UK Crisis: The Beginning of the End of Fiat?

On September 26th, the British pound crashed to just $1.035— the lowest rate in over 38 years. The British pound sterling was one of the strongest currencies in the world for decades, so what is behind this sudden weakness? And more importantly, what should we do about it?

Trouble in Britain

Britain’s currency may seem volatile right now, but these problems have been a long time in the making. The decline started with the Brexit vote in 2016 but really started to pick up steam with recent changes in UK economic policy. 

These changes were motivated by historic high inflation, partly driven by massive government stimulus programs both before and during the COVID crisis. Like many other central banks, the Bank of England was creating huge amounts of money out of nothing to boost the economy. 

Inflation, as well as the energy crisis, are driving a cost of living crisis in the UK. To deal with this crisis, the new UK government announced a budget that would help reduce energy costs for consumers. That’s not the problem; the problem is how they’re planning to pay for it. 

The new budget also includes a number of tax cuts that disproportionately benefit the ultra-wealthy. This means the government is planning a major increase in expenditure and a reduction in revenue.

You might be wondering, then, how they’re going to balance the budget. That’s the whole problem– they’re not! Why make difficult budgetary reforms when you can just sink deeper into debt?

The new budget places the UK on a completely unsustainable debt track. Global debt markets are taking it as a signal that the UK has no intention of ever repaying its national debt. As a result, the price for the British government to borrow has skyrocketed as lenders price-in risks.

When in Doubt, Print More Money

The IMF, along with leading economists, criticized the plans, arguing that they would make inflation even worse. The UK has been especially hard hit by inflation with the rate topping 10% in July.

To rein in inflation, the Bank of England had announced plans to end its “quantitative easing” (ie. create money out of nothing) program, but the problems in the bond market have thrown a wrench in those plans.

British pension funds were highly exposed to the bond market, and crashing bond prices threatened to force the funds to sell, sparking a chain reaction. Thus, had this happened it would have lead to a total collapse in the market leaving unfunded pensions for retirees. A big deal you ask?!

Spending by retirees is crucial to the overall economy. Attempts to fight inflation are already threatening a recession, and a collapse of pension funds would easily turn the expected recession into a full-blown depression.

Of course, no politician wants these issues come election time. So what to do? Create more money, of course!

Out of the Frying Pan, Into the Fire

To shore up the weak bond market, the Bank of England is stepping in with a program called “yield curve control.” Yield curve control is a lot like quantitative easing (QE). QE involves creating a fixed amount of money and pumping it into the market to stimulate the economy. The difference is that yield curve control involves the creation of unlimited amounts of money rather than fixed quantities meaning the central banks would create as much money out of nothing as necessary to stabilize bond yields.

To recap– the central bank had to intervene to avoid a domino effect because if pensions were forced to sell bonds, it would lead to bond prices crashing which would force even more bond sales.

But why did bond prices crash in the first place? Because investors were concerned about the UK government not being able to make good on its debts.

The elephant in the room here is that when a government devalues its currency, it’s just a roundabout way of not making good on its debts driving inflation with yield curve control. This will make debt, denominated in British Pounds, further hurting the bond market. Damned if you do, damned if you don’t.

But, will yield control curve really devalue the currency? Historical evidence says it will. Japan started a yield curve control program in 2010, and since then the value of the Yen has been cut in half.

Where does the madness end?

The UK has no easy way out of this crisis. For now, it appears the “least bad” option is to continue devaluing the GBP.

Meanwhile, precious metal dealers in London are running out of bullion.

The dollar is surging as investors move money from British pounds to dollar-denominated bonds, but a surging dollar is also likely to cause more geopolitical instability. This is because many countries hold dollar-denominated debt, so a stronger dollar makes servicing this debt more expensive.

Third-world countries will be especially hard hit which may fuel more civil unrest, coups, and illegal immigration.

There are fundamental imbalances and injustices in the system, so the only realistic way out of this mess is a return to sound money. Money is too important to leave in the hands of potentially corrupt governments. This is why SilverToken is helping move toward a world where currencies are governed by competition in the free market. Click here to learn more about how SilverToken can help protect your wealth and build a more stable financial system.