adhering to incorrect ideological orthodoxy is killing the UK.

 

Like I always say, don’t take my word for it. Open any, I literally mean, ANY English language newspaper on the subject and you will see that the new British government, installed just 3 weeks ago, has been thoroughly excoriated for stupidity and stubbornness. Worse still, the Prime Minister, Liz Truss, displayed empty-headedness, when in a critical radio interview midweek intended for her to explain the mini-budget, broke the silence of the leadership team by replacing it with a number of lapses into speechlessness when confronted with tough questions on what she and her finance minister are trying to do. Speechless! Oh my god!! What a display of incompetence on the part of the leader of the sixth largest economy in the world, one of the top two financial centres on Planet Earth, and bearer of the torch for the traditions of a once great empire.

 

In one week, Labour gained 33 points in YouGov polls against Truss’ party, dominant for a decade over what was considered a has-been party of the Left in a country where a five-point swing can change the government. This is a political disaster of major proportions.

 

If things don’t change, Kwais Kwarteng, the finance minister, steeped in his intellectual arrogance (he was indeed an accomplished student throughout his life) that his way is better than anyone else’s and unable to accept advice from the stalwarts in the civil service (in fact firing his head of the Treasury who contradicted him), will himself be replaced in fewer days since he proposed the shit that made no sense to anybody in the City, Fleet Street and even distant Singapore.

 

What happened?

 

Last week, I analysed what ensued when Kwarteng revealed his first economic plan as the new finance minister, intended to “revive” the British economy. My comments were made earlier than most other analysts, and since then, I have not read another comment that varies substantially from mine. I am not a local expert in close touch with other experts in the City. Hell, I don’t even live in the UK…

 

But it was not like it needed rocket science to understand what Kwarteng proposed and how that would impact the British economy and financial markets. Even the Bank of England intervention was not unexpected, as their mission is to safeguard the integrity of the country’s financial system.  What was however unknown throughout the week until the end of it was how close the country came to financial collapse.

 

What emerged around Friday, as reported in the British financial press, was that financial institutions in the City saw the collapse of the gilt market in its immediate reaction to the mini-budget, and they bashed the Pound. While this was in progress over Friday and Monday, Britain’s “Lehman Moment” almost broke out.

 

Well, not quite. The bankruptcy of Lehman Brothers in 2008 that brought on the Global Financial Crisis was caused by a much more complex problem and in the context of a much larger market. But for the UK, the problem that emerged as the gilt market tanked was caused by the same kind of leverage that brought down Lehman. As usual, people borrowed too much money and had to meet margin calls.

 

Here is a short account of what happened by Livy Investment Research for Seeking Alpha, an American investment website, on Sep 30, 2022.

 

“What is Happening in the UK?

In response to surging inflation worldwide over the past year, major central banks have sought aggressive monetary policy tightening measures that include rapid interest rate hikes, which have sent sovereign bond yields - including the U.S. Treasury and UK Gilt - towards record levels. In the latest development, long- dated 30-year UK Gilt yields surged rapidly beyond 5% for the first time in two decades earlier this week, with U.S. Treasuries tracing a similar trajectory as yields on the benchmark 10-year notes surged beyond 4% on Wednesday for the first time in more than 10 years.

 

Recall the economics - bond yields measure the spread between the bond's price and the bond's interest payments. When there is a selloff in credits/bonds, prices come down due to the flood of supply in the market. And when prices come down, the spread between the bond's price and its interest widens, resulting in higher yield. In other words, bond price and yield move in reverse - when there is a violent selloff, prices come down and yields surge.

 

So why did yields surge at such a rapid pace earlier this week? In addition to expectations for further rate hikes within the foreseeable future to counter inflationary pressures, the UK government's recent proposal for the "largest tax cuts since the early 1970s" under new Prime Minister Liz Truss' leadership worsened jitters across the market. The proposed package, which also includes subsidies for household energy bills, is expected to cost at least £150 billion ($169 billion), which will primarily come out of additional sovereign bond issuances:

 

The package of subsidies and tax cuts-which will be largely funded by borrowing, will cost more than £150 billion, equivalent to $169 billion, over the next couple of years, analysts say. The government said it would borrow an additional £72.4 billion to fund the package in the short term. However, the overall borrowing in the coming five years could be closer to £300 billion, said Azad Zangana, senior European economist at Schroders.

