The nosedive in the pound and the UK government’s pursuit of policies to spur an economy beset by surging prices have prompted scathing comparisons between Britain and emerging markets. Bank of England Governor Andrew Bailey and the independent central bank may be all that prevents this unflattering label from sticking.
The pound fell to a record low against the dollar Monday after Chancellor of the Exchequer, Kwasi Kwarteng, vowed to press on with more tax cuts, despite a rout Friday in sterling and UK debt. Nothing wrong with aspiring to growth; a recession is widely predicted. But the selloff has been driven by the radicalism of the fiscal plans, including the biggest tax giveaway in half a century. This at a time when the dollar is ascendant against almost anything.
Japan waded into the currency market Thursday for the first time in decades to put a floor under the yen, and there is speculation British authorities may be similarly forced to step in. There’s even talk of an emergency hike in UK interest rates to stem the collapse in sterling. Traders rushed to price in increases of as much as 150 basis points by the next policy meeting in November. China, with its formidable state power, is also striving to limit the decline in the yuan.
Being mentioned in the same breath as an emerging market has, at times, been a favorable analogy. It meant outsize growth prospects and a can-do approach to economics and business. But it can also mean a propensity for policy to lurch suddenly — shorthand for loose governance and a luke-warm commitment to rein in inflation.
Former US Treasury Secretary Larry Summers lamented Britain is following the worst approach of any consequential nation in a long time. “The UK is behaving a bit like an emerging market turning itself into a submerging market,” Summers told Bloomberg Television’s “Wall Street Week.” The situation is so dire that some comparisons have even been drawn with Turkey, an economy whose policies appear designed to exacerbate inflation — currently running at around 80% — rather than contain it. Ankara has become such a poster child for bad behavior that it’s often not mentioned in polite company.
By one metric, the UK is not a million miles away. The pound has lost 21% versus the greenback this year, the most of any major currency. Turkey’s lira is down 28%. Alarmingly, the pound’s drop is now greater than the currency of Japan, a country that steadfastly refuses to lift interest rates and that intervened to buy the yen after it tumbled to the lowest since the Asian financial crisis of the late 1990s.
To be in this company is unfair. The BOE has increased rates seven times since kicking off the inflation-fighting cycle late last year, beating the Federal Reserve to the starting line, and long before the European Central Bank got going. A day before Liz Truss’s new government announced its “Growth Plan,” the BOE enacted its second consecutive move of half a percentage point; three of the nine members of the bank’s Monetary Policy Committee advocated for moving by three-quarters of a percentage point, as the Fed and ECB have done.
Given the thrust of the government’s approach, there is probably some regret at the bank. So fast are global monetary authorities upping the ante, that 50 basis points — a move that would have been seen as resolute just months ago — now looks underwhelming. That is unfortunate because at some point the central-banking sprint has to slow and officials need to look around and assess the impact on growth from restrictive stances.
As unedifying as the current UK spectacle is, Britain is not yet in Turkey mode. A big part of what ails Turkey’s economy and financial markets is the corrosive nature of inflation that’s not only untamed, but almost welcomed. A succession of central bankers who tried to quell price increases were seen as insufficiently committed to rate cuts and informed by President Recep Tayyip Erdogan’s team that their services were no longer required.
Until Truss’s administration tries to fire the BOE chief or pressures him to resign, Britain isn’t close to replicating the underlying substance of the Turkish mess. As fraught as 2022 has already been for central bankers, Bailey’s greatest test may be yet to come. He is the adult in the room.
A classic emerging-market response today might be to impose some kinds of controls on capital or, in the extreme, fix the currency. That’s not remotely close. Malaysia got away with both in 1998, but not without reputational questions, including the firing and imprisonment of the finance minister and a purge at the central bank. And Malaysia didn’t begin that adventure as an advanced economy, with all expectations and conventions that come with that.
Whenever the subject of a strong dollar comes up, people hark back to the era of Robert Rubin, who served as Treasury Secretary from 1995 to 1999. Summers was his deputy at Treasury and succeeded Rubin. Rubin was adamant that a strong dollar was in the country’s best interests. But there were occasional and very significant exceptions. Rubin sold the dollar in June 1998 to support Japan’s efforts to stabilize its currency. In 2000, Summers unloaded dollars to purchase euros as part of a Group-of-Seven rescue for the beleaguered new currency.
In his memoir, “In an Uncertain World: Tough Choices From Wall Street to Washington,” with Jacob Weisberg, Rubin said there were rare instances when currency intervention made sense. Reflecting on the yen action, Rubin wrote that the “psychology” of the foreign exchange market was changed. “We intervened very seldom, and each of our interventions was successful,” he said.
Right now, the psychology of the market is to inflict pain on any non-dollar nation perceived to be lax on inflation or a laggard in the interest-rate space. Panic on the part of the BOE might make it worse. Markets may have to deteriorate more before an official response is forthcoming. If Bailey becomes the man of the hour, my advice would be to speak carefully and forcefully. Don’t give multiple interviews. Don’t have a press conference where the conversations can go awry and risk being misinterpreted. Keep the message simple. Rubin was a master of message discipline. It would be wise to follow him.
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