Peter Coy - Britain’s Troubles Are Teaching Us Something About Financial Markets
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Could what’s happening economically in Britain happen in the United States? At the moment the question seems ridiculous; the nations are going in opposite directions. Global investors’ confidence in the United States has pushed up the value of the dollar, while their lack of confidence in Britain has pushed down the pound.
But that could change. On Thursday, the day Prime Minister Liz Truss announced her resignation, I spoke with Brad Setser, a senior fellow at the Council on Foreign Relations who is an expert on global trade and capital flows. He said Britain’s crisis “is a reminder that even advanced economies cannot count on unlimited access to foreign financing.”
Claudia Sahm, a former Federal Reserve economist, told the news website Semafor that Britain “is the canary in the coal mine.” She added, “The United States is getting a heads-up from the U.K. that policymakers who make unforced errors are being punished by markets.” A failure by Congress to raise the debt ceiling would be the kind of unforced error she’s talking about.
True, it’s hard to imagine a dollar crash at the moment. Britain’s lesson “obviously doesn’t apply to the U.S. right now,” Setser told me. “If anything, there’s too much confidence in the dollar and the dollar’s too strong.”
But Britain and the United States are in similar situations in some ways, he said. If you look across the highly industrialized democracies known as the Group of 7, they are the only two nations that have big, chronic deficits in both their government budgets and their current accounts (the current account is the broadest measure of trade in goods and services as well as investment income and transfers).
Both of those statistics signify a need for money to keep flowing in. Britain’s crisis is “the first recent case where an advanced economy with its own currency arguably ran into trouble raising both the fiscal financing it needed and the external financing it needed,” Setser said.
“For the first time in several years there was a plausible argument that Britain was losing the confidence of its external creditors,” added Setser, who has served as a senior adviser at the Office of the United States Trade Representative and a deputy assistant secretary for international economic analysis in the Treasury Department.
Let’s compare the two nations. Britain’s net government borrowing this year will be about 4.3 percent of its gross domestic product, just a little more than the corresponding figure of 4.0 percent for the United States, according to estimates in the International Monetary Fund’s World Economic Outlook. Britain’s current account deficit this year will be about 4.8 percent of G.D.P. versus 3.9 percent for the United States, the I.M.F. estimates.
Among the Group of 7, France, Italy and Japan are likely to have even bigger government budget deficits, but no members of the group will have deficits on their current accounts as big as those that Britain and the United States are likely to have.
If the nations are so similar economically, why has one’s currency strengthened while the other’s has weakened? One reason is that the United States, for all its problems, is at the moment more politically stable than Britain, which will soon have its third prime minister in eight weeks. Truss lost investors’ confidence when she attempted to push through big tax cuts while shielding Britons from high energy prices at enormous cost.
Britain will continue to face financial challenges no matter who replaces Truss, Michael Hart, the chief economist of City of London Investment Management Company, told me on Thursday. The awareness of those challenges kept bond investors from getting too exuberant over Truss’s resignation, he said, adding, “The long-term outlook remains uncertain.”
The United States also has long-term financial challenges, but its currency tends to strengthen whenever there’s a crisis — even when the crisis originates mainly in the United States, as it did in 2007 and 2008. That’s because the United States is still perceived as a fundamentally stable nation and because dollars are widely used around the world, even in transactions that don’t involve Americans as either buyers or sellers.
The dollar’s strength also creates problems, as I’ll discuss soon in another newsletter. It makes American exports more expensive and imports cheaper, which worsens the current account deficit. In other words, it makes a chronic problem even worse. But at least U.S. authorities don’t have to worry that global investors will run away at the first sign of trouble.
For now, anyway. Britain’s troubles make clear that the financial markets have enormous influence over governments. In 1983 the economist Edward Yardeni called bond investors “vigilantes,” a term that stuck. The vigilantes are in hot pursuit of Britain and leaving the United States alone, but they could fix their gaze on America one day.
“Markets are calling the shots right now,” Geoffrey Yu, a senior foreign-exchange strategist at Bank of New York Mellon,” told Bloomberg, referring to the mess in Britain. “That’s the bottom line.”
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Quote of the Day
“Finance can only be understood as a gambling game, and gambling games can only be understood as a form of finance.”
— Aaron Brown, “The Poker Face of Wall Street” (2006)
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Peter Coy has covered business for nearly 40 years. Follow him on Twitter @petercoy
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