 

Source: The Wall Street Journal

Circling back to basic economics, more debt supply means further lowering of prices and higher yields. The long-dated 30-year UK Gilt yields surged beyond 5% earlier this week while the pound plunged toward record low levels after last Friday's tax break proposal, with U.S. Treasury yields headed the same direction, drawing the Bank of England to intervene as part of efforts to stem the "furious selloff" that risks more economic damage.

 

And immediately after the Bank of England stepped in to arrest the selloff in UK Gilts with the announcement of buybacks on long-dated UK Gilts - less supply, means higher prices, lower yields - the notes' 30-year yield diminished at a record pace to under 4% overnight. The surge in 10-year Treasury yields also stabilized under 3.8% as the bond-market selloff slowed, which also drove a brief relief rally in U.S. equities on Wednesday.

 

What is Incentivizing the Bank of England to Step In?

 

While the Bank of England has cited its intervention as a mean to "calm markets and prevent the financial contagion from causing wider economic damage", market professionals spanning fund managers and strategists suggest that there is likely a bigger problem at hand. The rapid rise in UK bond yields was effectively putting the region's pension funds at risk, given their participation in liability-driven investments, or LDIs:

 

The [Bank of England] stressed that it was not seeking to lower long-term government borrowing costs. Instead it wanted to buy time to prevent a vicious circle in which pension funds have to sell gilts immediately to meet demands for cash from their creditors. That process had put pension funds at risk of insolvency, because the mass sell-offs pushed down further the price of gilts held by funds as assets, requiring them to stump up even more cash. "At some point this morning I was worried this was the beginning of the end," said a senior London-based banker, adding that at one point on Wednesday morning there were no buyers of long-dated UK gilts. "It was not quite a Lehman moment. But it got close." …

 

"If there was no intervention today, gilt yields could have gone up to 7-8 per cent from 4.5 per cent this morning and in that situation around 90 per cent of UK pension funds would have run out of collateral," said Kerrin Rosenberg, Cardano Investment chief executive. "They would have been wiped out."

 

Source: Bloomberg

What are LDIs?

 

LDIs are largely favoured by pension funds to "match long-term liabilities they have to retirees with less capital than they would by owning regular long-dated government bonds". Essentially, pension funds - which promise retirees a certain return upon their respective retirements - leverage LDIs, which are investments into a combination of derivatives (e.g., interest rate swaps), to generate the "same" level of return needed to satisfy their obligation to retirees as if they had invested in long-dated government bonds with guaranteed returns, but without the same extent of upfront investment. The difference in assets pledged to LDIs and actual long-dated government bonds are then allocated to other "higher growth assets like stocks or real estate":

 

LDIs aim to help pensions close the gap between what they owe retirees and the money they have at hand by enabling them to invest less in hedging interest rate moves and more in higher growth assets like stocks or real estate. The pension funds invest money with an LDI manager. The LDI enters into trades that try to match a pension fund's liabilities through a combination of bonds and derivatives such as interest rate swaps and repo trades.

 

Source: The Wall Street Journal

Now, the issue is that rapidly rising interest rates are putting this seemingly sound strategy at risk. The value of LDIs decrease when interest rates rise and yields surge, which then requires pension funds to raise "more collateral to back the investments" - recall that the essence of LDIs is that, for example, when pension funds put $1 of asset on the line they get $2 of exposure, but if your $1 on the line is now worth less, you have got to pay up on the difference to maintain the exposure ratio. As a result, pension funds in the UK have been scrambling to liquidate their positions in the "higher growth assets like stocks, corporate bonds or real estate" to cover margin calls on their LDIs. But by rapidly selling off the higher growth real assets, pension plans are essentially driving asset prices lower at the same time - and again, lower bond prices mean higher yields, and higher yields mean more collateral needed to maintain the LDIs, thus feeding into a vicious "death spiral".

