Sterling’s – and Everybody’s – Crisis – EconLib

23 Septemberrd, Britain’s former Chancellor of the Exchequer, Kwasi Kwarteng, announced a mini-budget containing a range of tax cuts aimed at boosting the country’s sluggish productivity and economic growth. Sterling fell sharply from $1.13 to $1.08 and yields on British government debt rose.

Kwarteng’s mini-budget was largely blamed for this, but before that sterling was losing value against the dollar: it stood at $1.35 on December 31, 2021. There are other factors behind sterling’s fall, and it may be the most severely affected yet, which is essentially what ails other currencies – and the economy – too.

When Covid-19 hit in early 2020, the British government, like many others, shut down its economy and locked down its people to slow the spread of the virus. Like other governments, Boris Johnson’s Conservatives – with overwhelming cross-party support – have passed huge spending packages to pay for aid. As a result, ‘public sector net borrowing’ – the budget deficit – came to 14.4% of GDP in 2020/2021, the highest level since World War II.

The government is concerned that this surge Amount The loan will be pushed cost Regarding borrowing, a concern shared with monetary and fiscal authorities in other countries. So, like other countries, to avoid the doomsday scenario of simultaneously increasing borrowing and spending, the Bank of England opened a line of credit directly to the Treasury. Between March 2020 and July 2021 total government debt was £413 billion and the Bank of England bought 99.5% of it – £412 billion – with newly printed money.

As in other countries, this newly printed money results in an economy whose ability to produce goods and services available for purchase has been damaged by COVID-19 and rising inflation. Britain’s consumer price index rose 0.4% in February 2021: in the year to July 2022, it rose 10.1%.

The Bank of England, mandated to keep inflation at 2%, was forced to act, but it did so more slowly than other central banks. While the Federal Reserve has raised the fed funds rate by 75 basis points in its last three hikes, the Bank of England stuck with a 25bp increase until June, when it raised the base rate by 50bp. It was expected to raise the base rate by 0.75bp at its meeting on September 22 – the day before Kwarteng’s mini-budget – but did so by only 0.50bp, surprising markets and signaling it would maintain a relatively tolerant stance on inflation.

Nevertheless, this rate hike, like in other countries, has increased the cost of borrowing. The 10-year gilt yield rose to 4.282% today from 1.809% on August 1. It comes just as the government announced a £2,500 cap on typical household energy bills until 2024, a measure that could cost up to £150bn. That’s a doomsday scenario Amount As the debt is increasing at the same time cost All the money that was printed and generated to avoid inflation, is the same here. The massive money printing of 2020 did not ‘prevent an economic crash’, some recent commentators have suggested, it merely postponed it.

The Bank of England needs to abandon its dovish stance and raise interest rates quickly. This should be done not to hit the external target of a fixed exchange rate – within a week of the mini-budget, sterling has regained lost ground against the dollar – but to meet the internal target of low inflation. A not insignificant part of the story of sterling’s weakness is the strength of the dollar – the euro, for example, has fallen from 1.14 to the dollar on 2 January to 0.96 currently. Targeting the exchange rate with a stronger currency would end sterling’s crisis, repeating the ERM’s disastrous membership errors of the early 1990s.

These are tough times for sterling but the story that has brought it to this pass – massive government debt, the monetization of that debt, rising inflation and rising interest rates – is not unique to Britain. Other currencies may soon join sterling in the tank.


John Phelan is an economist at the Center for the American Experiment.

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