In Liz We Truss?
Thanks to the United States being the best place in the world to invest, we've never had to cover the economy of a foreign nation before on this site (outside of the absurd inflation numbers of Nazi Germany and modern-day Venezuela).
However, recent developments in the United Kingdom have been so interesting, I felt like I had to cover it. In today's piece, let's discuss the political and economic turmoil occurring in the U.K at this moment in time, which has led to a shocking devaluation of their currency, the not-so-Great British Pound. But to understand what's happening today, we have to jump back to the far-flung historical year of 2016.
Let's Talk About Brexit
Imagine for a moment that you're back in 2016. In the U.S, we're coming out of the Obama years and into a hotly contested presidential election between Hillary Clinton and the former host of "The Apprentice" who at one point had 14-1 odds to become president.
Well, that man did become the President of the United States, riding a wave of America-first populism that resonated with the voting base, and energized some who were not the typical "Republican voter." I mention all of this because the effects of Donald Trump's campaign were not just felt on American shores: the rise of right-wing, geo-centric populism was a wave that several global politicians rode. One politician that took the baton and ran with this idea was then-Mayor of London, Boris Johnson.
Old Boris ran his campaign essentially as a "Make Britain Great Again" movement that centered on the idea of England paying massive sums of money to the European Union, and getting nothing in return outside of mass immigration and a stagnant economy. And in this, he was kind of right.
In 2007, the United Kingdom's G.D.P per capita (essentially a measurement of a country's economic output per person) was $50,653, actually putting this measure above the United States' own at that time. Obviously, 2008 saw a global financial crisis that crippled every country on the planet, but the U.K never really recovered. By the end of this year, 2022, the U.K's per capita G.D.P figure is projected to be $41,900, representing nearly a 20% drop from 15 years ago.
Johnson and his Conservative "Tory" Party (not the same as the American Conservative Party) campaigned on this principle, advocating for taking the dues England paid to the E.U and reinvesting them into their own economy. And it worked.
In 2016, the U.K held a general referendum vote on Brexit with two options on the ballot: "Stay" or "Go." 51.89% of Britons opted for "Go," which meant that England was formally leaving the E.U. Then-Prime Minister David Cameron resigned, and new PM Theresa May issued the official "We Out" papers to the E.U.
This referendum also forced a "hung Parliament," which, without getting too into the weeds of British voting schedules and Parliamentary systems, essentially meant that a general election occurred in which the Tories took over and Boris Johnson was installed as the new Prime Minister, starting in 2019. Under Johnson, the U.K left the E.U on January 31, 2020.
The Effects of Brexit
Economically, Brexit was universally viewed by economists as what's known as a "horrible idea." Brexit would not only have some strange and damaging effects in the short term, but many economists agreed that the longer term effects of the referendum would crater the British economy. And unfortunately, those fears came to pass.
Immediately following the referendum vote to leave the E.U, the Pound crashed as foreign companies threatened to pull back on direct investment into the country. Multi-national organizations began disaster planning, closing U.K offices and slashing jobs held by Britons. Wages dropped, employment dropped and international trade nearly completely halted.
Longer term, the U.K government conducted an analysis of potential economic impacts of Brexit that ended up leaked to the public in 2018. In the document, the British government indicated that they were preparing for one hell of a haircut, with economic growth cut by between 2%-8% annually for the 15 years following the decision.
Leaving the E.U also affected immigration, but that's exactly what the British people wanted, right? That's the platform that Johnson ran on: less fees and less foreigners. Turns out, many of those foreigners that were emigrating to the U.K were those that were taking on the "dirty work" of supply chain employment. They drove trucks across the country, operated ferries and were the lifeblood of shipyards. When immigration ended and many of these people were removed from the country, the British supply chain fell to pieces, which drove supply down. This, coupled with stable demand, created upward pricing pressure, which we like to call "inflation."
Related: How Inflation Really Works
This is a dramatic simplification of the rest of the earth-shattering consequences of Brexit on the British economy, but there were a myriad of other economic issues brought to the fore thanks to England leaving: the agriculture sector got pummeled, England got to fish its own waters exclusively which led to an overabundance of fish and a deflationary fish market (never thought I'd type that sentence but here we are), air travel all of a sudden got extremely convoluted and the bottom fell out of scientific funding in the country as that was entirely paid for by E.U budgets.