 

To better put into perspective the risk that this strategy exposes the UK's already vulnerable economy to have the Bank of England not stepped in, we turn to the ballooning size of LDIs over the past 10 years:

 

Over the past decade, LDI has become a core investment strategy for many pension schemes. Pensions and others had invested £1.6 trillion in LDIs by 2021, up from £400 billion in 2011. A 2019 survey of 137 big UK pension schemes found 45% had increased their use of leverage in the past five years. the maximum leverage allowed by the pensions ranged up to 7x.

 

Source: The Wall Street Journal

What Does This Mean for the U.S. Economy?

 

LDIs are not only favoured by pension funds in the UK but also widely embraced by pension funds in other major economies - including the U.S., though at a lesser extent. Specifically, the popularity of LDIs surged in response to a regulatory change in 2006 that required pension funds to measure their contractual liabilities to retirees "using long-term corporate bond rates" (i.e., at present value). This had inadvertently incentivized the pension funds to incorporate LDIs as a hedge against the risk that "falling rates and rising inflation will increase their future obligations".

 

As the U.S. economy unravelled this year amid aggressive rate hikes, surging inflation, and looming recession risks, the country's corporate pension plans - similar to those in the UK - are also facing margin calls. The portfolio of pension funds, worth more than $1.8 trillion in the U.S., is reported to have "posted tens of millions of dollars in collateral over the course of this year as bond prices fell".

 

And with more aggressive rate hikes on the Fed's agenda in the near term until there is concrete evidence that the peak of inflation is well behind us, trillions of dollars' worth of Americans' retirement plans are at risk, adding further complexity to the market turmoil ahead.

 

What Does This Mean for Equities?

Under the current situation, there are really two immediate scenarios for how it will play out:

1. Continued capitulation - This would be the status quo. The Federal Reserve is expected to remain committed to their hawkish monetary policy tightening agenda to hopefully bring inflation down meaningfully and towards its 2% target. This means elevated Treasury yields will be sustained in the near term as borrowing costs surge, growth gets stifled, while price pressures remain high, resulting in further economic deterioration. And with soaring interest rates, LDIs are at risk, requiring pension funds to post more collateral, which could potentially lead to further liquidation of equity and credit investments, driving their prices lower and fuelling a vicious cycle of more collateral and price declines - the ultimate showdown.
2. Fed pivot - This would imitate the Bank of England's current pivot, a temporary measure that has yet to prove its effectiveness in stemming a potentially larger downward economic spiral with the added complexity of unravelling LDIs and pension funds. However, if the Fed were to slow its pace of rate hikes and balance sheet runoff, it risks leaving inflation entrenched which would be similarly detrimental to the U.S. economy, though supply-driven price pressures are showing early signs of easing.

 

Either way, the global economic outlook remains stuck in an increasingly opaque cloud of uncertainty. Volatility remains the near-term theme. While it may seem that the macro outlook is gaining some clarity after the Fed put its foot down on maintaining an aggressive tightening trajectory to tame inflation, the latest development regarding pension funds and LDIs - which have "largely gone unremarked" - introduces yet another layer of complexity to the dire market climate as if the flurry of unexpected events this year spanning protracted COVID restrictions and related disruptions, supply chain constraints, and impacts from the Russia-Ukraine war and ensuing sanctions were not enough to choke valuations across the board.”

 

And here is a British assessment of the same problem that brought the BoE into the market turmoil to basically save the country and to counter the negative effects of the Truss-Kwarteng proposals.

 

“UK Pension Fund Crisis shows there is no capitalism without capital or risk

Michael Tory, Co founder, Ondra Partners in the Financial Times, 1 Oct.

 

“It is beyond ironic that an investment strategy that claimed to eliminate risk threatened the unprecedented failure of the UK pension system this week.

