Monday 26 September 2022

Kwarteng does a Sterling job

All eyes will be on the foreign exchange markets today. Trading in Asia started last night with the pound quickly falling below $1.08 before recovering slightly but still below Friday’s close. In early trading this morning, the pound hit an all-time low of $1.037. As I type this, I can see on the BBC it is around $1.065 after a bit of profit-taking I assume. The euro is trading at around €1.10. Sterling has been falling slowly for a while now. Last month it was trading at $1.22. Kwarteng’s mini budget on Friday pushed it further down. There seems little to halt the slide.

Here's Ed Conway from Sky News:

A fall of nearly 15 percent in the value of a major currency in one month is not normal, let’s be frank. The fact that the chancellor sacked the top Treasury official Tom Scholar and refused to allow the independent OBR to publish a forecast shows the market that there are unexplained risks that they (and we) don’t know about. 

The value of Sterling is a measure of how foreign investors see this country and the confidence they have in its government. When the referendum campaign was on and Nigel Adams was going around urging people to vote leave, I wrote him a letter that ended with a comment that the markets will eventually pronounce on the wisdom or otherwise of Brexit. I still believe that.  This week has seen them give their latest verdict.

There are reports of Tory MPs who are livid about the mini-budget and are preparing to submit letters of no confidence in Truss after three weeks, surely the shortest political honeymoon on record?

On 24 June 2016, the pound saw the biggest one-day fall in 30 years and it’s worth reminding ourselves just what this means. Effectively Sterling was devalued, making everything in Britain worth that much less, including our businesses.

At the start of 2021, the pound was approximately 15 percent weaker relative to the euro than it was on the eve of the referendum on the UK’s membership of the European Union (EU) in June 2016. 

Britain imported £654 billion of goods and services in 2021. If we assume Sterling might have been 15 percent stronger had we remained in the EU, we could have purchased the same quantity but for about £100 billion less.

OK, it’s a big assumption I know, but it gives you some idea of what Brexit and the exchange rate are doing to the wealth of this country. Economists will say that a lower valued pound will boost exports and bring in more money to compensate. But there is no evidence that our exports have been boosted, in fact, other countries are increasing their exports more than we are in spite of a lower pound.

Some pro-Brexit economists argue that it’s all down to the strength of the dollar and there is some truth in that, but the euro hasn’t fallen anything like as sharply as the pound. Last week there were suggestions that European companies are looking to pick up bargains, which means more profits being repatriated to benefit other countries. 

In The Telegraph, Ambrose Evans-Pritchard says Kwasi Kwarteng’s "tax cluster bomb risks blowing up Britain’s credibility" and in his piece, he mentions that the UK has a net international investment position (NIIP) of minus £742 billion which means foreign companies own £742 billion more than we own overseas. This can only get worse. Foreign takeovers by British companies become more expensive while the cost of  'investments' in the UK fall.

Foreign investors are not as gullible as the British right-wing media and take a hard-headed view of these things. The near 7 percent drop in Sterling's value which has occurred since Friday following Kwarteng’s statement showed that they don’t much like what they see. Who can blame them?

In 2016 Brexiteers made a lot of our payments to the EU. The infamous £350 million a week figure was, as is now well known, based on the gross annual figure and didn’t include our rebate or the EU regional and structural funding spent in this country. It just so happens that £350 million a week is about £19 billion over the year.

By a curious coincidence, that is the figure (actually £19.4 billion) spent in one month on debt interest in June 2022. It’s the largest amount of interest paid on UK debt since records began in 1997. The increase was largely due to the effect of Retail Price Index (RPI) rises on index-linked gilts.

Another impact of last week’s desperate financial gamble is that the people who are going to pay for the government’s desperate financial gamble have decided the risks have increased and the interest charged on new debt is going up.  Debt interest payments are not going to come down for a very long time.

All of this is going to find its way through to inflation as the cost of imports rises. The Bank of England’s job of bringing inflation down is going to be harder and since their only real tool is interest rates, they will need to be higher for longer.

And shoppers facing a cost of living crisis due to soaring energy prices are going to see food price inflation, already at 13-14% will go even higher.

The Nobel prize-winning economist Paul Krugman doesn’t think we’ll see a Sterling crisis in the sense of it spiraling down but I think we could see some panic in Whitehall, Threadneedle Street, and The Treasury this week.

This little clip this morning on GMTV with Mark Littlewood of the IEA was interesting. He says "the markets love what the government is doing" and thinks the only worry is how to balance the books because "government spending has enormously outstripped growth over the past seven years." 

Germany and France have grown much faster than Britain during that time but nobody mentioned Brexit. And God knows what would have happened if the markets didn't like what the government is doing.

The logical answer would be to rejoin the single market but the IEA isn't going to suggest that.  Instead, they are going to keep arguing that spending must be cut and cut and cut to keep pace with falling tax revenues.

Leave voters are soon to realise what they actually voted for in 2016.

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