Why is the pound falling?

The pound sterling has been falling for a while now, but its value took a deep dive recently. The drop was triggered by a 45-billion pound (about Rs 393 crore) tax cut announcement made by UK's Chancellor of the Exchequer, Kwasi Kwarteng.

What happened: If you have been following the news, everyone abroad seems to be terrified about the recent fall in the value of the euro and the pound (Great Britain Pound), given that both currencies have been falling for more than a year now. 

• One year ago, if you would have paid 1 pound (Rs 87 as of today) at an exchange counter, you could have received $1.35 (Rs 110.58 as of today).
• If you do that today, you will get just $1.07 (Rs 87.61). So, the value of the pound has reduced by $0.28 or Rs 22.68 per pound.   

Now, why is the GBP falling? 

1. Existing issues have gotten worse: The UK has been facing a cost of living crisis since early 2021, which got worse thanks to Putin shutting off gas lines.

As per the UK's House of Commons Library,

• the inflation rate in the UK is 9.9% and at a 30-year high as
• gas prices rose by 95%, and
• electricity prices rose by 54% in a year

As per a report in the World Economic Forum, “A single working adult living in the UK needs to earn at least £293 each week in order to reach the minimum standard of living. This is a 26.8% increase since 2021, when the average adult needed £231 per week.”

2. The new Prime Minister's new economic policy (ie permanent tax cuts) is being criticised: UK's new PM Lizz Truss is expected to stop inflation, increase wage growth, deal with the energy crisis and kickstart the economy.

• Though these issues were present even when Boris Johnson was the PM, the previous ministers only took actions like increasing tax rates and reducing deficits (the difference between government spending and earning is called deficit and the governments usually spend more money than earning it).   

Liz Truss after crashing the economy 3 weeks into the job pic.twitter.com/79oaOas7sS

— Louis Staples (@LouisStaples) September 26, 2022

BUT

Lizz Truss has been reversing the actions of her predecessors and has been taking aggressive actions in the last 3 weeks.

It seems like her plans have not been received well by folks not only in the UK, but also by the International Monetary Fund (IMF). IMF, in fact, has asked Truss to reconsider her 3 main ideas, which look like this: 

• Large tax cuts: Taxes on the highest income-earning rung will go down from 45% to 40%, while those on the lowest tax rung will now pay 19% tax instead of 20%. Also, corporate taxes will be reduced. 
• Abolishing the levy on National Insurance Payments: Employees have historically paid 1.25% of their wages as a levy on insurance payments (along with income tax) which they do not have to pay anymore. 
• A 2,500 pound price cap on energy prices: The government has limited the annual household electricity bill to 2,500 pounds (ie. about Rs 2,18,000) for the year 2021-22, and will reduce the cap to 2,100 pounds (Rs 1,83,500) for the year 2022-23. If energy bills exceed this price guarantee limit, the government will end up bearing the balance cost. 

But won't these steps reduce the cost for normal residents? Why are people complaining about these steps and why is the GBP value going down?

Since Liz Truss became Tory Prime Minister, the UK markets have seen $500Billion wiped out, that means Liz Truss has LOST £1Billion an hour!!!! An hour 😱 Lost £1 Billion!!! pic.twitter.com/vc6xBaHFxR

— ARTIST TAXI DRIVER (@chunkymark) September 28, 2022

Here's why this is a problem: The large tax cuts are expected to cost the government about 45 billion pounds (about Rs 393 crore), whereas the two-year energy price caps will cost the government about 100 to 150 billion pounds (ie Rs 875 to Rs 1313 crore) in the first year alone since the government will have to bear the actual cost of electricity over and above those borne by British households.

• UK's Kwasi Kwarteng announced that the government plans to borrow this amount to fund this expense.
• This led to the Bank of England's Chief Economist to announce that banks would likely have to raise interest rates AGAIN in the future to fund this extra government borrowing and spending (interest rates may go up by 5% by next year so indirectly, this affects all residents who borrow loans, which will in turn increase inflation). 

I asked a Tory Mp to let me know what was happening on the Kwasi Kwarteng call and they replied: “I’m barely listening. Contemplating my next career while trying to fix my mortgage…”

— Anushka Asthana (@AnushkaAsthana) September 27, 2022

Experts have been calling out this policy because this move will mean that Britain takes more debt while not really solving the problem as such. And we all know how stable a country really is when it takes up a debt of this amount.

• This will put Britain in a large interest loop and many investors don't really like where this move seems to be taking them.
• These policies benefit the rich 2-3 times more than the poor, because the rising gas prices cause middle-class folks to cut down on consumption. 
• Since the rich can afford the high energy prices, they are less likely to reduce consumption. 

What is this “we don’t comment on market movements” bollocks from Truss and Kwarteng? You caused it. It affects people - their mortgages, their cost of living, their businesses. So answer for it.

— David Baddiel (@Baddiel) September 27, 2022

Reactions: This has caused investors in the UK to sell off their assets and led the value of the pound to plunge to a low that has not been crossed since 1985.

Something fishy? There are allegations, of course: 

When will @KwasiKwarteng publish details of all his meetings? https://t.co/Gurpo7QO3V

— Chris Bryant (@RhonddaBryant) September 27, 2022