 

The main focus of attention so far in probing what went wrong has been on what took place over the few days leading up to the Bank of England’s emergency intervention on Wednesday to stem a crisis in pension funds over so-called liability driven investment strategies.

 

These strategies aim to hedge the liabilities of funds to meet their pension promises with the use of derivatives. But they suddenly exposed the sector to a now infamous “doom loop”, when falls in gilt prices triggered calls on schemes to provide more collateral on such trades, in turn spurring more sales of UK government bonds to raise cash.

 

However, the origins of the crisis stretch back more than 25 years when some of the current government’s members were still in secondary school. Starting in the late 1990s, a series of tax and regulatory changes made the provision of defined benefit pensions by companies to their employees so onerous that, by and large, companies closed their funds to new members.

 

Such schemes typically promised workers a retirement income that was a multiple of their years of service. The closure to new members of the vast majority of these schemes would lead to seismic — and completely foreseeable — implications for the UK economy and financial system over the following two decades. It led to a profound change in the way funds would be managed because of the compound interaction of two factors.

 

First, the funds now had a finite time horizon, servicing only existing members, and were therefore no longer indefinite intergenerational savings vehicles. Rather, they had become more akin to annuities and would need to be managed as such. For example, their now foreshortened time horizons made it harder to recover from the impact of poor investments, which significantly curtailed their appetite for risk.

 

Second, corporate sponsors’ risk profiles were asymmetric — companies were on the hook for all of the funds’ deficits and losses but had no practical access to any upside surplus until the last pensioner had died. So they behaved completely rationally to support pension trustees in their quest to eliminate all risk.

 

These two factors, combined with the increase in longevity, has had devastating consequences for the entire UK economy ever since. The recent meltdown is just an inevitable culmination of those earlier decisions.

 

The pursuit of zero risk led to a massive and permanent change in pension funds’ asset allocation — the proportion of their funds invested in bonds increased from less than 20 per cent in 2000 to 72 per cent in 2021. The Investments in listed UK equities declined steadily, from 50 per cent of their asset allocation in 2000 to 4 per cent in 2021.

 

For all practical purposes, defined benefit pension funds have ceased to supply long-term equity capital to invest in the growth of UK companies. The reservoir of equity capital built up by these funds over generations has been mostly drained.

 

This has reduced funding for homegrown centres of research and innovation while rendering critical infrastructure and much of the country’s technology and defence sectors dependent on foreign companies or private equity for capital.

 

Tragically, we have ended up with an emasculated system that is unintentionally self-destructive and, as this week has shown, still remains vulnerable. If anything good is to come out of this latest crisis, it is hopefully a recognition that, rather than a few tweaks here and there, we must now change this system root and branch, once and for all.

 

The UK government should as a matter of urgency commission an official inquiry into both how the nation’s pension savings system could have been put at such extreme risk and what steps need to be taken to ensure that this can never be allowed to happen again.

 

We now need to put in place a new, longer-term and more resilient savings system, better matched to the long-term interests and global competitiveness of the real economy. We need a pension system that is more inclusive of all generations and especially one that can supply long term risk capital to support the economic growth ambitions to which our new government is committed.”

 

For those who still think the above two articles are gibberish, let me do a simple translation for you.

 

When the mini budget was announced, the UK bond market did not like the tax cuts proposed as this comes at a time when the British government is supposed to be fighting inflation and the-cost- of-living crisis. With the tax cuts and the increased expenditures for covering expanded spending (including the subsidies for covering citizens’ energy bills), public borrowing in the UK bond market would have to increase. As such, the institutional lenders to the government who see a higher default risk given the increased debt levels, demanded higher risk coverage against default. This would be higher interest rates. As such, gilt interest rates immediately shot up.

 

This led to the leveraged positions of the pension funds, which had been buying derivatives to enable them to replicate the performance of gilts to meet their liabilities without using as much cash, to face sharp and mounting losses on $1.6 trillion of these LDI’s mimicking such bonds. They would have to top up margin. To do that, they need to sell some of the cash bonds in their portfolio, thereby creating further pressure on interest rates. All in all, the expected massive selling to meet margin calls would have crashed the gilt market, and if that came to pass, the UK economy would be imperilled.

