Reflections On The U.K. Meltdown

My fifth grade teacher was as old school as you can get. She made us write out so many multiplication tables that our hands would cramp. We were expected to recite them from memory, and if we failed, we were shamed by having to write six of them on the chalkboard in front of the class.

To mix things up a bit, she once had us prepare tables converting the U.S. dollar to foreign currency equivalents. To show you how the translations got burned into my brain, I still remember that the British pound was worth $2.40 at the time.

So, it was especially significant for me when the pound dropped to less than half that rate this summer. The fall of sterling has resulted from a series of missteps by the British government, some fleeting and others that are more lasting. As we watch developments, we should keep in mind that what’s troubling the United Kingdom could easily become problematic elsewhere.

My colleague, Vaibhav Tandon, covered the basic details of what happened in his excellent piece, “The U.K. Takes A Pounding.” In the four weeks since that article was posted, markets have remained volatile. And last week, Prime Minister Liz Truss was forced to resign after a tenure of only 45 days.

There are many lessons that can be derived from this episode, which should be appreciated across world capitals.

The bond vigilantes are back. In the early 1990s, the American political advisor, James Carville, said that he wanted to be reincarnated as the bond market, allowing him “to intimidate everybody.” During that era, budget policy that threatened the drive for price stability was met with reproach by investors, who became known as “vigilantes.”

For the past twenty years, however, fixed income investors have been relatively calm. Even though government borrowing has skyrocketed in most countries, interest rates have remained low. Secular governors were containing inflation, and central banks stood ready to react if it broke that containment.