I want to quickly note that this is all just the economic impact of Brexit. Outside of straight economics, societal issues quickly arose. Northern Ireland and Scotland actually voted to stay in the E.U, leading them to attempt to issue their own emancipation documents from the U.K, which ultimately failed. This whole debacle also reignited the ultra-nationalists in Northern Ireland, which kicked up further violence in the region not seen since The Troubles of the 1970's.
Life After Brexit - Modern England's Economic Troubles
I mentioned above that the U.K left the E.U on January 31, 2020. Anyone remember what happened about 6 weeks after that date?
That's right! Just like everything else in the world over the last two years, COVID fucked everything up. But how, exactly?
Britain's Economy During COVID-19
Am I looking to rehash the horrors of the last few years here? Of course not, but it is important that we dive into the economics of COVID. For example, the British government, as cited earlier, expected the absolute worst-case economic scenario from Brexit to be an 8% hit to the G.D.P growth. COVID rocked the U.K economy to the tune of 9.7% in 2020, including a 25% drop from February to April of that year (pre-lockdown to full lockdown).
Just like the rest of the world, service businesses shuttered and began laying off employees in the thousands. As jobless claims began to mount, global governments took different courses of action. The United States issued several rounds of "Economic Impact Payments" if you're above the age of 30 or "stimmies" if you're Gen-Z. These were one-time checks meant to help cover bills while you were (hopefully) temporarily out of work. The U.S also instituted Advance Child Tax Credits, where was essentially borrowing money against your future tax refund, in order to help ease the financial burden.
The U.K took a bit of a different approach. Rather than issue one-time checks to citizens, they decided to foot most of the bill in what was referred to as the "Furlough Scheme" but formally named "The Coronavirus Job Retention Scheme." Enacted from March 1, 2020 through September 30, 2021, the CJRS was a federal grant dealt to corporations that did not lay workers off and continued to pay wages. In return, the federal government would pay 80% of the worker's wage, with the corporation footing the other 20%. For employees, this was great! It reduced the potential financial burden of unemployment. For the Bank of England, however, this was a stretch.
At a total price tag of 70 billion GBP ($100 million USD), this was the biggest economic outlay by the British government in peacetime ever, and the biggest total economic outlay since World War 2. However, the CJRS wasn't the only expenditure that the Bank of England was forced into. Much like their U.S counterpart, the Federal Reserve, the BoE began "quantitative easing," or the act of purchasing bonds on their own balance sheet to keep asset markets afloat. Remember this term as we'll be back to it in a minute.
Basically, these factors exacerbated the inflation issue that was caused during the Brexit rollout, which led to pain in the pocket of every British citizen. But it was about to get worse.
Britain's Economy in 2022 - The Russian Energy Crisis
Welcome to the absolute hellscape that is 2022. Supply chain issues and endless government money printing have led to inflation across the globe. We think the 8-9% inflation in the U.S is bad? Well, it is, but not as bad as the 10-12% inflation that the U.K has experienced this year! Combine that with the G.D.P figures I cited earlier and the average British worker has effectively lost 20% of their real wage in the last 15 years. Well buckle up buttercup because shit has been traveling northward, but it has not yet hit the fan.
Let's visit for a moment the world of political ineptitude. You see, when the rest of the world thinks that your leadership is a total clownshow, corporations and other countries that would typically invest in your country tend to pull out (see: the strength of the U.S dollar between the years of 2016-2020). Well, Boris Johnson didn't exactly cover himself in glory as Prime Minister, and a series of scandals rocked his administration in late 2021 into 2022 that eventually forced his resignation. In comes new Prime Minister Liz Truss in September 2022.
Truss has the unenviable position of taking over as leader of the country as two massive events are unfolding: Russia at war with neighboring Ukraine and Queen Elizabeth II passing away. While Big Liz passing away was a real tragedy, only Russia invading Ukraine is politically relevant to this story, so that's the one we'll need to focus on.
Why is Russia politically relevant in this story? Well, most of Europe is run on a grid of electricity and natural gas. Natural gas is critical to heating homes in Europe, and Europe is freezing cold for a large percentage of the year. Nowhere is this more true than England, where most of the homes are built with old stone and bits of straw, so natural gas is critically important to staying alive during the winter months.