 

BoE saw this. They quickly stemmed the exodus of funds from the bond market and declared they would engage in “unlimited” bond buying. In other words, they opened up all the exits in a room on fire and when investors saw that, they calmed down and did not run for any exit at all.   Yields on the gilts recovered to the level before the mini-budget. The currency markets were also reassured by the quick and pragmatic action of the professionals in keeping the UK economy in a healthy state. The pound rebounded, Monday to Friday this week, by 800 pips. That’s a lot.

 

Let’s hope that explanation was simple enough.

 

If you need it in a single sentence, it is that politicians created a f—king mess and civil servants saved their dumbasses. That was all there was to it.

 

What happens next? The point is that the British financial system is still not out of trouble. This is because the Dimwits on Downing Street have not stood down, in spite of everyone, I mean, everyone, including the IMF, telling them that the mini-budget cannot be implemented without the markets crashing again. Don’t do it, everybody is screaming, and yet these morons have just stuck to their guns and responded with stubbornness.

 

Therefore, if they don’t go voluntarily, they need to be ousted, sacked… The Tory Party is having its weekend party conference in Birmingham, and I would be surprised if they don’t take note of the 33% gap in the polls against Labour and take action. The result may be:

 

1. Kwarteng goes;
2. Both Kwarteng and Truss go:
3. They bring back, horrors, Boris…

 

If the Conservatives don’t do at least No 1, we will see early elections in the UK in which they will lose power to Labour.

 

If they do No 2, they will delay a defeat by Labour, and will still be mortally wounded and when the next election comes around, they will take a serious beating. In the meantime, who can they find to fill those two jobs? Rishi Sunak?

 

If they cannot find anyone else to take over Truss, and have to resurrect the zombie corpse of Boris Johnson, then the Tory Party is finished forever. They will become zombies.

 

How did this end up so badly?

 

Why can’t the Conservatives get the Truss-Kwarteng pair to just back down? I don’t know that they cannot, but here is an article I read in the FT about the character of the Chancellor, which provides a hint on the situation:

 

“Kwasi Kwarteng, the Chancellor who blew up the markets: By Sebastian Payne and Delphine Strauss Oct 1 2022 Financial Times

Hours after delivering his not-so “mini” Budget last week, Kwasi Kwarteng crossed the road to a small Westminster pub. As the pound crashed to its lowest level since 1985, the UK chancellor sank pints with his economic aides, grinning after unveiling the biggest round of tax cuts in half a century.

 

The next time he was seen in public, any jollity was gone. Striding determinedly towards Downing Street, he was stalked by a camera crew asking why the markets had so roundly rejected his Budget. As sterling hit all- time lows, Kwarteng walked on, stony-faced.

 

The 47-year-old, whose doctoral thesis was on 17th-century currency policy, frequently peppers his conversations with historical references to previous economic crises, according to a business leader who knows him well. Now, he is in the middle of one of his own making.

 

Even before last week, economists were deeply sceptical of his conviction that tax cuts and deregulation would usher in a “new era” of higher economic growth. They were dismayed when the chancellor went further than expected: adding cuts to the top and basic income tax rates on top of others that were pre- announced — and doubling down with promises of “more to come”. Ahead of next week’s annual conference, some Tory MPs wonder if the events of last Friday will finish his political career.

 

Born to Ghanaian parents in 1975 in east London, Kwarteng was privately educated at Colet Court before Eton, where he collected the school’s most prestigious academic prizes. His gamble on growth, which allies believe may still pay off, fits his boisterous character. During his university years at Cambridge, he achieved notoriety when he swore twice on air during the BBC quiz show University Challenge.

 

Tristram Hunt, director of the V&A museum, who lived with him as a student, previously told the Financial Times that Kwarteng was “quite ungovernable” in his convictions but conventional in his tastes. “He’s someone who is very much at home in an institution, whether university or parliament. He’s usually happy so long as he has a warm canteen lunch on a tray at 12.30pm.”

