The British Pound Is In Freefall. Here’s What It Means For Investors.

Key takeaways

• The British Pound has hit its lowest level against the U.S. dollar ever
• It comes off the back of a raft of major tax cats announced by new Prime Minister Liz Truss, in a classic case of ‘trickle-down economics’
• Markets are spooked by the potential outcome of policies and the bond market has reacted strongly
• As always, it presents opportunities for investors who may be able to benefit from the resulting volatility

The British pound has fallen to its lowest value ever against the U.S. dollar ever. It came off the back of new Prime Minister Liz Truss unveiling a raft of tax cuts and investment incentives with the aim to kick start the sputtering British economy.

The nature of the cuts mean that the most wealthy are likely to benefit the most, in a classic case of the theory ‘trickle down economics’ being put into action.

After previous Prime Minister Boris Johnson was voted out of office by a vote of no confidence from his own party, Truss came out ahead as new leader of the right wing Conservative Party, ahead of previous Chancellor (the top dog of the UK government budget and finance department), Rishi Sunak.

Sunak had painted a pessimistic picture for party voters and had cautioned strongly against the measure that Liz Truss was proposing. In the end, party members elected to go with the growth focused policies of the new Truss government, and so far it looks like it’s coming back to bite them.

So what exactly has happened to the British pound, what has caused it and what does that mean for US investors?

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What’s happened to the pound?

The pound has rebounded slightly throughout trading on Monday but in early hours trading in Asia hit an all time low of $1.0327. The foreign exchange market operates 24 hours a day globally, with traders and speculators able to make currency moves at various exchanges around the world.

At the time of writing on Monday the pound was hovering at around $1.08 and is slowly gaining ground throughout the day.

At one point the currency fell nearly 5% and even after this recovery is still down around 7% over the past two days. The moves have been so drastic that there have been rumors that the Bank of England (the British version of the Fed), may need to step in with an emergency rate hike some are suggesting could be as high as 2.00 percentage points.

This would take the UK’s base rate to 4.25%, and yields this high would make the Pound denominated debt and other investments much more attractive. This would likely stabilize the value of the currency but would also cause havoc for businesses and individuals, who would see the cost of debt skyrocket overnight.

It would come at a time when the UK, like most of the world, is dealing with record high energy prices and general rampant inflation.

What are are Liz Truss’s new plans

Once a year the UK Chancellor outlines the budget for the next 12 months. The announcement generally contains details such as proposed changes to the tax system, new government initiatives and alterations to the welfare and social care system.

With Liz Truss taking over as PM part way through the fiscal year, last Friday saw her Chancellor Kwasi Kwarteng announce what was being described in the lead up as a ‘mini budget’.

It was anything but mini.

The changes to the tax system were some of the biggest seen in decades, with the highest marginal rate of tax being scrapped completely, recent increases in levies for health and social care being wound back, reductions in tax on property sales and proposed hikes to corporations tax being undone as well.

But it didn’t stop there. Truss also announced the removal of a cap on bankers bonuses, tightening of legislation designed to squeeze unions and the scrapping of the proposed increase on alcohol tax.

Overall it was billions of pounds in tax cuts that appear to provide the greatest benefit to the wealthiest in the UK. It’s a classic example of trickle down economics, which is also known as supply-side economics.

Truss is by no means the first politician to implement such a plan, with many leaders across the world strong believers in the ideology. Some notable examples in the US include the Reagan and Bush tax cuts.

How is trickle down economics supposed to work?

The idea behind it is that tax cuts to corporations and the wealthy will eventually ‘trickle down’ to the rest of society.

The highest rate of income tax in the UK has just been cut from 45% down to 40% by these new reforms. This means that individuals earning over £150,000 (U.S. $162,611 at time of writing) will save in the region of £10,000 (U.S. $10,861) as a result of the change.

An individual with an income of £1m (U.S. $1.086m) will see an extra £55,000 (U.S. $59,708) in their back pocket.

The theory is that these people will then have more cash to spend. This could mean more vacations, upgrades to the car, more dinners out or new home renovations. This increased spending could then serve to boost the economy, because it would mean increased revenue for businesses.

With increased revenue and demand, businesses will need to hire more staff, which improves the labor market and begins to lift wages.

Because higher earners are likely to see this extra income as ‘free money’ they are more likely to spend it. They already have all of their basic needs met through their regular income, and therefore it’s less likely to be dropped into a bank account or into a retirement investment.

So does it work?

That’s the million dollar question. As with most theories of economics, there’s no definitive answer. Economies are vastly complex and have billions of moving parts. You can argue whether it has been successful in the past, but that doesn’t necessarily mean a future implementation of the theory wouldn’t result in a different outcome.

What does a falling British pound mean for investors?

The immediate fallout from these measures is causing some major ripples in the UK. The currency is falling fast which is flowing through to crashing bond prices. But what does that mean for U.S. investors?

Well for a start, any global investment funds are likely to have some exposure to the UK market. These issues could flow to the already struggling eurozone, which means foreign investments could see some greater volatility.

It also highlights some of the challenges facing governments in navigating the high inflation, low growth environment that we find ourselves in right now. The shock that is being felt in the UK could be replicated in the U.S. if similar policy moves were implemented.

Not that we’re likely to see those any time soon. Joe Biden tweeted last Tuesday that he was “sick and tired of trickle-down economics” and that “it has never worked.”

So how should investors navigate the markets right now? We’re seeing increasing problems across the world at the moment. Things aren’t all sunshine and rainbows in the U.S., but they’re actually looking ok compared to much of the rest of the world.

That’s particularly true when you consider how much worse the U.S. stock market has performed compared to other major economies. The S&P 500 is down almost 23% so far this year, while the UK’s FTSE 100 is down just over 6%.

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