The velocity of money tends to decline in highly indebted economies.
The UK is currently one of those places that tried to use debt financing to restimulate economic growth. Instead, all they got was burnt toast, and you can’t unburn toast once it’s burnt.
Let’s step through a chronology of what has happened in the past two weeks in the UK and break down why this could have a cascade effect into global financial markets.
The UK has suffered a number of significant economic shocks. It started with Brexit and the flight of European headquarters to other parts of continental Europe. Then came the pandemic, then the supply chain disruptions, followed by a worker shortage, a food shortage, and now an energy shortage. It’s clear that despite very high price inflation, the UK is in economic contraction. Normally in a recession, the government wants to stimulate economic growth. But wait, stimulative policies can be inflationary and we already have too much inflation.
The government of Liz Truss proposed a series of stimulative tax cuts on the 23rd of September. After the financial markets reacted negatively to the announcement resulting in a drop in the value of the British pound, and an increase in the yield on the sovereign debt called the gilt. The finance minister doubled down on the announcement and the prime minister went on national TV on over the weekend to say that the government would not change course on the tax cuts.
The 180 degree about face came the very next day.
The volatility in the bond market is truly unprecedented in the UK and is on par with the volatility we saw in the US in 2008.
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Host: Victor Menasce
email: podcast@victorjm.com
