Why Has The British Pound Sterling Turned Into Toilet Paper Currency? 

Could Britain’s proud tradition of having a respected global currency be coming to an inglorious end? 

Could the sterling soon be mentioned in the same disdainful breath as such ‘toilet paper currencies’ as the Turkish Lira or the Argentine peso?

Undeniably, the sterling is certainly looking at parity with the dollar. Recent falls largely reflect the strength of the dollar but also, now, a depreciation against the euro and other currencies.

Currency markets are notoriously febrile, but there is a deeper weakness being felt in the government bond market with a sharp increase in bond yields as traders start to worry seriously about the risks of lending to the British government.

So, what’s turned the GBP into the equivalent of a shitcoin? 

In my investigative journalism, I found that there’s no clearer smoking gun than this: The BBC’s coverage of the Queen’s funeral is 100% to blame.

. . . no?

In actuality, there are 5 big reasons why concern about sterling and about the British economy is justified:

1. Policy incoherence. A popular metaphor is that, after last week’s events, the government has its foot hard down on the accelerator, with highly expansionary and inflationary fiscal policy. while the Bank of England has the hand brake on hard in the form of higher interest rates. There was widespread scepticism about the financing of Kwasi Kwarteng’s so-called ‘mini’ budget on Friday with the massive expansion of public spending, to counter the impact of the energy price shock on households and firms, combined with a big package of tax cuts. Scepticism was compounded by the Chancellor’s weekend comments that more tax cuts are on the way.

2. Lack of transparency. Policy incoherence might be swallowed in the markets if there were some credible numbers demonstrating that the government’s tax cuts could, indeed, produce the economic growth needed to make debt levels sustainable. But the Chancellor has ducked the test of asking the Office of Budget Responsibility to put forward a set of independent forecasts. He also fired the Permanent Secretary to the Treasury, who has unique experience of economic crisis management, because his advice was unpalatable.

3. The Current Account deficit. The expected deficit for 2022 is over 5% of GDP reflecting serious imbalances in the domestic economy, weak trade performance and a heavy reliance on Britain’s ability to attract foreign capital. The deficit puts the UK in the same company as crisis-hit emerging markets like Egypt, Pakistan, Turkey, Colombia and Chile (also Greece, though it has a rapidly improving economy and the Euro as a currency).

4. Central Bank doubts. The independence of the Bank of England is crucial both to getting double digit inflation under control and to retaining the confidence of international markets. The implied threats to Bank independence by Liz Truss during her leadership campaign have been reinforced by reports that the Chancellor has set up twice-weekly meetings with the Governor. To discuss what? The Chancellor will no doubt suggest that the Bank’s, and Mr Bailey’s, futures depend on the Bank being ‘helpful,’ aware that Mr Bailey had a reputation as a financial regulator for not rocking the boat.

Fortunately, other members of the Monetary Policy Committee are less exposed to pressure.

They will be expected by markets to raise interest rates by at least 1% next month (or perhaps earlier in an emergency meeting to support sterling).

But, since the government’s fiscal policy is likely to lead to a longer period of above-target inflation, requiring unpopular high rates for longer, the members of the MPC will also have to show stamina in asserting their independence.

5. Underlying weaknesses. Bond dealers and currency traders are amongst the people who will benefit from the tax cuts favouring high earners. It is unlikely that this will sway their judgement about the flimsily evidenced theory that cuts in personal and corporation tax will lead to a surge in the underlying trend growth rate. A more important influence on growth is the fact that, despite some supportive policies, business investment has been flat (since Brexit) mainly because of political uncertainty. Productivity growth also remains very low – and below that of comparable countries – due to deep-rooted deficiencies in skills and education and the reluctance of many firms to innovate: problems that take years if not decades to rectify.

All of these reasons point to the unalienable truth that fiat is increasingly a risky proposition for retaining value. God save the King. 

Currency weakness is just one symptom of dysfunctional policy or deeper economic problems, and the fact that we no longer have a fixed exchange rate means that a run on sterling does not, of itself, precipitate a crisis.

It is possible that devaluation, even if unplanned, could trigger a revival in exports provided the competitive advantage isn’t wiped out by inflation.

In any event the currency is still some way from ‘toilet paper’ status, but without a more convincing story as to why markets should buy into Truss’s Britain, confidence could drain away very quickly.