 

Before politics, Kwarteng had a varied career — including as a historian, journalist and financial analyst for JPMorgan and Odey Asset Management. His first book, Ghosts of Empire, was harshly critical of the British empire, contrary to much Tory thinking. “Much of the instability in the world is a product of its legacy of individualism and haphazard policymaking,” he opined, a phrase recently quoted against him.

 

Kwarteng entered parliament in 2010, but he fell on the wrong side of then prime minister David Cameron for criticising his housing policy and supporting Brexit. He filled his time with writing: his book War and Gold examined monetary policy and conflict. But it was another publication that has drawn the most attention. Britannia Unchained, co-authored with now prime minister Liz Truss and others, set out radical free market ideas to tackle the “bloated” British state, which they claimed was undermined by “high taxes and excessive regulation”.

 

Some view the chancellor’s insistence on his growth plan as a sign of ideological inflexibility, which made him deaf to warnings of the fragile mood in markets. Kwarteng has been known to order officials that advice be no more than a paragraph — and read to him out loud.

 

The chancellor has a divisive reputation. Some colleagues admire his willingness to challenge conventional wisdom. “Talking to Kwasi is never boring. He is an iconoclast and just the sort of person you want in government,” a fellow cabinet minister says. Others think this strays into overconfidence. “Kwasi isn’t exactly known for crossing the t’s and dotting the i’s,” one senior Tory MP remarks. “He’s always been phenomenally arrogant.”

 

Civil servants are uncertain. “Having a know-it-all with limited government experience during a financial crisis is not exactly ideal,” one senior Whitehall official says. “He is in that cabal of people who think they’re right, they don’t get challenged,” one prominent economist moots.

 

But others say the chancellor is more open to fresh ideas than he may appear. “In a meeting, he does more talking than listening, but he absolutely hears you,” the business leader says. “If you only know him a little, you think he’s not listening. If you know him better, you know that he is.”

 

The biggest issue, according to both supporters and critics, is not the substance of his policies, but his disregard for institutional architecture. Although Richard Hughes, chair of the Office for Budget Responsibility, offered to write an updated forecast for the fiscal statement, Kwarteng reportedly brushed it aside.

 

Even supporters are alarmed. “If you’re not having your homework marked, it’s even more important that you stick to what’s expected,” says Gerard Lyons, chief economic strategist at Netwealth, who has advised him.

 

Ed Balls, who helped design the framework for Bank of England independence, says markets were already unsettled by Truss’s suggestion that the bank’s mandate should be reviewed, and by the sacking of the Treasury’s top civil servant Sir Tom Scholar, even before the tax plans were published without the usual OBR forecast or with reference to the fiscal rules.

 

Kwarteng had been “contemptuous” of an institutional framework that would constrain his choices, Balls says, adding: “It’s not about whether taxes went up or down . . . for 25 years there has been a cross-party consensus on the right way to go about making monetary and fiscal policy. If you rip that up, you are totally exposed.”

 

Would the above predictions on the intransigence of Kwarteng come true? How would I know? I’m just an uninfluencing blogger. But if the FT has done its due diligence and risks its reputation on its pages, I would be happy to go with its analysis.                    That will mean, for me, that the man won’t retract his mini-budget, or back down from the policies that will pour gasoline on the inflationary fire, chasing after the elusive growth that he and his PM wants. And we will be observing the worst political crisis in the UK since Brexit was first proposed in 2016.  Case closed.

 

The BoE has a reputation of having steady hands, and this week has shown that it has the mettle to act. But while they are independent of the political class, this is not like they are fighting an external enemy. Their worst enemy is in fact their own bosses, the PM and the finance minister, who employ them to think straight.   But how long can this last?