Shortly after Russia invaded Ukraine, the United Nations imposed a series of sanctions on Russia and Vladimir Putin that were intended to cripple Russia's economy. The U.N, doing some humanitarian math, figured that they could put Russia in a chokehold without directly leading to loss of Russian life, who largely oppose the invasion. These sanctions included things like cutting Russia off from SWIFT, the global inter-country payments network, seizing assets from Putin's oligarch loyalists (which weirdly included Chelsea Football Club) and shutting trade off to Russia.
Unfortunately, these sanctions didn't deter Putin and his economy, and Putin hit back...probably. In a series of explosions deemed as "self-sabotage," the Nord Stream 1 and 2 pipelines were critically damaged, which are the pipelines that transport natural gas from Russia into Poland, where it's typically distributed across Europe. This has caused an unprecedented supply shock of natural gas in Europe, and it's hitting where it hurts: the wallet.
In an appearance on Plain English with Derek Thompson, British economist Duncan Weldon outlined just how startling this pipeline issue is going to be for most British citizens:
So we are looking at, for a household in Britain, heating and using electricity in the house, the typical bill has risen from under £1,000 a year, that’s about $1,200 a year ago, to about £2,000 now. So it’s already doubled. Before the government introduced changes in the last few hours really, we were expecting prices to rise to £3,500 this winter and something over £5,000 next winter. - Duncan Weldon on an appearance on Plain English with Derek Thompson
In a genuine good-faith effort to undo this potential damage, Truss and her government proposed a new economic plan: households will pay their energy bills up until they hit the 2,500 number, after which the U.K government will cover the rest.
This sounds great, right? Sure, if you're the homeowner or renter that is now having their extra bills covered. But what about if you're the Bank of England? Well, that's less great, and the reason is: debt.
I mentioned earlier that the Coronavirus Job Retention Scheme was the biggest ever economic outlay in peacetime by the British government. Truss saw that and said "hold my lager and lime," and unveiled this new energy plan which has a bill somewhere in the region of 150 billion once its all said and done. That is two-times larger than the CJRS program, and a number so large that it's effectively a 2% hit to the entire British G.D.P for this year and next year.
Here is where the story unfortunately takes a turn for the worse, and we start to venture into the territory of complete lunacy. You would imagine that, in order to pay for all of this, the U.K government would need to raise taxes, either on its citizens or on businesses that operate in the country? Well, my rational friend you, you are incorrect. Liz Truss is actually cutting taxes. This is also all occurring when the Bank of England is attempting to unwind (that is: "selling off") the bond positions they purchased during the pandemic, in a move called "quantitative tightening."
The combination of a historic government fiscal outlay, unprecedented tax cuts, quantitative tightening and supply shocks across Europe have led to what President Selina Meyer might call: the perfect storm of fuck.
Over the last month, the Great British Pound has lost about 10% of its value against the Dollar, dropping to a low of 1.03 Dollars-per-Pound, an all-time low. Bond rates have spiraled out of control, leading mortgage lenders in the country to outright pull products from the market. The federal bond market is so shaky due to lack of investor confidence that the Bank of England actually had to issue a formal statement saying they are ending quantitative tightening and restarting quantitative easing.
The other issue here is the scariest phrase I've ever created but here it goes anyway: ambient inflation. Inflation around the world is sort of just "there" at the moment. How do you combat that? You raise rates! Raising rates means it's more expensive to borrow money, which means that demand typically cools, driving prices down. Well, now you have a dogfight between the U.K government enacting inflationary measures to assist in easing the financial burden of its citizens, coupled with the Bank of England attempting to enact deflationary measures to protect the economy and cool inflation that's already run past 10%.
In the short-term, the United Kingdom could be screwed. It's in outright war with itself from the inside out, and even countries like Turkey are laughing at the leadership of the U.K. Liz Truss has only been in her job for three and a half weeks at time of writing, but elections in the U.K don't work the same way they do in the U.S, and a vote of no confidence could already by hanging over her head.
On the flip-side of this, someone will get rich on this. Remember George Soros? The hedge fund legend who made $1 billion by shorting the British Pound in the 1990's? Well, we could see something similar here. Treasury gilds have never been higher in the U.K, so unless you truly think that the entire country of Britain is going to fail, then now could be an interesting time to jump in if you're a long-term investor.
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