 

There is the further problem that in the background, without any help from the Truss-Kwarteng team, the Pound’s natural direction is down. If we look at the last 150 years of Pound Dollar exchange rates (all the data that I have seen and certainly long enough to base my analysis on, the pound has not had a major break on the upside against the US unit for all that time. While I cannot show this in a chart in this commentary, I do have the following illustration of the exchange rate over the last decade when sterling dropped by 31 percent:

 

To be fair, it is not just the Pound that is declining over the past decade. Most major currencies around the world have suffered from the same problem. Not depreciating against the US Dollar has been very tough.

 

Here is a table showing the trend in all the major G7 countries, plus the main currencies in Asia over the last 12 months. None of the countries I have chosen include the basket cases that are generally found in the Global South and I have also included the alternatives to paper currencies - gold and cryptocurrencies. Those were crushed by the dollar over the last year, with some of the worst cases having halved in value.

 

One Year Change against the US Dollar, ranked according to the magnitude of change against the USD, with less loss ranked higher.

	Current Rate	% change	Least Loss ranked highest
Mexican Peso	20.146	2.35	1
Brazilian Real	5.4125	-0.57	2
Vietnamese Dong	23869	-4.71	3
Gold	1660	-5.31	4
Singapore Dollar	1.4321	-5.43	5
Swiss Franc	0.9887	-5.68	6
Indonesian Rupiah	0.000065	-6.43	7
Canadian Dollar	0.7229	-8.30	8
Indian Rupee	0.1225	-9.05	9
Malaysian Ringgit	4.6359	-9.70	10
Thai Baht	0.0265	-10.88	11
Taiwan New Dollar	0.0314	-12.53	12
Chinese Yuan	7.1151	-10.24	13
Australian Dollar	0.6399	-11.49	14
Phillippines Peso	0.017	-13.15	15
Chilean Peso	0.001	-16.23	16
Euro	0.9803	-15.31	17
British Pound	1.1156	-17.17	18
NZ Dollar	0.5591	-18.94	19
Pakistan Rupee	0.004384	-25.03	20
Japanese Yen	1.4474	-29.85	21
Sri Lankan Rupee	0.0027	-45.15	22
Turkish Lira	0.054	-51.92	23
Bitcoin	19403	-55.65	24
Ethereum	1324	-55.86	25

Even for the second largest economy in the world, the Chinese Yuan has lost more than 10 percent against the Dollar.

 

Across the planet in 2022, a defence against the strong US dollar seems to be failing everywhere. Sterling depreciation, at about 17-18 percent in just 12 months, is just about average.

 

As such, to assess the performance of each currency, we have to factor in the fact there is a natural tendency for the US dollar to appreciate and to assess the direction of the pound, it is just a matter of figuring out how much more it will fall, rather than whether it will turn around.

 

Given the inherent strength of the Dollar, an exchange rate policy in the UK to keep the pound strong is not likely to be important to either the BoE or any new government that takes over from Liz Truss. It is more likely that they will focus on keeping interest rates low, so as not to derail the pension market nor the housing market. There is actually not much leeway for innovative monetary policy in the context of high interest rates pursued by the US Federal Reserve.

 

The problems in the British financial markets have been exposed during the last week. The politicians want to spur growth, but the BoE wants to tamper inflation. These are completely contradictory economic objectives. It is nearly impossible to simultaneously achieve both objectives. One of the two will have to fall by the wayside.

 

This last week, the BoE has to pivot on its policy of raising its interest rates to quell inflation, in line with its counterpart across the Atlantic. In a day of turbulence, the policy went out the window, and it was forced to reverse course to save the gilt market. By “unlimited” bond buying, you can also read it as “we will print unlimited amounts of money”. It is the same thing. When confidence returns to the UK financial market, and even in the absence of the pro-growth pair of Truss and Kwarteng, it is very likely that even a new political leadership will continue to protect jobs, continue with quantitative easing and live with rising prices.

 

If so, we can expect the Pound to continue on its 150-year decline. Parity with the Dollar is just the next step.

 

Keep selling Pounds.

 

 

 

By:

Yeong, Wai-Cheong, CFA

Fintech Entrepreneur, Money Manager and Blogger Un-Influencer in a World full of Hubris